Advanced Private Equity & Leveraged Buy-outs Masterclass

Course Overview:

This program is designed to provide participants with a comprehensive view of private equity from the perspective of all the main participants. These include the providers of loan and bond finance, the private equity firms, the various professional advisers and the management team. The focus is largely on development capital (i.e. for firms with debt capacity) but also touches on matters relevant to venture capital.

The first, second and third day of the course covers the three key stages of the deal transaction from entry to exit. It provides an insight into the main value drivers in the process and the main areas of risk, the major structural issues that need to be considered and the structure and parameters used to gauge the optimum amount of debt/equity in the capital structure.

Participants will acquire a thorough understanding of the various types of debt that are available, including both senior and junior loans and the various types of bonds which are being used increasingly by private equity firms and corporates, as well as the key issues for the providers of both loans and bonds.

The programme covers critical issues from the perspective of the PE firm and an understanding of how their funds are structured as this means they approach transactions from a different perspective to corporates. Finally, the varied roles of management, key issues that arise for them and their interaction with the PE investors are also covered as these aspects are vital to ensure management remain properly incentivised to create value.

The programme will benefit those involved in private equity whether directly (e.g. investor, manager or lender) or indirectly, typically as a professional advisor. It adopts a pan-European approach to the topic but the presenter is able to discuss issues relevant in the USA and Asia in view of his exposure to those markets if participants require. Reference will be made to current trends and data in the markets across Europe.

Participants will be provided with numerous case studies to reinforce the various aspects and will also be provided with an LBO model which will be used to structure a transaction.

The fourth and fifth day of the course will cover the key elements of modelling in an LBO analysis. Participants will value the target business using historic data and available equity research. The valuation process will incorporate absolute and relative valuation techniques. Once the target business has been valued, participants will be introduced to LBO analysis and construct an LBO model.

The LBO modelling analysis will be developed by assessing the debt capacity of the business to determine the range of capital structures available for the transaction and how credit analysis is used in the LBO modelling process.

The participants will then cover more complex LBO instruments such as warrants and PIKs and how to calculate returns to each of the equity and debt providers.

Participants will model a more complex capital structure and calculate exit values and the IRRs generated by each investor. Using the integrated model participants will then analyse various scenarios (management case, base case, payout case) to derive the optimum financing structure taking into account the financial constraints of each investor.

The participants will undertake an adjusted present value (“APV”) analysis to determine where value has been created in the LBO transaction, using an APV model and finally look at recovery analysis for a failed LBO transaction.

Case Study: The participants will use a variety of case studies and exercises during the two days, based on publicly quoted and generic businesses.

Participants will be required to bring a laptop and a calculator to the course

Course Content

DAY 1

Introduction & background

• Overview of the PE market
  • Venture capital
  • PE / leveraged deals
• The three stages of the deal
  • Entry, operations & exit
• The traditional PE value creation model – the 3 key value drivers
• Techniques for enhancing returns
  • Capital structure’s impact on value
  • Using soft exits recaps / refinancings
  • Equity bridges
  • Leveraging the fund

Structuring issues & structuring parameters

• Structuring issues
  • Taking security / collateral generally
  • Security contrasted: UK vs Europe vs USA
  • Financial assistance
  • Ranking & priority of senior vs junior debt & pari passu loan/bond structures
  • Tax issues – group tax relief & thin cap
  • Squeeze-outs
• Spectrum of financing instruments in LBOs – overview
• Structuring parameters – creating an appropriate financial structure (overview)
  • Percentage senior, junior and equity in debt capital structure
  • EBITDA multiples
  • Target returns for PE & mezzanine funds

Case Study: Calculating the entry and exit value, the funding sources, the basic approach to deriving the equity split between PE and management on entry and exit and introduction to estimating the correct capital structure

• The acquisition – offer structure
• Offer structure – cash free, debt free with normalised working capital/net asset value etc
• Risk matrix – analysis of the five key value drivers / areas for due diligence
  • Cash & trapped cash
  • Debt – what’s included?
  • Working capital (key to the deal?)
  • Capex
  • EBITDA (the good news & bad)
  • Establishing the run rate
• Value matrix – techniques for mitigating the risks and identifying value
• SPA structuring – locked box vs completion accounts
  • Pros & cons of each

Case Study: Identifying problematic items in reconciling equity value to enterprise value and the correct approach to calculating the correct level of working capital

DAY 2

Financing Instruments – loans: key commercial terms & current trends

• Senior loans; key facilities & issues
  • Typical terms
  • RCFs – avoiding typical pitfalls
  • Capex facilities
  • Cash sweeps – typical, terms structure & issues
  • Margin ratchets
• Mezzanine and junior mezzanine
  • Rationale of warranted vs. warrant-less
  • Key issues for the warrant-holder
  • Key issues in warrant-less deals
• Other forms of junior loans (note: both 2nd lien and PIK loans have been nascent in Europe since 2007)
  • Second lien loans
  • PIK loans
• Asset based lending
  • Application & use
  • Typical terms & conditions

Case Study: Reviewing a capital structure and how different instruments can be used to optimise the capital structure, provide more head room and handle capex

Financing instruments – high yield notes: key commercial terms & current trends

• High yield notes
• Market trends
• Pros & cons of high yield and why it has been so successful
• Summary of the typical terms applicable to notes
  • Covenant structure
  • Call protection
• Review of the bond covenant package
• Loans vs bonds compared
  • Loans’ maintenance covenants vs Bonds’ Incurrence covenants
  • Other differences
• Senior secured (first lien) notes
• Second lien notes
• Senior (unsecured) notes
• PIK notes, “pay if you want” (“PIYW” or “Toggles”), “pay if you can” (“PIYC”)
• Fixed vs FRNs

Case Study: Identifying problematic items in reconciling equity value to enterprise value and the correct approach to calculating the correct level of working capital

The lender’s perspective

• Lender’s approach to credit decision (Loans)
  • measuring debt capacity
  • security over assets
  • exit routes
• Overview of loan documentation and impact on deal/restructuring
  • Loan as a radar system
  • Typical structure
  • Key parties (obligors, borrowers and guarantors)
• Key financial ratios / covenants
  • Limitations / interaction of the annual debt service coverage ratio (“ADSCR”), total debt/EBITDA, interest cover
  • Selecting the appropriate ratio for the deal
• The four deal scenarios and the role of due diligence
• Inter-creditor issues
  • The key issues for senior vs junior debt
  • Key issues for pari loan / bond structures

Case Study: Review a detailed term sheet for a senior loan, identify the key commercial aspects and how and where it should be amended to make it borrower / lender friendly

DAY 3

Sponsor’s perspective

• Structuring the equity
  • Structure – loans, preference shares
  • Typical returns
• Equity ratchets
  • Rationale, structure
  • Pros and cons of positive vs. negative, stepped vs. linear
• Structure and key terms for PE funds (and impact of the deal)
  • Investment period (how long)
  • Preferred return (rate, calculation)
  • Carry (European vs US approach)
• The 5 critical issues to sponsors
  • Portfolio fit
  • The business model
  • Management – what PEs approach
  • Approach to generating value/returns
  • Exits – hard vs. soft

Case Study: Calculate the exit value and discuss how structuring the PE equity can affect the returns of management

Exits – hard & soft

• Hard exits vs soft exits
  • Review of market trends
• Exit strategy – duel, triple track
  • Pros & cons
• IPOs
  • The key ingredients for IPO
  • Partial vs complete exit
  • What about the management – problem areas
• Sale of equity – partial vs complete sale
  • Problem areas – trade vs secondary PE deals
• Soft exits – a useful way of enhancing returns
  • Recaps, refis
  • Management and other fees

Case Study: Discuss the pros and cons of a dual/triple track exit strategy and the key issues to both the PE and management

Management issues

• Multifaceted role and duties of management
  • Issues vis-à-vis role as director, employee, shareholder, warrantor
• Key documents & terms
  • Shareholders’ agreement vs articles/ statues (pros & cons)
• Critical issues in the investment agreement
  • Good vs. bad leaver
  • Management warranties
  • Equity – valuation issues pre exit (why “fair value” is dangerous)
  • Transfer issues – drag, tag-along rights
• Critical issues in the service agreement
  • Restraints
  • Termination

Case Study: Review and discuss the key terms in the management agreement and how they should be structured in a “management friendly” manner

Day 4 & 5

Leverage Overview

• Background to the LBO market
  • Why do LBOs happen?
  • The agency effect
  • Main parties to a deal and their roles
• Basic theory – The effect of leverage on firm value
  • Levered vs unlevered businesses
  • The value of the tax shield
  • Bringing in bankruptcy costs

The LBO process

• Stand-alone value of the target – what price to pay?
• Modeling an LBO deal – does the deal meet our returns?
• Further analysis – assessing the debt capacity
• Determining the capital structure
• Assessing the value creation

Valuing the target

• Sourcing information – Historic and forecast date
• Analysing equity research
  • Key attributes of broker analysis
  • Pluses and minuses of equity research
• Building a DCF valuation using equity research
  • Which elements of research to use
  • Cross checking the research
  • Identifying errors in assumptions
• Modelling the stand alone valuation
  • Which WACC to use
  • Underlying assumptions in a DCF
  • Different approaches to terminal value
  • The value driver approach – producing a more realistic terminal value
• Comparing and contrasting DCF and LBO model structure

Case Study I: Participants model the stand alone valuation of the target using historic data and equity research

LBO Modelling Overview

• Key elements of an LBO model
  • Comparing and contrasting DCF and LBO models
  • Sources and uses of funds
  • Key drivers in an LBO model
• From stand alone valuation to LBO analysis
• The debt waterfall and initial capital structure
• Assessing the IRR and initial optimisation of the capital structure

Case Study II: Participants use the stand alone valuation of the target to complete and LBO model

Assessing debt capacity for LBO financing

• Financial interdependencies
• Financing growth
• Sustainable debt
• Target debt capacity assumed in a WACC calculation, debt capacity and interest cover
• Debt capacity in LBOs
• Debt capacity multiples in practice and credit analysis
  • The rating agency ratios
  • Additional constraints in practice
  • “Max out” calculation – optimising the structure with further constraints

Case Study III: Modelling the debt capacity of the target using multiple and credit analysis

Capital providers and their typical characteristics

• Background to the capital markets and key providers of finance
• Current market conditions and ability to finance
  • The high yield market
  • Mezzanine finance
  • Deal multiples and exit conditions
• Institutional and management equity
• Traditional/new lenders
• Senior tranche profiles
  • A, B, C, RCF
• Subordinated tranche profiles
  • Second lien
  • Mezzanine (with/without warrants)
  • PIK
  • High yield bonds
• More complex issues – warrants and options

Case Study IV: Modelling a more complex capital structure with various scenarios calculating exit value and IRR for each of the capital providers

Assessing value creation in LBO transactions – APV analysis

• Key components of an APV valuation
  • Unlevered value
  • Value of the tax shield
  • Direct and indirect cost of leverage
• APV valuation and DCF valuation
• APV valuation in a steady state
• Calculating AP in a steady growth environment
• Incorporating APV analysis in an LBO transaction analysis

Case Study V: Where has value been created, modelling APV analysis for an LBO transaction

Case Study: Review and discuss the key terms in the management agreement and how they should be structured in a “management friendly” manner