Private Equity

An Overview
Clark L. Maxam, Ph.D.
Director of Research – Braddock Financial Corporation
and
El Pomar Professor of Entrepreneurial Finance – University of Colorado,
Colorado Springs
 Private Equity – Broadly Defined
• Technically refers to any type of equity
investment in an asset in which the equity
is not freely tradable on a public market.
• Less liquid
• Long Term in nature
Private Equity – Categories and Players
• Angel
– Early Stage: Seed, Start-up
• Professional Venture Capital
– Early Stage, Expansion, Later Stage
• Private Equity
– Later Stage, Buyout, Special Situations
• Hedge Funds
– All Stages
The Private Equity Market
 Key Player Overlap

Angel
Venture Capital

Private Equity Hedge Funds

Traditional Private Equity – Primary Activity
• Professional pools of capital that buy all
the publicly traded equity of target
companies = “Go Private”
• Usually done with borrowed money
– High degree of leverage
• Aka : Leveraged Buyout
 The Basic Value Creation Formula
Fundamental Ideas
1) Re-focuses acquired businesses resulting in lower
costs and improved efficiency.

2) Value is created through basic finance that says debt

can increase firm value if you can afford it!
• Exploits corporate aversion to debt (Henry McVey,
Morgan Stanley).

3) Regulatory Arbitrage – Sarbanes-Oxley

 The Basic Value Creation Formula
Debt can increase Value

Dupont Equation

NI NI Sales Total Assets

ROE   X X
Equity Sales Total Assets Equity

Leverage – Debt as % of Assets

 Equity  Multiplier  ROE
 The Basic Value Creation Formula
Debt can increase Value
Consider a company that takes on debt at a cost of $3 in Net Income, but
changes NOTHING ELSE.

NI Sales Total Assets

X X  ROE
Sales Total Assets Equity
16 160 100 16
X X   16%
160 100 100 100
12 160 100 12
X X   40%
160 100 30 30

Could drop NI to 4.8 and still match the previous ROE!!

 The Basic Value Creation Formula
An Example – Carlyle Group
Leveraged Buyout

Case 1 (5 years) – No Profit Increase Case 2 (5 years) – Profit Increase

 Regional Breakdown of Private Equity Investments
Funds Raised

100.00% 7% 2%
7% 8%
80.00% 17%
38%
60.00%

40.00%
69%
52%
20.00%

0.00%
2000 2005

North America Europe Asia/Pacific Other

Source: International Financial Services

Private Equity Investments by Country

Source: International Financial Services

Source: National Venture Capital Association,Thomson Venture Economics
Source: National Venture Capital Association,Thomson
 Cambridge Associates U.S. Private Equity Index
(period ending 9/30/2006)

35
30
25
20
15
10
5
0
8Yr

12Yr

13Yr

14Yr

18Yr

19Yr

20Yr
1Yr

2Yr

3Yr

4Yr

5Yr

6Yr

7Yr

9Yr

10Yr

11Yr

15Yr

16Yr

17Yr
Source: Cambridge Associates, LLC
Private Equity Issues Going Forward
• PE as a new Model of General Management (Jensen)
– Overcomes entrenched thinking, management and
disjoint between manager incentives and capital
markets.
– Problematic Trends
• Publicly held Private Equity – oxymoron
• Fee Structures not tied to exit
• Hedge funds in the PE business – not a transaction
business.
Private Equity Issues Going Forward

• 2007 estimate of$160B in dry powder 

$750B  $590B in debt appetite.
– Banking capacity is finite and already
extended.
– Potential regulatory limits
Private Equity Issues Going Forward

• PE Boom has been fueled by

– Historically low rates
– Regulatory arbitrage

• Both could reverse quickly and change the metrics

dramatically