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Private Equity
Overview, Best Practices, and Current Challenges
Mohamed Abdul Hady, CAIA
1

The Private Equity Fund Structure
2

The Fund Cash Flow Profile (J‐Curve)
3

Initial Evaluation: The First Look
Company Industry Financial
• Management team
(bench strength)
• Value proposition and
differentiation
• Business model
economics
• Relationships with
customers and
suppliers
• Organizational model
(e.g., incentive
compensation)
• Competitive dynamics
• Industry size and
growth
• Cyclicality
• Fragmentation vs.
consolidation
• Identification of key
risks
• Comparable company
analysis
• Financial model
(historical and
projected)
• Working capital
• Capital expenditures
• Capital structure and
leverage
• Investment security
• Target returns
• Valuation
5

Valuation: In the Eye of the Beholder
• Discounted Cash Flow analysis
– Incorporates the theory of a Discounted Cash Flow analysis
– Importance of sensitivity/scenario/simulation modeling
– Focus on Free Cash Flow and debt covenants
• Public Company and Transaction Comparable Analysis
– Only as good as the comparability of the companies used
– May need to interpolate between multiple sets of comps
• Value of Assets
– Consider value based on assets rather than cash flow
Valuation is an art not a science
6

Due Diligence: Trust but Verify
• Management
– Background and reference
checks
– In‐depth interviews
– Employment agreements
• Company and Industry
– Speak with industry
experts, customers and
suppliers
– Validate company value
proposition and industry
dynamics
– Quantify possible risks
• Accounting
• Independent accounting
review
• Legal
• Identify any outstanding
litigation and potential
liabilities
• Intellectual property and
patents
• Insurance
• Understand scope of
coverage required and
currently in place
7

Case Study: Financing LBO
$0.0
$20.0
$40.0
$60.0
$80.0
$100.0
Uses
Sources and Uses in a Leverage Buyout
$Millions
Sources
Purchase
Price
$100.0 Million
Fees and
Expenses
$100.0 Million
Senior
Debt
Equity
Subordinated
Debt
Key Terms
• Type of security (preferred
equity or common)
• Pay‐in‐Kind (“PIK”) Coupon
• Term of loan
• Amortization schedule
• Rate
• Covenants
• Often a “bullet” loan
• May ask for warrants
• Often a “bullet” loan
• May ask for warrants
8

Value Creation: Ideas into Action
• Board of Directors representation
– Identify new Directors with relevant experience who
can assist the Company
– Develop a “100 day plan”
• Augmenting the Management Team
– If necessary, recruit new CEO/ CFO
– Identify functional areas to add additional talent
– Incentive key players
• Execution of the growth strategy
– Buy and Build: Add‐on acquisitions
– Accelerating Growth: Investments in new products or
markets
– Transformation: Professionalize operations
9

Operational & Financial Restructuring Issues
Source: INSEAD.
10

Changing Nature of the Superior Return Source
11

Source: Mckinsey ‐ How M&A practitioners enable their success
NOW: Integration (adding value phase) is the KEY
12

Focus of Integrations
Source: Mergermarket / CMS Cameron McKenna, Feb 2007 13

Exits: Realizing the Investment
• Initial Public Offering (“IPO”)
• Sale to strategic buyer (e.g., industry
competitor)
• Sale to another Private Equity Fund (“Financial
buyer”)
• Sale to management (Management buyout or
“MBO”)
• Recapitalization (raise debt and provide a
dividend to the equity sponsors)
14

M&A: The Seven Deadly Sins
15

Key Challenges to Deal making in Volatility
Valuation, Negotiations, and Approval are Most Challenging During Volatility
Author: Ross Katz
17

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