Ian Armitage

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Private Equity
Ian Armitage Chief Executive Mercury Private
Equity
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Dissecting Private Equity

• What is Private Equity?
• Why Should Your Clients Do It?
• Why Should Your Clients Not Do It?
• Investment Routes
• Have new investors missed the boat?

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What is Private Equity?

• Venture Capital
• Leveraged Buy-out (LBO) Business

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Venture Capital
RD
Start-up
Early Stage Expansion
Late Stage Expansion
Pre- flotation
Seed
Risk
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Luminar - Venture Capital
Operator of theme bars
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The LBO Business
Turnaround
Replacement capital
Institutional buy-out
Management buy-in
Management buy-out
__________ Orphan Assets ___________ __ Business
with no Owner Succession __
Seller
No
No
Yes but supplement
Management
Risk
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Dechra - An LBO From Gehe AG
The UKs leading distributary vetenary drugs
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Sources of Capital Risk Profile
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The Case For Private Equity

• Private equity out performs over the long term
• Source WM Company/BVCA Performance Measurement
  Survey

• It is a loosely-correlated asset
• May be able to increase performance without
  materially increasing risk

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1999 Private Equity Returns
per annum 3 years 5 years 10 years Private
Equity 31.1 27.2 20.0 FTSE All-Share 20.4 20
.3 14.9 FTSE 100 22.2 21.8 15.6 FTSE
SmallCap 15.5 15.6 10.8
median return
Source BVCA WM Company
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1999 Private Equity Returns
per annum 3 years 5 years 10 years Total 31.1
27.2 20.0 Early Stage 15.8 16.6 8.7 Expansion
Capital 30.3 26.9 12.6 Mid MBOs
19.9 22.1 17.3 Large MBOs 31.0 26.4
22.9
Source BVCA WM Company
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The Case Against Private Equity

• High Risk
• Low Liquidity

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Risk

• Single company risk Leveraged
  Young Moderate to high Smaller

10 Year Record Loss Ratio 7 Returns 46.8 pa

• Portfolio risk Low

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Liquidity
50
0
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Liquidity

• Self-liquidating
• Growing secondary market

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Other Issues

• MFR
• Valuations

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Private Equity

• All UK pension funds should consider an
  allocation to private equity

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How do you invest in private equity?

• Direct
• Private Equity Manager
• Fund of Funds
• Quoted Investment Trust

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How do you select a manager

• In the normal way
• People
• Performance
• Processes
• Philosophy/Strategy

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Have Investors Missed The Boat?
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Europe Is Restructuring
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PII Group
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E-Commerce
New Channel
Fulfilment
Infrastructure
Dot.com
Bricks and mortar. Suppliers of equipment,
software, services etc to Dot.com businesses.
Classic internetcompany -usuallyretail or
portals.
Clicks and mortar. New secondary on-line
revenue streams.
Bricks and mortar. Outsourced back office
(e.g. logistics) of Dot.com businesses.
Tesco, Dell, Clinphone MapQuest.com, 1-800
Batteries, Trados Global People Network
Bertrams Irish Express Cargo Braitrim Wincanton
Amazon.com QXL.com Freeserve
IBM CISCO BT, Vitria Agora
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Bertram Group
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Private Equity

• Long-term out-performance
• Risk liquidity concerns are overplayed
• Use to increase returns without materially
  affecting risk
• Expert funders of change at a time of
  restructuring

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Appendices

• Definition of Terms
• Investment Return
• Detailed Schematic of MPE Investment Process
• MPE Organisation Structure
• Extract from MPE Business Planning Process

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Appendices - Definition of Terms

• Venture Capital
• Early Stage (Seed to Start-up) Capital for
  businesses in the conceptual stage or where
  products are not developed and revenues and/or
  profits may not have been achieved
• Expansion Late Stage (First stage to
  Mezzanine) Growth or expansion capital for
  mature businesses in need of product extension
  and/or market expansion. Sometimes referred to
  as development capital
• Buy-out Capital Equity capital for acquisition
  or refinancing of a larger company
• Restructuring Capital New equity capital for
  financially/operationally distressed companies
• Mezzanine (/subordinated) debt
• Intermediate debt capital between equity and
  senior debt for acquisition or refinancing
  transactions
• The debtholder participates in equity
  appreciation through conversation features such
  as rights, warrants or options
• Carried Interest (carry) This represents the
  share of a private equity funds profit that will
  accrue to the general partners
• Fund of funds Private equity funds whose
  principal activity consists of investing in other
  private equity funds. Investors in fund of funds
  can thereby increase their level of
  diversification
• General Partner (GP) /Sponsor Managing partner
  of a Limited Partnership, who is responsible for
  the operations of the partnership and, ultimately
  any debts taken on by the partnership
• Hurdle Rate (or Preferred Return) A hurdle
  return allows investors to get preferential
  access to the profits of the partnership. In
  absence of reaching the hurdle return, the
  general partners will not receive a share of the
  profits

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Appendices - Investment Return
Private equity investment return in a partnership
typically follows a J-curve e.g. in the early
years while investments are being made a Private
Equity fund will show negative returns.
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Appendices - Detailed schematic of MPE Investment
Process PII

• Growth buy-out 105m
• Support Services Sector
• Deal introduced by primary contact
• Initial Appraisal Market and technology leader,
• under managed, requiring
• first class CEO
• Conversion British Gas wanted
• speedy and comprehensive
• response - certainty
• Diligence 3 month exercise key issues were
• long term contracts, intellectual property and
  R D
• Negotiation
• Structure Transneft contract

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Appendices - MPE Organisation Structure
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Appendices - MPE Business Planning Process
Process The investment process is different to
that employed by public security investors. The
best is data driven, disciplined and designed to
minimise judgement calls with the intent to add
value. Here is the MPE process
Deals do not flow Requires consistent marketing
Normal disciplines Get the first call
Key skill Decision to allocate resource Win
confidence of counterparties
An important skill. Not all value items
measured in S agreement
Legal completion output is Shareholders Employ
ment contracts Banking documents Sale
Purchase agreement Warranties
Indemnities Other contracts e.g. supply
contracts Management incentives
Complete through strategy review and business
plan
Identify and effect improvements in operations
Detailed exercise for exit, c.2 years ahead of
time
Either float, trade sale or recapitalisation
Combine internal resources People Accounting
system controls Market position dynamics Tech
nology Facilities Environmental Insurance Lega
l