Private Equity E-Book

Harry Cendrowski

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 595

Veröffentlichungsjahr: 2012

Beschreibung

An authoritative guide to understanding the world of private equity (PE) investing, governance structures, and operational assessments of PE portfolio companies An essential text for any business/finance professional's library, Private Equity: History, Governance, and Operations, Second Edition begins by presenting historical information regarding the asset class. This information includes historical fundraising and investment levels, returns, correlation of returns to public market indices, and harvest trends. The text subsequently analyzes PE fund and portfolio company governance structures. It also presents ways to improve existing governance structures of these entities. A specific focus on portfolio company operations, including due diligence assessments, concludes the text. * Seamlessly blends historical information with practical guidance based on risk management and fundamental accounting techniques * Assists the book's professional audience in maximizing returns of their PE investments * Highly conducive to advanced, graduate-level classroom use * Purchase of the text includes access to a website of teaching materials for instructional use Learn more about PE history, governance, and operations with the authoritative guidance found in Private Equity: History, Governance, and Operations, Second Edition.

Leseprobe

Contents

Cover

Series Page

Title Page

Copyright

Preface

Module I: The Private Equity Model and Historical Information

Chapter 1: Introduction to Private Equity

Introduction

What Is Private Equity?

General Terms and Brief Overview

The Limited Partner Agreement and General Partner Incentives

Private Equity Firm Structure and Selected Regulations

Types of Private Equity Investment

The Private Equity Fundraising Process

Recent Fundraising Trends

General Partner Investment Restrictions

Conclusion

Chapter 2: Overview of Historical Trends

Introduction

A Brief History of Private Equity

Private Equity at the Turn of the Century

Venture Capital Investment and Returns by Fund Stage

Venture Capital and Buyout Returns by Fund Size

Secondary Funds

Conclusion

Chapter 3: Trends in Private Equity

Introduction

A Changing Tide

Overall Industry and Fundraising Trends

Selected Regulatory Changes and Proposals

Rise of Strategic Buyers

Conclusion

Chapter 4: Harvesting Private Equity Investments Through Initial Public Offering

Initial Public Offerings

Chapter 5: Legal Considerations in Initial Public Offerings

Introduction

Initial Public Offering

The Sarbanes-Oxley Act and Dodd-Frank Act

Conclusion

Chapter 6: Harvesting Investments Through Mergers and Acquisitions

Introduction

M&A Basics

Types of Takeovers

Reverse Takeovers

The Takeover Process and Financial Adviser Selection

Analyzing Potential Buyers

The Sale Process

The Bidding Process

Reaching an Agreement

Historical M&A Trends

Conclusion

Chapter 7: Legal Considerations in Sale Transactions

Introduction

Sale Transactions

Conclusion

Chapter 8: Intellectual Property and Private Equity

Introduction

Intellectual Property Rights and Remedies

Pre-Acquisition Due Diligence

Creating Intellectual Property Value During Management

Positioning the Exit—Reverse Due Diligence

Module II: Governance Structures in Private Equity

Chapter 9: The Private Equity Governance Model

Introduction

A New Model for Corporate Governance

Conclusion

Chapter 10: Value of Internal Control

Introduction

Introduction to COSO and Internal Control

Components of Internal Control

Control Objectives and Control Components

Internal Control and the Private Equity Firm

Conclusion

Chapter 11: Internal Control Evaluation

Introduction

PCAOB Auditing Standard No. 5

Phase 1: Planning the Audit

Phase 2: Using a Top-Down Approach

Phase 3: Testing Controls

Phase 4: Evaluating Identified Deficiencies

Phase 5: Wrapping Up

Phase 6: Reporting on Internal Controls

Conclusion

Chapter 12: Financial Statement Fraud and the Investment Decision

Introduction

Money Laundering

Categories of Fraud

What Is Fraud?

The Required Elements of Fraud

Financial Statement Attestation

Recommendations

Fraud and Due Diligence Procedures

Conclusion

Chapter 13: Professional Standards

Introduction

Federal Trade Commission

Securities and Exchange Commission

“Private” Equity Going Public

Public Company Accounting Oversight Board Standards

American Institute of Certified Public Accountants Auditing Standards

American Institute of Certified Public Accountants Accounting and Review Standards

Institute of Internal Auditors Standards

Information Systems Audit and Control Association

Conclusion

Module III: Understanding Operations

Chapter 14: Contemporary Business and Competitive Intelligence

Introduction

Contemporary Business Intelligence

Competitive Intelligence and the External Environment

Normalizing Performance

Cost of Capital and the Option to Invest

Developing Unique Intelligence

An Economic View of Quality

Developing Relationships and Navigating Crises

Application to Private Equity

Conclusion

Chapter 15: Organizations as Humans

Introduction

Purpose of the Organization

Genesis

Development and Specialization

Parts of the Whole and Maturation

Environmental Adaptation

Environmental Influence and Interaction

Maturity Creates “The Machine”

Death of the Organization and Rebirth

Strengths and Weaknesses of the Organizations as Humans Metaphor

Conclusion

Chapter 16: Beginning the Lean Transformation

Introduction

Conclusion

Chapter 17: Performing Manufacturing Due Diligence Assessments

Introduction

Performing the Assessment

Operational Data and Cost of Sales

Conclusion

About the Authors

Glossary

Index

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Copyright © 2012 by John Wiley & Sons, Inc. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

First edition published in 2008 by John Wiley & Sons, Inc.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Private equity: history, governance, and operations / Harry Cendrowski... [et al.].—2nd ed.

p. cm.— (Wiley finance series)

Includes index.

ISBN 978-1-118-13850-2 (cloth); ISBN 978-1-118-22542-4 (ebk);

ISBN 978-1-118-23885-1 (ebk); ISBN 978-1-118-26350-1 (ebk)

1. Private equity. I. Cendrowski, Harry.

HG4751.P744 2012

332′.041—dc23

2011052820

Printed in the United States of America

Preface

Shortly after the writing of this book's first edition, the U.S. economy was shaken by a catastrophic economic crisis, the likes of which had not been seen since the Hoover administration. A multitude of factors combined to cause falling stock markets, rising unemployment, and a general angst among the American public, who watched as once-iconic firms faded into history. Lehman Brothers and Bear Stearns were dissolved. Merrill Lynch sold itself to Bank of America for roughly one half of its prior year value. AIG sought billions from the federal government to preserve solvency. Industrial icons General Motors and Chrysler filed for bankruptcy. America's disease soon evolved into a worldwide pandemic, crippling economies that, three years later, are still attempting to regain their footing.

While the American economy was fighting the Great Recession, the Private Equity (PE) landscape was facing its own battle. Returns of PE portfolio companies, including buyout and venture-backed businesses, plummeted as harvest environments became challenging. Many PE investors faced liquidity issues and found themselves over-allocated in alternative investments as the value of their public securities degraded faster than illiquid assets. Investors subsequently moved to reduce PE investments, resulting in some of the leanest fundraising levels seen in recent times.

At the time of this writing, the U.S. economy appears to be on the mend, though European debt default worries continue to make investors skittish. The general environment for PE firms remains challenging and, in some instances, less lucrative than it was prior to the latest economic crisis. Except for a handful of occurrences, the multibillion dollar deals that grabbed headlines in 2006 and 2007 no longer exist. Debt is often less freely available, and acquisition prices are up as strategic buyers look to put some of their estimated $1 trillion in balance sheet cash to work. Investors hoping to quickly recover their 2008–2009 losses may be disappointed by near-term returns.

For comparative purposes and consistency, most chapters within this book contain graphs of annual data through December 31, 2010. While the first half of 2011 appeared promising for PE, European debt market jitters stemmed PE's rebound in the second half of 2011: Deal volume fell by roughly 23 percent in the third quarter of 2011 as compared with the second quarter of 2011, while exits fell by 54 percent over the same time period. Though deal volume and exits decreased, valuations remain aggressive, putting extreme pressure on PE firms to deliver returns.

PE firms have historically made money by leveraging a portfolio company and using its free cash flow to pay down and convert debt to equity over a five- or six-year holding period. In an environment with high acquisition prices and reduced debt availability, this model is not sustainable. We believe operational expertise, ingrained within a PE firm's culture, is necessary to generate high returns in today's environment. While many firms state they possess an operational focus, this focus must permeate the firm's culture and should be reflected in the backgrounds of its partners. An operational focus is likewise essential for venture capital firms. Venture-backed companies that are able to maximize capital efficiency through streamlined operational processes will be more likely to generate high abnormal returns for their parent funds and investors. Though the PE market is challenging, it remains a unique engine of the U.S. and world economies.

PE, including buyouts and venture capital, helps foster ingenuity, creativity, and an entrepreneurial spirit within the communities it reaches. It also provides a mechanism for older companies to reshape themselves into more modern entities. As the United States rebounds from the economic crisis, PE and its numerous forms, including fundless funds, can greatly assist in repairing the economy and the country's spirit: No other organizational form is endowed with a commensurate governance structure that aligns the incentives of all parties, helping achieve results that are optimal for society as well as for investors.

The exposition of PE is the focus of the treatise in your hands. More specifically, its purpose is threefold: to describe the history of PE; to illustrate how governance structures differ between PE portfolio companies and those of public corporations; and finally, to explain how the operations of PE portfolio companies can be improved. Along these lines, the text provides valuable information for numerous audiences: students unaccustomed to PE, PE professionals, and investors should all find valuable information in this book. Chapters have been designed on a standalone basis, although we highly recommend that readers unaccustomed to PE read the initial three chapters of the book before perusing other sections.

The book begins with Module I—The Private Equity Model and Historical Information, a comprehensive introduction to the PE process: The key players, terms of investment, and historical trends are described in detail. In reading these chapters, the PE novice will become accustomed to the terminology used by industry professionals along with the roles played by participants in this asset class.

Harvesting plays a pivotal role in PE investments. In this module we also introduce the reader to the harvesting mechanisms of the initial public offering (IPO) and the sale to a strategic or financial buyer—also known as a merger and acquisition (M&A) deal—as well as legal considerations in both harvest mechanisms and those pertaining to intellectual property.

From there, the book transitions into Module II—Governance Structures in Private Equity, a discussion of the unique governance structures that the PE model imparts on portfolio companies. Applicable professional standards, models of internal control, and contemporary business intelligence are also discussed. Though not all models directly apply to PE, they are expounded as best practices that may be employed by funds and their portfolio companies

The book concludes with Module III—Understanding Operations, which provides information devoted to assessing and improving the operations of portfolio companies. A metaphor for analyzing organizations is introduced in Chapter 15, that of organizations as humans. This philosophical framework provides the reader with a detailed methodology for understanding the complexities of today's organizations. Subsequent chapters discuss the topics of lean manufacturing and operations assessments; they are designed to assist PE professionals in understanding how to perform operations assessments, and also how to improve the manufacturing operations of portfolio companies.

After completing the book, it is our hope that the reader will have gained an understanding of the intricacies within the PE industry as well as an appreciation for the asset class.

Harry Cendrowski Chicago, Illinois January 10, 2012

Module I

The Private Equity Model and Historical Information

Chapter 1

Introduction to Private Equity

Harry Cendrowski

Adam A. Wadecki

Introduction

Private equity (PE), including buyout and venture capital (VC) transactions, is a critical component of modern finance. Since 1980, over $1.1 trillion has been raised by U.S. buyout funds and roughly $700 billion has been raised by VC funds. (See Exhibit 1.1 and Chapter 2 for additional information on fundraising trends.) Eight hundred thirty billion dollars was raised by U.S. buyout funds in the last 10 years alone, while $489 billion was raised by U.S. VC funds over the same time period.

Exhibit 1.1 Historical Venture Capital and Buyout Annual Fundraising Levels, 1980–2010

Source: Thomson's VentureXpert database.

While relatively small levels of PE capital were raised through the early 1980s, PE fundraising levels have experienced considerable growth—and cyclicality—since that time. However, in spite of the large amounts of capital placed in PE, relatively few individuals have even modest knowledge of this central pillar of the contemporary financial system.

This chapter introduces PE, defines frequently used PE terms, provides an overview of the PE model, and describes the PE fundraising and investment processes. It is not comprehensive in nature but, instead, presents an introduction to numerous concepts that are discussed in greater detail in later sections of this book. Newly defined terms are italicized for the reader's convenience.

For comparative purposes, data within this text is generally examined on an annual basis; the latest period of data available prior to this book's publication was the year ending December 31, 2010.

Though many forms of PE exist, this book will largely focus on two types of such investments: buyouts and VC. Other types of PE investments, including mezzanine financing, private investments in public equity (PIPEs), and fund of funds (FoF) investments, will be discussed throughout the work; however, these will not be the primary focus of this text.

What Is Private Equity?

Many definitions of PE exist, though, at the simplest level, PE is a medium or long-term equity investment that is not publicly traded on an exchange. PE includes VC and buyout transactions as well as investments in hedge funds, FoF, PIPEs, distressed debt funds, and other securities. It also includes angel financing or investments in very early stage companies. The focus of this text is VC and buyout transactions, and the funds originating such transactions as these funds manage a majority of PE capital.

The previous definition of PE generally holds, though exceptions exist. PE includes transactions structured with convertible debt; the purchase of publicly traded companies that are subsequently taken private and delisted from an exchange; and illiquid investments in publicly traded companies. However, while a business itself may be publicly traded, a PE fund's investment in such a business is generally not traded.

In the United States, PE investments are themselves not traded on the New York Stock Exchange (NYSE), NASDAQ, or other regional exchanges, though some PE firms, including The Blackstone Group (Blackstone) and Kravis, Roberts & Company (KKR), have gone public in recent years. Without an exchange on which to trade shares, and in the absence of market makers, PE investments are generally illiquid and held for between three and seven years before a liquidity event or harvest occurs. At this time, the PE fund is able to realize gains (or losses) from the sale of the company.

There exist two categories of PE investment: capital placed in funds (fund investing) and capital placed in portfolio companies (direct investing), or companies under direct ownership of an entity. For example, a pension fund rarely invests capital directly in portfolio companies, though some exceptions do exist. Pension fund managers and their staff instead generally focus their efforts on fund investing activities: they place capital with PE funds that act as appointed managers between the pension fund and portfolio company. PE funds, conversely, use their capital to make direct investments in portfolio companies.

General Terms and Brief Overview

To understand the PE arena is to understand the “man behind the curtain” in The Wizard of Oz—many details of the industry are shrouded in secrecy, and firms are often reluctant to divulge details of their funds to outsiders. Nonetheless, once understood, the complexities of the industry largely vanish, and the reader is left with a concrete understanding of the motivations that keep such a well-oiled machine running. The privacy in which the industry operates is essential to its function. Many of the PE transactions involve providing liquidity to family and privately held companies not at all interested in publicity. In the VC segment, many of the investees are technology based and careful guarding of private and proprietary business intelligence and intellectual property is essential until such investees reach critical mass and can lead or sustain novel market positions.