A high level overview of the private equity market, how fund economics work, and what questions to ask general partners when evaluating fund investment merit.

1. CONFIDENTIAL
Understanding Private Equity
April 17, 2013
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2. CONFIDENTIAL
Agenda
Ø Introduction / Background
Ø Asset Class Overview
Ø Market Overview
Ø Private Equity Funds
Ø Evaluating Private Equity Funds
Ø Questions & Feedback
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3. CONFIDENTIAL
Introduction / Background
Ø Justin Shuman
- Drexel University (2002 – 2007)
- DuPont Capital Management Private Markets Group Analyst (2007 – 2009)
- Cornell MBA (2009 – 2011)
- Sterling Partners Associate (Summer 2010)
- Harris Williams & Co. Associate (2011 – 2013)
Feel Free to Contact Me:
Justin Shuman
215-837-1199 (mobile)
justin.shuman@gmail.com
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4. CONFIDENTIAL
Objectives
Ø Develop a high-level understanding of the private equity landscape
- Investors
- General Partners
- Portfolio Companies
Ø Establish an elementary understanding of fund economics and how investors make
money
Ø Walk away with a “tool box” of questions that will help you evaluate private equity
funds in the future
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5. CONFIDENTIAL
What We are NOT Going to Focus on..
Ø Mechanics of an LBO and academic financial explanations:
ROE = (Profit Margin )* (Asset Turnover)*(Equity Multiplier)
Ø Finding a job in private equity
Ø Political views and potential legislation surrounding the asset class
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6. CONFIDENTIAL
Asset Class Overview
Ø Private Equity
– Capital that is invested in private and illiquid securities
• Leverage Buyouts (“LBOs”) – most common
• Venture Capital
– Seed
– Early-Stage
– Late-Stage
– Growth
• Mezzanine
• Real Estate
• Distressed Debt
• Secondary – the purchase of interests in all described herein
• Other – Mortgages, Real Assets (timber, toll roads, infrastructure)
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7. CONFIDENTIAL
Private Equity Value Chain
Ø Value Chain
- Investors commit capital to funds, fund-of-funds, or directly invest in assets
- Funds deploy capital into assets on behalf of their investors (LPs or Fund-of-
Funds)
- Investments receive capital from LPs, Funds, and Fund-of-Funds
- Pension Funds
- Endowments
- Foundations
- Bank Holding Companies
- High-Net-Worth Individuals
- Insurance Companies
- Investment Banks
- Corporations
- Other…
INVESTORS (“LPs”) FUNDS
PE Fund
PE Fund
PE Fund
Fund of Funds
INVESTMENTS
Venture
Growth Equity
Buyouts
Mezzanine
Special Situations
Real AssetsDirect Investments
Invests in PE Funds
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8. CONFIDENTIAL
A Short Vocabulary Lesson…
Limited Partnership Agreement (“LPA”): the agreement that binds LPs to GPs and defines investment
strategy as well as all other rules for fund governance
Commitment: LP investment in a private equity fund
Capital Call: issued by the GP before the closing of a transaction. A capital call requests capital from
LPs to fund investment
Investment Period: normally 5 years from the fund being “turned on” (i.e. fees commencing and the
first capital call). After 5 years the GP may not draw down capital for new investments (“use it or
lose it”)
Fund Life: usually 10 years
Fund Extension: highly negotiated but often 2 year increments to provide more time for the GP to
manage and exit existing investments in the fund.
Deal-by-Deal: economic calculation that determines carried interest on a deal-by-deal basis (easier to get
to the carry early)
Back-Ended: economic calculation that determines carried interest on a total fund basis (more difficult
to get to the carry early)
Hurdle Rate: the IRR hurdle which a GP must earn for LPs before it can begin to take 20% of the profits
IRR: internal rate of return is the discount rate that will bring a series of cash flows to an NPV of 0
Return on Invested Capital (“ROIC”): realized capital / invested capital
EBITDA Multiple: purchase price / EBITDA
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9. CONFIDENTIAL
Fundraising Climate
Ø Significant amounts of private equity raised before the downturn created buying power
– Moving further into an investment period heightens pressure to invest
– Assuming a five-year investment horizon, $141 billion of private equity’s $348 billion of dry powder will need to be
invested over the next two to three years
Ø Given the capital overhang, fundraising has proven challenging since 2008
– With 805 funds currently in the market, time from initiation to final close is proving longer than 2005 – 2008.
– Fundraising in 2012 fell to the lowest level seen in more than a decade, but the amount of capital raised increased 13%
from 2011 as larger funds found the most success
$428
$501 $481
$433
$373
$348
$0
$100
$200
$300
$400
$500
$600
$0
$20
$40
$60
$80
$100
$120
$140
$160
$180
2007 2008 2009 2010 2011 2012
CumulativeOverhang
OverhangbyYear
Cumulative Overhang Under $100M $100M - $250M $250M - $500M
$500M - $1B $1B - $5B $5B +
For the Years Ended December 31, 2007 – 2012
($ in billions)
Capital Overhang of U.S. PE Investors by Vintage Year
Source: Pitchbook.
229 228
275
221
118 113
128
110
0
50
100
150
200
250
300
2005 2006 2007 2008 2009 2010 2011 2012
No.ofFundsRaised
U.S. Private Equity Fundraising
Source: Pitchbook.
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10. CONFIDENTIAL
33%
21%
13%
12%
9%
8%
4% 34%
20%
13%
14%
6%
7%
5%
Business Products & Services Consumer Products & Services
Healthcare InformationTechnology
Financial Services Energy
Materials andResources
0
100
200
300
400
500
600
700
800
900
$0
$50
$100
$150
$200
$250
$300
1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10
4Q10
1Q11
2Q11
3Q11
4Q11
1Q12
2Q12
3Q12
4Q12
TotalCapitalInvested Deal Count
Private Equity Deal Activity
Ø 172 exits took place in 4Q 2012, and the record 6,538 portfolio companies still held will drive future
activity
Ø Private equity deal flow has been partially supplemented by the record $64.1 billion in dividend
recapitalizations in 2012, 58% higher than the previous record of $40.5 billion for the full year 2010
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Total Private Equity Deal Flow PE Deals by Industry
For the Years Ended December 31, 2011 – 2012
Source: Pitchbook.
For the Quarters 1Q07– 4Q12
Source: Pitchbook.
TransactionVolume
ValueofDeals

11. CONFIDENTIAL
Ø Middle market M&A transactions (<$500MM) accounted for 91% of private equity deal volume in
2012 as investors exhibited a preference toward smaller deals
Ø 49% of private equity capital was allocated to deals below $500 million in 2012, the second highest
total since 2005
Ø Since credit market conditions are positive, the proportion of large deals should grow in 2013
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2005 2006 2007 2008 2009 2010 2011 2012
0-24M 25M-99M 100M-499M 500M-999M 1B-2.5B 2.5B+
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2005 2006 2007 2008 2009 2010 2011 2012
0-24M 25M-99M 100M-499M 500M-999M 1B-2.5B 2.5B+
Private Equity Deal Size
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For Years Ended Dec. 31, 2005 – 2012For Years Ended Dec. 31, 2005 – 2012
Percentage of PE Transactions (Count) by Size Percentage of PE Investment by Deal Size
Source: Pitchbook.Source: Pitchbook.

12. CONFIDENTIAL
Economics
Ø LP Management Fee
- LPs agree to pay funds 2% of commitments during the 5 year investment period
- Continue to pay 2% on cost-basis of remaining fund investments
- Management fee pay for deal team members’ salaries, travel, and other fund
expenses
- Any “excess” fees not used at the end of the year are normally paid out in
bonuses to deal team members and divided among the partnership
Ø Carried Interest
- Incentive payment for successful transactions that exceed hurdle requirements
• Normally 8% hurdle rates (management fee, invested capital, and other
fees are taken into this calculation)
- The fund is entitled to 20% of profits in excess of the hurdle
Ø Company Management Fee
- Funds often charge their portfolio companies a percentage of EBITDA as a
management fee
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13. CONFIDENTIAL
Finding Attractive Assets
Ø 80 deals are reviewed on average for every 1 investment
Ø Funds use a myriad of filters to sort through deal-flow to identify potential
investments
ü Strong and stable cash flow (EBITDA – CAPEX)
ü Strong management
ü Low maintenance and growth CAPEX requirements
ü Growing end-markets
ü High barriers to entry
ü Potential for margin improvement and cost reduction
ü Acquisition opportunities
ü Logical path to exit in 4-7 years
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14. CONFIDENTIAL
Financing the Deal
Ø Equity
- Fund: capital call draws down equity from LPs in pro-rata fashion
- Management: existing management usually “rolls” equity
- Co-investors: LPs that directly invest in the equity outside of the fund
Ø Debt
- Senior Debt: secured by assets
- Subordinated Debt: unsecured, second lien on assets
- Mezzanine Debt: fills the gap between equity and debt
• 14%-16%, PIK, warrants, “bullet” amortization
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15. CONFIDENTIAL
Creating Value
Ø Funds pull many levers to create values for their LPs
ü Professionalize management, accounting & control systems
ü Adjust firm strategy and rationalize product lines, workforce, etc
ü Debt can increase firm value if you can afford it! (Exploits corporate
aversion to debt)
ü Regulatory Arbitrage – Sarbanes-Oxley
ü “Bolt-on” acquisitions
Ø Robust company performance can lead to dividend recaps as early as years 2 and 3
- Used normally when sale prospects are less than optimal
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16. CONFIDENTIAL
Exiting: 4-7 Years Later…
Ø After value has been created over the hold period, it is time to sell the company
- Filter and select 5-7 investment banks to “pitch” a sale process
• Firm credentials
• Industry and positioning thoughts
• Valuation range
• Most likely purchasers
Ø “Winning” bank conducts a sale process
- Broad: show the deal to hundreds of potential buyers
- Narrow: show the deal to the most likely potential buyers
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17. CONFIDENTIAL
Evaluating Fund Managers
Ø Team
- Does the team have complementary backgrounds? – not just all ex-bankers or ex-
consultants
- What qualifies the team to purchase and operate businesses?
- Are there any legal blemishes on any team member’s background?
Ø Strategy
- Industry expertise? What’s the angle?
- Operationally focused – professionalize the business through accounting and control
upgrades, manufacturing best practices, customer/workforce rationalization
- Financial engineering (debt pay-down) – NO private equity fund will ever market
that they are using financial engineering to generate returns
- “Roll-up” – purchase a platform business from which a large company will be built
through acquisitions
Ø Track Record
- How many deals have <1.0x ROIC? – What missteps occurred? Has the fund
learned from mistakes?
- Is the fund executing deals outside of its historical strategy? – New industries than
in the past…larger deals than in the past….etc.
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18. CONFIDENTIAL
Recommended Books & Websites
Ø Books
- “Applied Mergers & Acquisitions” – Robert F. Bruner
- “Investment Banking: Valuation, Leverage Buyouts, and Mergers &
Acquisitions” – Joshua Rosenbaum and Joshua Pearl
Ø Websites
- www.prequin.com
- www.pehub.com
- www.pitchbook.com
- www.thedeal.com
- www.dealbook.com
- www.altassets.com
- www.bloggingbuyouts.com
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