MODULE 3

PRIVATE EQUITY
AND VENTURE
CAPITAL
By Professor Stefano Caselli
Università Bocconi and SDA Bocconi
Content 1
1.  The Managerial Process for Equity Funds
2.  Fundraising
3.  Investing: The Decision Making Phase
4.  Investing: The Deal Making Phase
5.  Managing and Monitoring: Supporting the Company
6.  Managing and Monitoring: Covenants Usage
7.  Exiting
8.  Private Equity Advice for Entrepreneurs – Interview with Fabio Sattin
 1
Introduction
In the previous week we saw:

§  The different formats in which an investor can invest in PE

§  The different regulations and fiscal frameworks for the players involved in the
PE activity

This week is concentrated on the management of private equity and venture capital
funds.
After an overview of the managerial process of an investor we will, in detail, see the
four different steps of this process.

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 1
The Managerial Process
Equity investments can be developed through different vehicles and each operate
with a different legal entity, even if the most popular are limited partnerships,
investment firms and closed-end funds.
Even if vehicles are different, managerial practices and typical phases of activity are
very similar.
As a matter of fact, the functioning is based
on two different players: Managers and
investors.

For this reason, it is important to understand the different aspects of the Managerial
Process of private equity.

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 1
The Managerial Process
The managerial process is the day-by-day activity of the managers managing the
investment made by the investors.
When highlighting the characteristics of the managerial process, both academia and
practitioners consider this process as made up of four steps:

1)  Fundraising
2)  Investment activity
3)  Managing and Monitoring
4)  Exiting

For each phase there is also a different contribution coming from the management
themselves, the advisory and the board of directors.

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 1
Fundraising
This first activity of fundraising is included in the managerial process even if this activity
starts before the vehicle is launched.
The fund-raising activity is devoted to promote the business idea of the new vehicle of
equity in order to find money.
It is in fact a very preliminary activity (Note: remember that in Closed-End Funds this
activity occurs before time 0?) occurring before the actual starting of the investment. In
the case of the Closed-End Funds this takes 1.5 years, whereas for VCF this phase takes 1
year.
If managers are able to collect the whole investment and they are able in this way to get
to time 0, the legal entity starts its activities and then the other three activities
(investment, managing and monitoring, and exiting) start.

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 1
Investing, Managing & Monitoring, Exiting
When the fundraising phase comes to an end, the other three phases start.
In the ordinary activity the managers have to decide the investment policies and the
investment target; at the same time they manage and monitor the company in which
the investment is made; and, at the same time, they have the exiting issue; that is
they have to understand when (and if) they will be able to exit.

The exiting moment is in the end the

reason why managers do PE activities.

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 1
Investing
Investing is the mission of the equity investment vehicle to create value for the
investor through the scouting, the screening, the choice, the managing and the
exiting of ventures.
From when they decide to invest, managers have two problems: on the one hand,
they have to valuate the company in which they invest; and on the other hand, when
managers and GPs decide to invest they have to negotiate the mechanisms
supporting their management of the company. If the decision of the investment is
made, the managerial process enters another phase: The management and
monitoring phase.

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 1
Managing & Monitoring
Managing and monitoring activities concern the involvement of the vehicle in the
selected ventures. These two activities have to ensure the creation of value and to
control the opportunities for the financed venture.
When in this phase, the PE is a shareholder because the PE decided to invest in the
VBC.
The managers have to support and sustain the company in the ordinary activity.
For the managing and monitoring to be successful, the last phase has to come.

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 1
Exiting
Exiting concerns the decision to sell the equity owned in the portfolio in order to
have a gain. This single decision has to be planned with a broad portfolio vision.
For this to happen, the PE has to identify another shareholder to which they sell
their stake of the company. Because the liquidity is very low, finding a counterpart is
not easy.
This is the most important phase, because it is only with the exiting that the PE is
able to exit the investment and generate a capital gain (i.e. an IRR for the PE
investor).

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Content 2
1.  The Managerial Process for Equity Funds

2.  Fundraising
3.  Investing: The Decision Making Phase
4.  Investing: The Deal Making Phase
5.  Managing and Monitoring: Supporting the Company
6.  Managing and Monitoring: Covenants Usage
7.  Exiting
8.  Private Equity Advice for Entrepreneurs – Interview with Fabio Sattin
 2
Introduction
This clip focuses on one specific step of the managerial process: The fundraising
phase.

This phase occurs before time 0, since it is the phase in which the PE firm has to
gather the investors that want to invest in the funds.

This is a very hard phase for the PE. The managers have to convince the investors of
their idea: as a matter of fact, the investors will remain in that project for a very
long time (think of a Closed-end fund whose length is ten years).

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 2
Fundraising Steps
In the fundraising phase the management company has to sell the proposal launched
to the market.
The proposal is basically a business idea that leads to the creation of a vehicle to
invest in private equity to produce value that will be spread among the promoters-
managers and the investors.
Fundraising is a selling game in which reputation, mutual trust, and love for risk are
the pillars.
As a matter of fact, the success of the fundraising phase depends on the reputation
of the management company: The better it is, the easier this phase becomes.

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 2
Fundraising Steps II
The typical fundraising activity steps are as follows:

1.  Business Idea Creation

2.  Job Selling
3.  Raising Debt
4.  Closing

Of course, depending on the country and on legal framework, these activities can be
partially or totally driven by law.

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Business Idea Generation Job Selling Raising Debt Closing 2
1. Business Idea Creation
Business idea creation is aimed at producing an information memorandum to be
promoted in the market.
Before an information memorandum is produced “testing the waters” occurs. This
phase is carried on in a very informal way among the professional network of the PE
firm to assess, for instance, whether it makes sense for PE investors to invest in a
specific cluster of PE or not.
After the managers have received an informal consensus about their activity, a more
formal part begins and the information memorandum is produced.
The information memorandum has to explain the rationale of the business idea to the
business community (and to the supervisors, in case the fundraising occurs in Europe)
and has to appeal to the potential audience of investors.
The success of the involvement of an investor into the business idea is strictly linked to
the reputation and to the track record of the promoter.

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Business Idea Generation Job Selling Raising Debt Closing 2
1. Business Idea Creation II
The typical content of an information memorandum is as follows:
•  Choice of the vehicle
•  Target to invest (countries, sectors, life cycle stages)
•  Size of the vehicle and minimum amount at which the fund will be closed
•  Corporate governance rules (i.e. relationship between promoters-managers and
investors)
•  Size and policy of investments
•  Internal code of activity / LPA
•  Track record of the promoters-managers
•  Usage and size of leverage (in the case of a non-European fund)
•  Costs

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Business Idea Generation Job Selling
1. Business Idea Creation III
When this step comes to an end, there are two options depending on the countries in
which a PE firm operates.
If the PE firm operates in
Europe, the PE must
obtain the formal
approval from the
Supervisor and
afterwards, the
information memorandum
is transformed into an
internal code of activity.
Raising Debt Closing 2
In the US and in the UK,
the PE firm does not have
to obtain any approval,
rather the information
memorandum can be
transformed in the LPA
since it is a contract.
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Business Idea Generation Job Selling Raising Debt Closing 2
2. Job Selling
Job selling is the phase in which the managers have to convince the investors not
only to give an opinion about the idea, but also to invest in that idea. This is
actualized by the letter of commitment with which the investors declare how they
want to participate in the fund.
This phase often occurs via one-to-one meetings between the promoters and the
potential counterparts (may it be an insurance company, a bank or a high net worth
individual). In some other cases, this phase may be organized in a kind of meeting,
in which more than one investor is involved.

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Business Idea Generation Job Selling Raising Debt Closing 2
3. Debt Raising

This phase only occurs if the fund is based either in the UK or in the US.

Debt raising is job selling too, but with a different perspective in which the goal is to
sell a project to a community of financers.
Debt raising is strongly related to the reputation both of the promoter and of the
investors (good signaling effect). In fact this step is difficult for each counterpart
(the investors and the banks) because no one wants to make the first move.

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Business Idea Generation Job Selling Raising Debt Closing 2
4. Closing
After all the steps are concluded, whether the fund is located in the English-
speaking countries or in Europe, the closing phase starts.
The closing phase can be meant in two ways:

§  A “successful” closing occurs when the PE firm is able to collect all the money
necessary to begin the PE activity and this was possible thanks both to the
reputation and to the purpose of the initiative
§  A “pure” closing occurs when the PE firm is not able to collect the whole money
in the fundraising phase. Such is the case when the managers do not have a very
robust network.

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Content 3
1.  The Managerial Process for Equity Funds
2.  Fundraising

3.  Investing: The Decision Making Phase

4.  Investing: The Deal Making Phase
5.  Managing and Monitoring: Supporting the Company
6.  Managing and Monitoring: Covenants Usage
7.  Exiting
8.  Private Equity Advice for Entrepreneurs – Interview with Fabio Sattin
 3
Introduction
This clip and the following focuses on another step of the managerial process: The
investing phase.
After the money has been collected by the PE firm, the phase of investing activity
can start.
The investing activity is the core of private equity business and it is the main way to
develop the business idea for the managers on the investors’ behalf.

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 3
Investing
Investing is a very broad definition, in which we can distinguish two different
important moments:

1.  Decision-Making: the activity of valuation and selection in which the PE has to
assess whether the investing activity makes sense.
2.  Deal-Making: the activity of negotiation of the contracts by which the PE firm
can invest and actively participate in the company. These contracts include, for
instance, the calculation of the shares the investor has to buy, the corporate
governance rules…

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 Decision Making Deal Making 3
Decision Making
Decision making is the capability to understand the market and to pick up the right
opportunities.
This activity is made up of different steps:
Origination
Screening
As the process goes on, and the PE goes
Valuation and due diligence towards the decision to invest, both
Rating assignment costs and commitment of the PE firm
increase.
Negotiation
Decision to invest

The decision making process involves all of the players: the management company,
the technical committee, and an advisory company. This path is sequential and the
PE needs a green light in every step to move on to the next step.

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 Decision Making Deal Making 3
Origination
In this phase the PE must decide the destination of the money collected.
It is based on two different drivers: some part of the origination is spontaneous, as
you are a PE investor and the whole system knows that you have collected so much
money and that you are looking for a company in which to invest. This is why, the PE
firm has to screen a considerable amount of incoming proposal.
On the other hand, origination is based on a proactive activity. This means that the
managers have to scout the market and find the most suitable solution. This can be
done through the other players (the technical committee and the advisory board)
who can also help and scout the market.

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 Decision Making Deal Making 3
Screening
After the origination step, the screening step starts. In this phase about 90% of the
dossiers collected in the origination step will be eliminated (note: remember the
100/10/1 rule in startups?).
The screening is driven by the managers together with the technical committee. The
output of the screening is a very small number of dossiers which the PE firm can
further investigate and study deeply.

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 Decision Making Deal Making 3
Due Diligence and Valuation
This phase is the analysis of the business plan which starts right after the screening
phase; since it takes a very long time if done right, the PE should do it only for a
very narrow number of companies.
This phase is dedicated to exclude the proposals that do not make sense for an
investor.
The outcome of due diligence is a small number of proposals which it makes sense to
undertake the rating assignment for.

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 Decision Making Deal Making 3
Rating Assignment
In this phase the PE rates and grades the dossiers of the different companies. This is
fundamental to assess the level of risk and is important to understand if (and how)
the PE firm has to collect funds through debt.
For instance, assessing the level of riskiness and of indebtedness during an LBO in
which an SPV has to be financed using debt is of primary importance. If the level of
risk is too high after the rating assessment the deal can not be taken further.

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 Decision Making Deal Making 3
Negotiation
Negotiation is not based on the deal design, but it is the negotiation with the
entrepreneur to calculate the numbers of shares a PE owns and the stake to which
they correspond in terms of equity. In this phase the PE understands if there is room
for an external shareholder.

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 Decision Making Deal Making 3
Decision to Invest
The managers (the GPs or the directors in an AMC in Europe) have to convince the
whole Board of the PE firm if it is worth to invest in that specific company.

The decision of investing does not mean to invest

immediately in the company, rather it sets the beginning
of the second part of the investing phase: Deal making.

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Content 4
1.  The Managerial Process for Equity Funds
2.  Fundraising
3.  Investing: The Decision Making Phase

4.  Investing: The Deal Making Phase

5.  Managing and Monitoring: Supporting the Company
6.  Managing and Monitoring: Covenants Usage
7.  Exiting
8.  Private Equity Advice for Entrepreneurs – Interview with Fabio Sattin
 4
Introduction
This clip deals with the second part of the investing phase: Deal making.

In the first part of the investing phase, the managers of the PE firm decided to
invest after the green light of the Board of the AMC or by the GPs.

This second part concerns the deal making activity related to the financial and legal
issues related to the investment in the venture-backed company.

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 4
Deal Making
Deal making means setting up the contracts between the investors and the company
in which they find the right balance between the need of money of the company and
the expectation of IRR and capital gain for the PE investors.

Finding the right balance is not easy and the

whole process is based on three pillars:
1.  Targeting
2.  Liability profile
3.  Engagement

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 Targeting Liability Profile Engagement 4
Deal Making
Vehicle
Targeting
Amount of Shares

Contract Syndication
Designing & Liability Strategy
Techniques of Profile
Debt Issuance
Financing

Categories of
Shares

Engagement Paying Policy

Governance Rules

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 Targeting Liability Profile Engagement 4
Targeting
Targeting is based on two decisions that must be negotiated
with the company.
1.  The vehicle in which the PE firm invests
2.  The percentage of shares the PE gets

1. The Vehicle
This is the valuation of either a direct investment or in an indirect investment (with
the SPV).
The rationales of a direct investment may be among others: the business is totally
interesting for the investor; the control is complete; the commitment between
investor and company is high and exclusive.
The rationales of a SPV creation may be among others: the investor pays only the
relevant assets; the investment is tailor-made on the business plan. Remember that
this entails the use of leverage, therefore the PE firm has to convince the banking
system too.
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 Targeting Liability Profile Engagement 4
Targeting
2. The Amount of Shares
This negotiation follows the decision taken in the previous
step (i.e. the PE firm decided the vehicle through which it
will make its investment).

This step concerns the decision of the percentage of shares the PE has to buy and
the role it will have within the company equity. There are some key points to be
addressed:
•  Majority versus minority
•  Relative and absolute size of investment
•  Capital requirement impact
•  Voting rights and effective influence within the board of directors

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 Targeting Liability Profile Engagement 4
Liability Profile
The liability profile, as the name itself suggests, involves
the decision concerning the liability side of the company.
Again, there are two decisions a PE firm needs to make…

First choice: The Syndication Strategy

It concerns the decision to find other equity investors with whom build a syndicate
to invest together. At first sight, this decision may sound unfair due to the huge
amount of time the PE firm dedicated to the screening and to get to the final
decision.
Actually, this may be helpful to multiply the investment power and in this way, they
could share the risk borne otherwise only by the PE firm.

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 Targeting Liability Profile Engagement 4
Liability Profile
Second choice: Debt Issuance
It concerns the decision to combine equity investment
(with or without SPV, syndicated or not) with the usage of
leverage, this entails a very hands-on approach towards the
venture-backed company.

This decision is related to the debts of the venture-backed company whether they be
issued with bonds or obtained through loans and mortgages. In the latter case, this
means that the PE firm will have to negotiate with the banking system.

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 Targeting Liability Profile Engagement 4
Engagement
The third pillar of deal making concerns the engagement: in
this moment the PE firm has to set up the rules by which a
PE can govern the venture-backed company. This pillar is
made up of three activities.
Categories of Shares
It concerns the choice of the shares the PE has to buy in order to guarantee the best
way to develop the investment and the following managing phase. Typical choices
concerns:
•  Common shares
•  Shares with limited or increased rights
•  Shares with embedded option: for instance a share with a put option allowing the
PE to sell the shares under some particular circumstances
•  Tracking stocks
This decision has to be coordinated with the different classes of debt in case of
leverage.
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 Targeting Liability Profile Engagement 4
Engagement
Paying Policy
This concerns the questions a PE firm needs to address
related to the fact that a PEI is buying another company’s
shares.

The most important questions that need to be answered in this step are:
•  Does the PEI need to buy new shares or can it buy also pre-existing shares?
•  What’s the expectation of the entrepreneur? (to gain money or to have support)
•  What’s the relationship between the PEI and the existing shareholders?

The main activity of a PEI is to finance a company. In

some cases if the entrepreneur is important, or in case
he or she has a very strong contractual power, the PEI
may have to buy some of the entrepreneur’ s shares as
well.

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 Targeting Liability Profile Engagement 4
Engagement
Governance Rules
It is the negotiation of the functioning of the board to
ensure the capability of the PE to interact the company in
the best way as possible.

Some among the most discussed issues in this activity are:

•  Numbers of directors
•  Can the PEI sitting on the board of directors
•  The scheduling of the board meetings

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Content 5
1.  The Managerial Process for Equity Funds
2.  Fundraising
3.  Investing: The Decision Making Phase
4.  Investing: The Deal Making Phase

5.  Managing and Monitoring: Supporting the

Company
6.  Managing and Monitoring: Covenants Usage
7.  Exiting
8.  Private Equity Advice for Entrepreneurs – Interview with Fabio Sattin
 5
Introduction
This clip deals with the third part of the managerial process: Managing and
monitoring.

The PE company is one of the shareholders and at this moment the investor has a
conjoint aim: they want to enhance the value of the company as much as possible
and at the same time they want to find another buyer in order to exit and get their
capital gain.

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 5
Managing and Monitoring

Actions to create and to

measure value

Mitigate divergences of opinions

Managing & Monitoring and avoid conflicts between the PE
and the entrepreneur

Rules to protect the created

value

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Actions to create value Rules to protect value 5
Actions to Create Value
Typically the actions taken are dedicated to qualify the presence of the investor
within the managerial process of the venture backed company.

The nature of this presence depends on:

§  The stage of the investment
§  The style of the investor and the nature of the investment agreement

In the first case, if we consider the stages of investment moving from the seed to
the replacement financing, the involvement of the investor is decreasing (even if in
the vulture case the involvement is equal to the one in seed financing). Both in seed
and start up, the involvement could be even industrial and strategic, while in
expansion and replacement the support coming from the investor could be reduced
simply to advisory within financial and legal issues.

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Actions to create value Rules to protect value 5
Actions to Create Value II
Concerning the style of the investor and the nature of the agreement signed
between the venture capitalist and the venture backed company, it is generally
characterized by two different profiles:
§  The hands-on approach
§  And the hands-off approach

Hands-on stands for a deep involvement both in corporate governance and in

financial and strategic decisions; hands-off stands for a presence in the corporate
governance and involvement only in financial decisions.

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Actions to create value Rules to protect value 5
Actions to Create Value III
Regardless of the stage of life and the involvement of the PE firm, the key activities
that a PEI takes in order to create value are:
•  Board services
•  Performance evaluations and reviews
•  Recruitment management
•  Assistance with external relationships
•  Helping to arrange additional financing
•  Mentoring

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Actions to create value Rules to protect value 5
Actions to Create Value IV
Active participation in the life of the company with the provision of the proper corporate
governance. Creation of value means to support decisions, introduce professional expertise,
Board Services and impose a severe discipline. There is only one case in which this action is not necessary:
when the exit occurs through a put option with a bank.

Performance Development of all the required processes to monitor and measure value inside the company
Evaluations and and between the company and the investor (in terms of accountability, auditing, IT
systems…).
Review
The management team could be not adequate in terms of skills. The investor’s support is
Recruitment crucial to choose, from the marketplace, the right people to hire; this is particularly true
Management both for start ups and for SMEs.

Relationship Both current and strategic activities can benefit from the network of the investor
Management (customers, suppliers, governmental lobbying, …).

The PE has to be completely and fully available for the entrepreneur 24/7. the entrepreneur
expects the PEI’s support to make decisions at any moment. This activity concerns “soft
Mentoring assistance” in terms both of technical and personal support to the management and to the
entrepreneur (or shareholders).

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Content 6
1.  The Managerial Process for Equity Funds
2.  Fundraising
3.  Investing: The Decision Making Phase
4.  Investing: The Deal Making Phase
5.  Managing and Monitoring: Supporting the Company

6.  Managing and Monitoring: Covenants Usage

7.  Exiting
8.  Private Equity Advice for Entrepreneurs – Interview with Fabio Sattin
 6
Introduction
This clip deals with the other side of managing and monitoring.

Besides the creation of value, the PEI has to deal with the protection of such value:
the second moment of the managing and monitoring activity.

These actions are taken in order to protect the divergence of opinions between the
entrepreneur and the PEI and the risk of struggle that may derive from it.
These are rules for the VCB and the PEI to live together in a temporary (albeit very
important) “marriage.”

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 6
Managing and Monitoring

Actions to create and to

measure value

Mitigate divergences of opinions

Managing & Monitoring and avoid conflicts between the PE
and the entrepreneur

Rules to protect the created

value

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Actions to create value Rules to protect value 6
Actions to Protect Value II
The typical covenants are as follows:

1.  Lock up
2.  Permitted transfer
3.  Staging technique
4.  Stock option plan
5.  Callable and puttable security
6.  Tag along rights
7.  Drag along rights
8.  Right of first refusal
9.  Exit ratchet

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Actions to create value Rules to protect value 6
Actions to Protect Value III

A covenant between the investor and existing shareholders that forbids both existing
Lock Up shareholders and PEIs from selling for a certain period.
This is a kind of more sophisticated lock up. It is an agreement between the investor and
Permitted existing shareholders that prohibits both existing shareholders and PEIs from selling without the
Transfer approval of the other.
The injection of capital occurs in installments, with a financial target to be met before the next
Staging installment takes place. This agreement helps ensure that the money is not squandered on
Technique unprofitable prospects.

Stock Option An option given to the management of the venture backed company to buy stocks at a favorable
Plan stock price. The provision generates commitment to create value.

The issuing of securities in which the PEI has the right to sell the stocks to the existing
Callable and shareholders (puttable) and the existing shareholders have the right to buy the stocks from the
Puttable PEI (callable). In both cases, the option scheme can be: American or European (i.e., without or
with a specific data to exercise the right) and single or combined (i.e., only callable or puttable,
Securities or callable and puttable together).

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Actions to create value Rules to protect value 6
Actions to Create Value IV

A contractual obligation used to protect the minority private equity investor. In case the majority
Tag-Along shareholders sells the stake, then the PEI has the right to follow the transaction and sell its
Rights minority stake on the same conditions and to the same buyer that is buying the majority stake.
A contractual obligation used to protect a majority PEI. With this agreement, in case the PEI sells
the stake it has the right to ask the shareholders to sell their stake at the same conditions and to
Drag-Along the same buyer. It is a mechanism to maximize the price of the sold shares: the PEI has the
Rights possibility to sell 100% of the company without owning it and when you can sell the whole
company, you have a higher contractual power.
A provision by which the PEI can avoid the shareholders selling their stake to undesired
Right of shareholders. In this case, the PEI has to buy the stake of the selling shareholders at the same
First Refusal conditions offered by the potential buyer.
A provision by which the “remaining” shareholder has the right to obtain a percentage of the
Exit Ratchet capital gain deriving from the sale of the shares. This applies both to the PEI and to the
entrepreneur.

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Content 7
1.  The Managerial Process for Equity Funds
2.  Fundraising
3.  Investing: The Decision Making Phase
4.  Investing: The Deal Making Phase
5.  Managing and Monitoring: Supporting the Company
6.  Managing and Monitoring: Covenants Usage

7.  Exiting
8.  Private Equity Advice for Entrepreneurs – Interview with Fabio Sattin
 7
Introduction
In this clip we will deal with the last step of the managerial process of PE: Exiting.
This is the moment in which the PEI understands if (and how much) value has been
created by the VBC.

Exiting is the most difficult step for a PEI, because there exists both a pricing and a
liquidity issue.

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 7
Exiting
The exiting activity concerns the decision to sell the stake in order to gain the value
created through the investment and the managing & monitoring of the venture.

Exiting strategies have to be contextualized according to the portfolio strategy of

the PEI. There is in fact a double perspective where the IRR of the investment has to
be coordinated with goals and constraints coming from the whole portfolio.

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Exiting II
Exiting has to be coordinated with:
•  The specific rules and covenants of the investment
•  The timing opportunity driven by the company’s business
•  The timing opportunity driven by the financial market
•  The capital requirement and pricing constraints
•  The track record of exiting in the portfolio of the PE firm

Equity investments are made up of different clusters (i.e., seed, start up, expansion,
replacement, vulture) but theory and market trends show there is no correlation
between: the stage of investment, the holding period and the exit way strategy.

This suggests that each case has to be analyzed per se

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Exiting III
The typical exiting strategies are the following:

1.  Trade sale

2.  Buy back
3.  IPO or sale post IPO
4.  Sale to other private equity investors
5.  Write off

Even if in many investments the agreement for the exiting is clearly defined ex ante,
only the development of the investment itself can tell the right choice of an exiting
strategy.

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1. Trade Sale
Trade sale is the exiting in which the private equity investor sells its stake to another
corporation or to another entrepreneur.
This exiting strategy is based on the industrial relation between the private equity
investor, the buyer, and the venture backed company.
The purpose of a trade sale is generally an acquisition to develop a strategic business
plan from the buyer and for that reason trade sale can be developed through
different solutions.
Anyway, this option is not very widespread because usually entrepreneurs do not
want to share their company or their ideas with another company or worse, with
another entrepreneur.
They are common in two cases: in LBO and when the PE_ holds the drag along right
and they sometimes can occur in PIPEs.

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2. Buy Back
Buy back is the exiting in which the private equity investor sells its stake to an
existing shareholder or to a buyer chosen by the existing shareholders themselves.
Buy back is a trade sale in which the buyer is not a new corporation coming from the
market. It occurs when the shareholders who don’t want to leave the company call
for the equity investor to sustain the business.
One of the most used covenants in these cases is the puttable shares (the PE has the
possibility to sell the shares back to the entrepreneur).
This option to exit gives for granted the fact that the entrepreneur has got
liquidity enough to buy the shares, otherwise a negotiation starts between the
entrepreneur and the PE.

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3. IPO
This way out is the best option a PEI could ever dream of. In this way a PEI can
maximize the capital gain; and this occurs only in 1% of the cases. Through an IPO,
the private equity investor sales its stake in the stock exchange.
That means that an IPO is the condition by which a PEI launches the sale but the
mere sale can either occur during or after the IPO itself. In both cases, the private
equity investor is strongly involved in the IPO process, acting either as a global
advisor or as a manager. The different role depends on the nature of the private
equity investor.
An IPO is very difficult, though, because the company must be ready for it, the
business of the company has to be attractive to be accepted and the entrepreneur
has to be prepared to work and deal with retail investors. IPO launches follow the
so-called “bubbles”. For instance, going back to early 2000s many IPOs took place.

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4. Sale to Another Private Equity Investor

The sale to another private equity investor is the exiting in which the private equity
investor sells its stake to another private equity investor.
This exiting strategy is common in the American market and is based on strong
relationship between the private equity investor and the community of private
equity investors.
Although this kind of exit is not that easy due to the fact that different PE investors
have different goals: the first one wants to maximize the capital gain, whereas the
second one wants to buy the participation at the lowest possible price (in order to
maximize in the future the capital gain).
The purpose of this sale is to sell the stake to an investor which operates in the
following stage of investment (i.e., from seed to start up, from start up to
expansion, etc…) so that the VBC is walked through its life cycle.
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5. Write Off
Write off is the exiting in which the private equity investor cancels the value of the
stake in its portfolio; it is the worst nightmare of a PEI.
This happens when the company defaults and this may occur in start up and seed
financing because the business plan may be too aggressive.
A write off does not necessarily mean an IRR -100% because the PEI may try to sell
some valuable assets in order to recover from the loss.
Write off process can be driven by a private agreement or by law (i.e. failure
process).

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Content 8
1.  The Managerial Process for Equity Funds
2.  Fundraising
3.  Investing: The Decision Making Phase
4.  Investing: The Deal Making Phase
5.  Managing and Monitoring: Supporting the Company
6.  Managing and Monitoring: Covenants Usage
7.  Exiting

8.  Private Equity Advice for Entrepreneurs –

Interview with Fabio Sattin
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Who Is Fabio Sattin?
Founder of a Private Equity Firm: Private Equity Partners

Chairman of the EVCA in the past

Professor of “Private Equity and Venture Capital” at Bocconi University

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Q&A
Let’s focus on PE in continental Europe where the minority investments are very
popular and are a means to make the company grow. This means that the
entrepreneur and the investor have to work together.
What are the suggestions for an entrepreneur who has to work with a PE investor?
“The chemistry and the personal relation between the PE and the entrepreneur is
fundamental to make the partnership successful.
Suggestions? In the first place, the basic decision: the entrepreneur has to understand
that he/she needs a partner, not just a cash injection. The entrepreneur has to be open to
share his/her decisions and to be transparent about the problems. In addition, an
entrepreneur has to select the right PE firm for the specific needs. Besides the PE firm,
the entrepreneur has to pick the right person for this person will be actively involved in
the ordinary life of the company.
In the end, the entrepreneur has to understand the decision-making process of the
partner (either local or international). Depending on the needs, a local partner may be
more suitable than an international one, or the other way around. Also, the business
model is an aspect the entrepreneur needs to understand (some PE may be more keen on
IPO, rather than trade sale…).
Throughout the deal, the entrepreneur has to remember that the PE is an investor that
does not just provide money.
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Q&A
Sometimes there may be an overlap between management and when a PE invests in
a company.
How do you think it is possible to work together and successfully within this
interaction?

“This is a very crucial aspect, especially for Europe. When an entrepreneur opens the equity
to a PE investor, the entrepreneur needs to remember that the company will still be
managed by the management team. If an entrepreneur is not ready to distinguish her role
and the managers’ role, this means this in not the right time to open to PE.
The entrepreneur has to bear in mind that if he/she decides to open to PE, she will have to
accept the decisions taken by the PE.
Again, the entrepreneur has to be able to delegate the decisions to the management,
keeping under control the overall process.
It is very important from both sides to be very clear and maybe to write down what the
managers can or can not do, what the entrepreneur can or can not do.”
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Q&A
You said before that PE is like a marriage and we know that the IPO may be among
the most wanted desires at the end of the marriage. How is it possible to regulate
the marriage and the shared desire of an IPO?

“Normally there is a pre-IPO deal. The picture of a PE investor investing as a minority

shareholder for 3-4 years leading a company to be listed is the ideal picture.
If this is the case, the parties need to regulate it from the beginning of the deal, including
it in the terms and conditions.
Also, it should be stated that all shareholders and the management team must take every
decision with that final purpose borne in mind. Also, in the contract it should be defined
when the IPO is supposed to take place and who is selling and who is not and whether there
will be a capital increase.
For instance, in my personal experience, we have rules since our first IPO with Natuzzi in
1993. When there is an IPO, we sell 2/3 of the stake on the day of the IPO and the
remaining third of the stake after one year and this is made clear since day one.
According to me, having rules is the best way to avoid misunderstandings.”