Kennet - Growth Strategies For Bootstrapped Companies
Private Equity and Venture Capital 2
1. PRIVATE EQUITY AND VENTURE CAPITAL MASTERCLASS
Session 2. Private Equity deal origination,
execution and portfolio management
March 2013
Alexey Milevskiy
Gleb Fomichev
The presentation is prepared solely for the purposes of master classes
at the Higher School of Economics
3. Speakers
Alexey Milevskiy
Alexey Milevskiy is an Investment Manager at UFG Private Equity,
leading Private Equity firm managing over $500 million across several
funds in Russia and CIS. He participated in all stages of investment
process: origination, due diligence, structuring and execution.
Prior to UFG PE Alexey worked at European Private Equity division of
GIMV in Belgium, KPMG Business Valuation group and ING Bank.
Alexey holds masters degree from Vlerick Business School, Belgium and
bachelors from Higher School of Economics. He is also the winner of
several McKinsey&Co business case competitions.
Gleb Fomichev
Gleb Fomichev is an Analyst at JSFC Sistema, major Russian
investment company. Gleb is one out of 7 investment professionals
running Sistema’s $2 billion portfolio of high technology assets. He is
engaged in strategy development and portfolio companies management
as well as in new deals origination.
Prior to Sistema Gleb worked at A&NN Group, one of the top performing
Russian family office, where he managed fund’s assets in retail,
telecommunications, logistics, publishing and financial services sectors.
Gleb’s other experience includes E&Y business valuation team. Gleb
holds masters and bachelors degree from Higher School of Economics.
3
4. Session 1. Private Equity landscape
1st part
• Private Equity definition;
• Company funding lifecycle: FFF, business angels, venture capital, private equity, IPO;
• Organizational structure of a PE fund: LP-GP agreements;
• Typical activities performed by PE fund: fund raising, deal sourcing and originating, due diligence,
management of portfolio companies, exits;
• Key success factors for PE deals;
2nd part
• Russian PE/VC landscape: PE funds, captive funds and family offices, government-backed funds,
venture capital funds;
• Russian vs Foreign PE industry;
• Entry strategies: full buyout, growth capital, LBO, minority recapitalization, mezzanine, distressed
situations.
• Exit strategies: IPO, trade sale to strategic/financial investor, MBO, sale to other shareholder;
• PE careers.
4
5. Private Equity definition
Private equity is a:
• medium to long-term financing
• provided in return for an equity stake
• in potentially high growth
• unquoted companies
5
6. Private Equity value creation formula
Multiple
EBITDA growth Leverage
Expansion
Topline Efficiency
growth improvement
Superior returns
6
7. What value Private Equity fund brings
PE Entry Value creation within 3-5 years Exit
Financial support
- Raising new equity rounds and debt financing
- Financial planning and cost control, IFRS implementation
- Introducing transparent reporting system
M&A support
- Developing M&A strategy
- Search and valuation of attractive acquisition targets
- Legal support and deal structuring
- Integration assistance
Operational support
- Help in bringing top experienced people to the team to bridge personnel gaps
- Attracting independent board members and industry experts
- Motivation schemes implementation
- Development of tax and legal structure, IT-systems
- Access to a new partner and client network, help in expanding abroad
- Optimization business processes and internal decision-making
Help in forming/ adapting company strategy
- Business model adaptation to changing market realities
- Implementing company development plan and setting KPI’s
Preparing company for an IPO or trade sale
- Improvement of corporate governance
- Substituting investment banks at exit
- Legal support and deal structuring
7
9. Investment approach and key success factors
1 Market leaders are typically winning
2 Strong and motivated management team
3 Fair entry price
4 Proper deal structuring
5 Proactive monitoring
6 Clear exit strategy
7 Industry growth and deep market expertise
9
10. Private Equity fund structure
Limited Partners Distribution
Institutional investors of proceeds
• Pension funds
• Sovereign wealth funds
• Financial institutions
HNWI
Disbursement
of commitments Carry
Fund
General Partners
PE or VC firm
Equity Exit
Investment proceeds
Investee company
10
11. Typical PE/VC fund remuneration structure
Management fee 2%
LP GP
Carry 20%
Management fee of 2% is charged on the total amount of committed/invested
capital.
Carry is received upon exit from portfolio investments.
• First, LPs get total commitments at cost plus hurdle rate (8-10% annual).
• Second, remaining exit proceeds split while 80% goes to LPs and 20% to
GPs.
Carry is the main part of total remuneration and its existence ensures that the
interests of LPs and GP are aligned and GP focused on value maximization
and successful exits.
11
12. Company funding lifecycle
Revenue
IPO
Private Equity
Venture Capital
Business
angels
FFF Time
Start-up Early Growth Mature
12
13. Typical activities performed by PE fund
Pre-deal Deal origination Deal screening Due Diligence
Deal Negotiation Structuring
Deal sourcing
Company
Post-deal management, Exit
value creation
13
14. Deal screening example
Number of
deals
Deal received 500
Signing NDA 200
Investment Committee 20
Due diligence 3
Docs drafting and 2
closing
14
15. Russian PE industry landscape
Institutional funds Captive funds Government-
Family offices
backed
15
16. Russian VC industry landscape
International funds Russian funds Accelerators Government-
backed
16
17. Entry strategies
Target Stake Deal Deal Fund’s Type of
company acquired structure funding strategy fund
stage
Classical
Current PE funds,
Growth/ Debt/Self Buy and
Buyouts Mature
>50% shareholders
financed build
cash out mezzanine
funds
New issued stock Financial
Venture
Growth/ purchase/current Self investor
Growth capital Mature
<20%
shareholders financed (funds for
funds, PE
funds
partial cash out growth)
Financial
Venture
Development New issued stock Self investor
Early/Growth <20% funds, PE
capital purchase financed (funds for
funds
growth)
Financial
Current
Minority Growth/ Self investor Classical
<50% shareholders
recapitalization Mature financed (funds for PE funds
cash out
growth
Reorganizati Special
Distressed Mature/ Debt obligations Self
>50%/100% on and situations
situations Decline assignment financed
restructuring funds
17
18. Exit strategies
Acquisition of a target by it’s current management
Company team
size/maturity MBO Management’s stake before MBO - zero/
insignificant
Example: buyout of a non-core subsidiary
Disagreements on company’s development
Sale to other strategy
Dead lock danger
shareholder
Spin offs, non cash-deals
Acquisition by a new vehicle created
by new PE investor/strategic
Secondary buyout investor
The third, forth, etc buyout rounds
may also take place
Most IPO proceeds – growth
and development capital
IPO Only partial cash out of
current shareholders is
Likelihood
possible
of positive
target’s
performance
18
19. PE careers
Entry strategy Exit opportunities
Partner Unlimited
Work experience in Top management
Investment director Unlimited
Private equity positions in industry
Successful completed Top management
deals track record position in fund’s
Recruiters, networking company/project
Own business/project
VP/ Associate 1-3
director launch
years
Work experience in Big4, Middle level
IB, Industry is required Associate/ 1-3 management positions
Recruiters, networking years in industry
Investment
manager Upside position in a
smaller fund
Own project launch
1-3
Analyst years
Last year students
Internships
Applications on career sites
19
20. Session 2. PE deal origination, execution and portfolio management
1st part
Industry analysis
• Investment strategies: buy-and-build vs bet-and-win;
• Industry KPIs and application for financial modeling;
• Multiples variation by industries.
Financial modeling and leveraged buyouts
• Financial statement analysis: application for private equity;
• Valuation methods: multiples approach, comparable transactions approach;
• Private equity returns calculations: IRR, cash-on-cash, exit sensitivity analysis.
• LBO and financing of M&A transactions: debt and mezzanine financing for PE deals.
2nd part
Due diligence
• Commercial, financial and tax, legal due diligence
Deal structuring and negotiations
• Legal documents for deal execution: NDA’s, LOI’s, Term Sheets, SHA’s, SPA’s;
• Off-shore holding structures: English law, possible holding schemes.
• Deal structuring tools
• Deal negotiations: habits for effective negotiations.
Portfolio companies management
• Fund representation on the board of directors: strategy formulation, veto and approval rights, audit and
compensation committees;
• Companies monitoring: weekly/monthly management reporting packs, frequent interaction with management;
• Value creation strategies: fund raising, building corporate governance, management appointment, solving
operational issues, attracting consultants, finding clients, exit preparation, synergy identification among portfolio
companies.
20
22. Examples of attractive sectors in the current environment
Sector Investment rationale
1 Undeveloped industries/ sectors with high growth potential
• Internet tech companies • High Internet growth rates
• E-commerce • Service infrastructure is still underdeveloped
• Medical Services • Limited modern private medical services
• Fast Food
• Logistics
2 Traditional sectors
• Food retail • Import substitution
• FMCG • M&A opportunities, important to find right
• Pharmaceutical industry platform for consolidation
• Media, telecom • Regional growth potential
• New formats/ products development
• Room for improvement (margins, working
capital)
22
23. Two types of investment strategies investment strategies
Two investment strategies
“Bet-and-win” “Buy-and-build”
• Industry with high growth potential • Good industry knowledge
• Investment in market leader • Building market leadership through M&A
• Investment in strong management • Strengthen management team
team • “Discount entry price”
• “Fair entry price” • Majority stake buy-out
• Minority investment
Undeveloped industries/ sectors with Traditional sectors
high growth potential
Common principles
• The market in which the Company operates should be at least $100 million
• The demand for the Company products or services should be justified by macro trends
• The business model should be proven/ sustainable/ scalable
23
25. Industry sector top-down scorecard example
Sector description
• Description of the sector
Size and trends Regulations and environment
• Estimated size of the sector (for the latest year available). Sector • Assessment of the environment
CAGR and expectations for short and medium run. (favorable or risky)
• Key segments, information on segments’ share, trends, margins, etc. • Information on state support/
• Export and import information. Any info on taxes, export/ import regulations within the sector
quotas. • Information on international players
• Key buyers and suppliers. working within the sector
• Other information (e.g. recent trends, substitutes, etc) • Indication of PE activity in the sector
• Assessment of margins (EBITDA, other information) - can be gained
from Annual Reports, analysts’ reports, SPARK, etc
• Some indications on capital expenditures (e.g. cost of production
facilities, years to build/ get to full capacity)
Fragmentation and key players Potential Growth and Exit Strategy Overall conclusion and Exit Strategy
• Assessment of market consolidation (consolidated or • Overall measure of the sector
fragmented) attractiveness for the PE activity
• Key players, their market shares (high or low score)
• Information on recent mergers/ acquisitions • Decryption of potential targets
• Information on actioners, vertical integration of the players, etc • Description of exit strategy
• Competition assessment
25
26. Three different industry segment examples
Online
B2C
business
Food
retail
chain
Engineering
business
26
27. Example 1. Online B2C business
Key points to consider
• Unit economics, CLV > Customer acquisition cost
• Average check, churn, retention, repeat users
• Visitors, conversion
• Customer acquisition channels
• Head office costs, cash burn
• Logistics
• Inventory
27
28. Example 2. Food retail
Key points to consider
• Store level performance/locations. Top-line and bottom-line by store.
Revenue and EBITDA concentration.
• Store level economics: capex, revenue per store, target profitability
level, payback period, revenue ramp-up, time to break-even, time of
construction
• Benchmark against competitors. Revenue per sqm, profitability,
prices, SKUs, locations.
• Logistics. How in-bound and out-bound logistics works? Who are the
suppliers? Private labels?
• Rental agreements. How the stores locations are determined? What are
the terms and timeframe of the rental agreements?
• Costs as % of revenue. Marketing expenditures, personnel expenses,
head office expenses.
• Working capital. Inventory, a/r, a/p turnovers.
• Store opening pipeline. Geography of locations? Any preliminarily
agreements in place? How much they opened historically?
28
29. Example 3. Engineering
Key points to consider
• Customers. History of relationship. Blue-chip customers,
creditworthiness. Revenue concentration.
• Customer contracts terms, time periods and payment terms
• Value chain. Which part of the value chain does the company operates?
• Personnel utilization, turnover, average wages. Contract
agreements with personnel, motivational schemes in place
• Head office
29
31. Analyzing the target
High-growth/start-up
Established business
business
Past performance
analysis (financial
statement analysis, Management team
Current
current market position inspection
positions
analysis inspection) Monetization model audit
Current conditions of
production facilities
Valuation based on
Future growth estimation
trade multiples
Valuation/ Market prospective
DCF forecasting for
prospects analysis
scenario analysis and
estimation debt repayment DCF forecasting for
capacity estimation valuing business
32. Valuing the target
Revenue
Start-up Expansion Growth Decline
FFF, Venture Strategic investor,
Private equity funds
seed funds special situation fund
Time
Firm Current business and assets,
Future growth Current assets
value future growth
Valuation Comparable companies,
Negotiations Comparable companies
method liquidation method
Multiple if
N/A Extremely high High, average industry level Low
applied
33. Valuation methods. Multiples approach
I. Equity value/Net income IV. Industry specific multiples
Highly depends on capital Industry Multiple
structure EV/Reserves
1. Oil & gas
Not widely used for private EV/Production
equity valuations EV/EBITDAX
2. Metal & mining EV/Reserves
EV/Production
II. Enterprise value/Sales
3. TMT, internet, media EV/Subscribers
Highly depends on business EV/Population
marginality (“quality” of sales) EV/Fiber miles
The most simple in terms of 4. Financial institutions Equity value/Book value
calculation and quick value Equity value/Net Asset
value
estimation
5. Retail EV/EBITDAR
EV/Square footage
III. Enterprise value/EBITDA
6. Real estate EV/Square footage
Equity Value/Net Asset
Most commonly used Value
34. Valuation methods. Multiples approach
Enterprise value derivation
Enterprise value
Assets Liabilities & Equity
=
Equity value
Long term assets Debt +
• Investments in Convertible notes
associates Total debt
Mezzanine
+
Preferred stock
Current assets
• Cash & cash Common Equity +
equivalents Preferred stock Noncontroling interest
Noncontrolling -
interest
Cash & cash equivalents
-
Cash-flow Investors claims Associate companies
generating assets
= Equity value + other +
= Enterprise value + investor claims =
assets not generating
Other claims on assets
Enterprise value + cash (pension liabilities, employee stock
cash flow (cash) option)
35. Valuation methods. Multiples approach
EBITDA derivation
EBITDA calculation from IFRS and US GAAP reporting
Adding back D&A, taxes and interest payments to Net Income
Adjusted EBITDA (OIBDA) – removing away all one-off expenses (restructuring
costs, assets revaluation, special projects costs)
EBITDA calculation from RAS reporting
Adding back D&A, taxes and interest payments to Net Income
Adjusted EBITDA (OIBDA) – removing away all one-off expenses (restructuring
costs, assets revaluation, special projects costs)
D&A is reported in COGS and SG&A section. Reporting notes should be
investigated to detach it/simplified forecast of D&A based on PPE balance value
can be performed
36. Valuation methods. Multiples approach
Commercial meaning
EV
EBITDA
-
Not a capital intensive business
Perfect conditions of current Extensive capex program
production facilities High tax rate
Low tax rate High cost of capital
Low cost of capital Low market growth estimation
Outstanding growth prospective
+
General rule: General rule:
Oil & gas
Retail EV/EBITDA>5 EV/EBITDA<5
Metals & mining
Internet
Development
Healthcare
Infrastructure
37. Valuation methods. Transactions approach
Special Data
Bases use for Criteria Processing Final
transaction determination with sample multiple
search calculation
MergerMarket Target’s sector Moving away Median/average
Factiva Geography deals without multiple of a
DealWatch Deal type financial details selected sample
Zephyr Period Moving away of transactions
outliers
Stake acquired
Multiples check
38. Private equity returns calculations
ENTRY EXIT
Equity value
Entry EV/EBITDA x
Equity value
EBITDA LTM Exit EV/EBITDA x
EBITDA LTM
Net claims on assets
Net claims on assets
Funding from banks,
mezzanine funds, etc.
Equity consideration Dividends payments Equity stake of a PE
paid by PE fund fund
Value Dividends Value + Dividends + Value
Σ
+ -
Cash-on-cash 0
Value (1+IRR) k
39. LBO deal case. General structure
Current New investor 1
shareholders (PE fund)
New investor 2
(PE/mezzanine
fund)
Ownership
Equity New investor 3
(Bank)
Subordinated
notes,
convertible
notes Senior
debt
Target
Growth capital component
of LBO transaction
Capex program
39
40. LBO deal case. Valuation and funding structure
I. Valuation and structure II. Deal funding
Company financials Funding structure % mln $
Sales'12 mln $ 400 Equity contribution 30% 78
EBITDA'12 mln $ 48 Senior debt 40% 104
Net debt mln $ 20 Subordinated notes 20% 52
Noncontroling interest mln $ 15 Convertible notes 10% 26
Total 100% 261
Valuation multiples
EV/EBITDA on entry x 7 Total investments
EV/EBITDA on exit x 7
Pre-money valuation
Enterprise value mln $ 336 Entry mult x EBITDA’12-Net debt-NI
Equity value mln $ 301
Transaction issues
Growth capital investment mln $ 50
Current shareholders stake for sale % 70%
Pre-money equity valuation + growth
Post-money valuation capital
Enterprise value mln $ 386
Equity value mln $ 351
Total investments mln $ 261 Stake for sale x Equity pre-money
Cash out mln $ 211 valuation + growth capital
Cash in mln $ 50
41. LBO deal case. Debt & equity parameters
I. Senior debt
Term years 8
Interest rate % 8%
Principal amount mln $ 104
Repayment annuity payments
II. Subordinated notes
Term years 8
Cash interest rate % 10%
PIK interest % 4%
Principal amount mln $ 52
Conversion warrant -
III. Convertible notes
Term before conversion years min (10; new investment round)
Conversion price 10 years 1,5 x entry valuation
new round 0,8 x new investor valuation
Interest rate % 8%
Principal amount mln $ 26
IV. Common equity
Dividend payout ratio % 10%
Par value mln $ 78
44. LBO deal case. BS entries
A 1
mln $ 2012 Adjustments 2013
I. Non current assets
PP&E 100 Capex from new investment proceeds 145
Intangibles 10 10
Goodwill 0 Pre money equity valuation – Initial shareholders equity 201
Total non current assets 110 356
II. Current assets
Cash 80 3
Inventories 25 25
Reveivables 20 20
Total current assets 125 47
Total assets 235 404
III. Long term liabilities
Existing loan facility 100 Debt repayment from cumulative cash and operating cash flow of 2013 0
Senior debt 0 Principal amount – repayment of principal in 2013 99
Subordinated notes 0 Value of the notes issued in 2013 52
Convertible notes 0 Value of the notes issued in 2013 26
Total long term liabilities 100 178
IV. Current liabilities
Current portion of long term debt 0 0
Payables 20 20
Total current liabilities 20 20
V. Equity
Shareholders equity 100 Pre-money equity*(1-cash out stake)+equity contribution by PE+NI-dividends 191
Noncontrolling interest 15 15
Total equity 115 206
Total equity & liabilities 235 403
45. LBO deal case. BS forecast
A 1 2 3 4 5 6 7 8
mln $ 2012 2013 2014 2015 2016 2017 2018 2019 2020
I. Non current assets
PP&E 100 145 145 145 145 145 145 145 145
Intangibles 10 10 10 10 10 10 10 10 10
Goodwill 0 201 201 201 201 201 201 201 201
Total non current assets 110 356 356 356 356 356 356 356 356
II. Current assets
Cash 80 3 8 19 46 77 111 146 181
Inventories 25 25 25 25 26 28 29 30 30
Reveivables 20 20 20 21 23 25 25 26 26
Total current assets 125 47 52 65 94 130 165 201 238
Total assets 235 404 409 421 451 487 522 558 594
III. Long term liabilities
Existing loan facility 100 0 0 0 0 0 0 0 0
Senior debt 0 99 89 78 66 53 40 25 8
Subordinated notes 0 52 54 56 59 61 64 66 69
Convertible notes 0 26 26 26 26 26 26 26 26
Total long term liabilities 100 178 170 161 151 141 129 117 103
IV. Current liabilities
Current portion of long term debt 0 0 0 0 0 0 0 0 0
Payables 20 20 20 20 21 23 23 24 24
Total current liabilities 20 20 20 20 21 23 23 24 24
V. Equity
Shareholders equity 100 191 204 225 263 308 354 402 452
Noncontrolling interest 15 15 15 15 15 15 15 15 15
Total equity 115 206 219 240 278 323 369 417 467
Total equity & liabilities 235 403 408 421 450 486 521 557 594
49. Exit strategies. Returns on exit
Alternative
Valuation
Valuation
scenario: fully
equity financed
buyout
PE fund equity
PE fund equity PE fund equity
Convertible
Convertible notes
notes
Subordinated Subordinated PE fund equity
notes notes
Senior Senior
Debt Debt
2013 2017 Time 2013 2017 Time
49
51. Due diligence types
Due diligence Due Diligence types
• Typically takes 4-5 weeks Commercial
• Can be organized through
VDR (Vendor Data Room)
• Serves as a basis for Operational
negotiations on warranties,
indemnities
• Possible adjustment to Financial and
EBITDA and purchase price
may be negotiated based on
tax
due diligence results
Legal
Environmental
51
52. Due diligence consultants
Commercial Financial and tax Legal
Large deals Mid-size deals Generalists
Mid-size deals
Mid-to-small deals
Law firms
Mid-to-small deals
Also doing transaction
documentation
52
54. A typical example of deal structuring in Russia
Shareholder A Shareholder B Shareholder C
100% 100% 100%
BVICo BVICo BVICo
30% 30% 40%
Shareholders’ Agreement
Cyprus HoldCo Buyer SPV
Sale and Purchase Agreement
Joint 50% 50%
Venture
Cyprus SPV
100%
Russian
LLC/CJSC
Source: Goltsblat, Salans 54
55. Why English law is used in Russian transactions?
Use of legal concepts not available
Key merits of English law under Russian law or untested in
Russian courts. For example:
• Flexible • representations, warranties,
• Adaptable indemnities
• Commercial • put and call options
• Freedom of contract • drag and tag along
• Predictable • conditions precedent
• Reputable judiciary • restrictive and negative covenants
• Common law and precedents • retention and escrow accounts
• deadlock mechanisms
• English law is widely used in international transactions (often in conjunction with local laws)
across a variety of jurisdictions, including on many deals in the Middle East, Africa, Singapore,
Hong Kong, China, India, Russia and the CIS
• English law is a common law system, based on a combination of legislation and case
precedent. This makes English law flexible, adaptable and practical
• The laws and rules themselves are less prescriptive when interpreting the intentions and
actions of the parties and instead the courts will interpret what the parties have written in the
contract
• English courts have a strong reputation for reaching fair, balanced and unbiased judgments
and rulings
Source: Goltsblat, Salans 55
56. Typical deal documents for PE transactions
NDA - non-disclosure agreement, is a legal contract that outlines
confidential information that the parties wish to share with one another for
NDA certain purposes, but wish to restrict access to or by third parties. NDA
protects confidential nonpublic business information
LOI/MOU - letter of intent/ memorandum of understanding is a
document outlining an agreement between two or more parties before the
LOI/ MOU
agreement is finalized, written in letter form and focuses on the parties'
intentions. Non-binding.
TS - term sheet is a bullet-point document outlining the material terms and
TS conditions of a potential deal. After execution TS guides legal counsels in
preparation of a final agreement (SPA, SHA). Non-binding.
SHA - shareholders’ agreement is an agreement among a company’s
SHA shareholders describing how the company should be operated and the
shareholders' rights and obligations. Binding.
SPA - share purchase agreement is a legal contract which outlines terms
SPA
and conditions for acquiring a company's shares Binding.
56
57. NDA
NDA - non-disclosure agreement, is a legal contract that outlines
confidential information that the parties wish to share with one another for
NDA certain purposes, but wish to restrict access to or by third parties. NDA
protects confidential nonpublic business information
LOI/MOU - letter of intent/ memorandum of understanding is a
document outlining an agreement between two or more parties before the
LOI/ MOU
agreement is finalized, written in letter form and focuses on the parties'
intentions. Non-binding.
TS - term sheet is a bullet-point document outlining the material terms and
TS conditions of a potential deal. After execution TS guides legal counsels in
preparation of a final agreement (SPA, SHA). Non-binding.
SHA - shareholders’ agreement is an agreement among a company’s
SHA shareholders describing how the company should be operated and the
shareholders' rights and obligations. Binding.
SPA - share purchase agreement is a legal contract which outlines terms
SPA
and conditions for acquiring a company's shares Binding.
57
58. NDA
Common issues addressed
• Parties
• The definition of information to be held confidential
• The exclusions from what must be kept confidential
• The disclosure period - information not disclosed during the disclosure
period (e.g., one year after the date of the NDA) is not deemed
confidential
• The term (time period) of the confidentiality
• Obligations of the recipient regarding the confidential information
• Insider trading (in case of public company)
• The law and jurisdiction governing the parties
However, it is hard to prove breach of an agreement and quantify losses, so
typically NDA is just a formality…
58
59. LOI/ MOU
NDA - non-disclosure agreement, is a legal contract that outlines
confidential information that the parties wish to share with one another for
NDA certain purposes, but wish to restrict access to or by third parties. NDA
protects confidential nonpublic business information
LOI/MOU - letter of intent/ memorandum of understanding is a
document outlining an agreement between two or more parties before the
LOI/ MOU
agreement is finalized, written in letter form and focuses on the parties'
intentions. Non-binding.
TS - term sheet is a bullet-point document outlining the material terms and
TS conditions of a potential deal. After execution TS guides legal counsels in
preparation of a final agreement (SPA, SHA). Non-binding.
SHA - shareholders’ agreement is an agreement among a company’s
SHA shareholders describing how the company should be operated and the
shareholders' rights and obligations. Binding.
SPA - share purchase agreement is a legal contract which outlines terms
SPA
and conditions for acquiring a company's shares Binding.
59
60. LOI/ MOU
Common issues addressed
• Parties
• Consideration - price for the assets and business to be purchased
• Term Sheet
• Timing for Term Sheet signing and transaction completion
• Public announcements restrictions
• Non-binding nature of the document
Differences between LOI/MOU
• LOI outlines the intent of one party toward another with regard to an
agreement, and may only be signed by the party expressing intent
• MOU must be signed by all parties to be a valid outline of an
agreement
60
61. Term Sheet
NDA - non-disclosure agreement, is a legal contract that outlines
confidential information that the parties wish to share with one another for
NDA certain purposes, but wish to restrict access to or by third parties. NDA
protects confidential nonpublic business information
LOI/MOU - letter of intent/ memorandum of understanding is a
document outlining an agreement between two or more parties before the
LOI/ MOU
agreement is finalized, written in letter form and focuses on the parties'
intentions. Non-binding.
TS - term sheet is a bullet-point document outlining the material terms and
TS conditions of a potential deal. After execution TS guides legal counsels in
preparation of a final agreement (SPA, SHA). Non-binding.
SHA - shareholders’ agreement is an agreement among a company’s
SHA shareholders describing how the company should be operated and the
shareholders' rights and obligations. Binding.
SPA - share purchase agreement is a legal contract which outlines terms
SPA
and conditions for acquiring a company's shares Binding.
61
62. Term Sheet
Common issues addressed
• Parties
• Total price consideration, formula for calculation, adjustments
• Debt and working capital
• Payment tranches
• Transaction calendar and deal closing date
• Short list of conditions precedent, representations and warranties,
existence of certain indemnities
• Exclusivity
• Break-up fee
• Subject to due diligence
• Confidentiality
• Governing law
62
63. SHA/SPA
NDA - non-disclosure agreement, is a legal contract that outlines
confidential information that the parties wish to share with one another for
NDA certain purposes, but wish to restrict access to or by third parties. NDA
protects confidential nonpublic business information
LOI/MOU - letter of intent/ memorandum of understanding is a
document outlining an agreement between two or more parties before the
LOI/ MOU
agreement is finalized, written in letter form and focuses on the parties'
intentions. Non-binding.
TS - term sheet is a bullet-point document outlining the material terms and
TS conditions of a potential deal. After execution TS guides legal counsels in
preparation of a final agreement (SPA, SHA). Non-binding.
SHA - shareholders’ agreement is an agreement among a company’s
SHA shareholders describing how the company should be operated and the
shareholders' rights and obligations. Binding.
SPA - share purchase agreement is a legal contract which outlines terms
SPA
and conditions for acquiring a company's shares Binding.
63
64. Deal structuring entails negotiations
SPA I win
structuring I win You win
You lose =
DEAL
I lose I lose
SHA You lose You win
structuring
64
65. SPA related deal structuring
SPA I win
structuring I win You win
You lose =
DEAL
I lose I lose
SHA You lose You win
structuring
65
66. Representations, warranties and indemnities
Representations
• Representations are statements by one party (usually the seller) which induce
another party (usually the purchaser) to enter into a contract
• If the statement relied on is untrue or incorrect and the position misrepresented, the
other party may be entitled to terminate or rescind the contract and/or claim
damages
Warranties
• Warranties are terms of a contract which, if breached, will entitle the innocent
party to claim damages
• The contractual measure of damages aim to put the innocent party in the
position it would have been in had the breach not occurred
• Used in order to provide reassurance from the seller on factual matters or future
promises concerning the status of the target company and its business, assets,
liabilities and financial position
Possible warranties (but not limited to):
• Accuracy of financial information • Employment arrangements
• Ownership of assets • Recent material changes to the business
• Nature and extent of contracts • Intellectual property, appropriate licences
• Absence of any disputes • Share structure and ownership of the target
Source: Goltsblat, Salans 66
67. Representations, warranties and indemnities
Indemnities
• Indemnity is a promise to reimburse the buyer in respect of a particular type of
liability, should it arise
• Easier to establish than a warranty claim as there is no need to calculate loss
• Used where there is a known or potential, clearly identifiable liability, the risk of
which is to be borne by the party giving the indemnity, such as unpaid tax, a
potential environmental claim, or a specific issue arising from due diligence
• Warranties may be given on an indemnity basis
Tax deed
• Tax dead is a document containing tax indemnities
• If there are any unexpected tax problems associated with the target, the buyer
will expect that the price is reduced by an amount equal to the consequential tax
liability (buyer’s protection)
• The tax deed also contains lengthy provisions limiting the ability of the buyer to
bring claims under the tax deed (seller’s protection)
Indemnity security
• Retention, escrow accounts
• Pledge over assets
• Parent guarantee
Source: Goltsblat, Salans 67
68. Purchase price/ consideration
Purchase price mechanisms
• Completion accounts mechanism may be included, whereby an audit of the
target company and its business is conducted and the purchase price is
adjusted.
• The completion accounts process includes accounting assumptions and
valuation methodology or formula for price calculation.
• Contracts will sometimes also include deferred consideration payments at
agreed stages after completion
• Escrow accounts can be used, while money is deposited with a third party, who
holds it ‘in escrow’ for the parties and only releases it in accordance with the
terms of the escrow contract
• These can sometimes be linked to earn-out provisions, which compare future
economic performance against agreed targets (such as revenue or profits) and
then adjust the deferred payments according to whether or not these targets are
met.
• Price can be adjusted both sides according to ratchet scheme
Source: Goltsblat, Salans 68
69. Conditions precedent
Conditions precedent
• Conditions precedent (CPs) are clauses which provide that certain parts of the
contract will only come into force if and when agreed conditions are met
• There is no obligation to complete the transaction until the CPs are met. If SPA is
signed the buyer has no obligation to pay until the CPs are met
• The contract will typically include provisions dealing with the legal obligations of
the parties pending satisfaction of all the conditions and the efforts to which they
must go in order to achieve satisfaction of the CPs themselves
Possible CPs (but not limited to):
• Obtaining anti-monopoly approval
• Bank consent
• Change of control
• Approvals from key customers and suppliers to assign contracts
• Investment Committee approval
• Absence of any material adverse change in the financial condition of the target
Termination rights
• Material adverse change
• Material breach of warranty
Source: Goltsblat, Salans 69
70. Restrictive covenants
• Restrictive covenants are contractual promises, preventing the seller of the
business from competing with the business sold (non-compete), together with
non-poaching undertakings in relation to key staff, suppliers and customers
(non-solicit).
• They must be restricted in time and scope to be effective and enforceable
Source: Goltsblat, Salans 70
71. SHA related deal structuring
SPA I win
structuring I win You win
You lose =
DEAL
I lose I lose
SHA You lose You win
structuring
71
72. Put and call options
Put option
Right to put its
shares on Party B
• The right, not an obligation
Party A Party B • Put and call options should
Obligation to pay $ contain price of execution,
to Party A terms and possible triggers.
50% • Put price may be linked to IRR
shareholding 50%
shareholding or cash-on-cash multiple of the
(subject to
‘put’ right) Company investor
• May be used to give an exit
strategy or as an enforcement
Call option
mechanism on default under
Right to call for
shares from Party A
shareholders’ agreements
Party A Party B • Redemption shares are often
used as a ‘soft’ put option, but
Obligation to transfer
shares to party B, in can be redeemed only from net
exchange for $ profit
50% payment
50%
shareholding
shareholding • Call and put often used in
(subject to
‘call’ right) Company parallel, limiting downside as
well as upside
Source: Goltsblat, Salans 72
73. Covenants and veto rights
Covenants
• A covenant is an agreement or promise to do (positive covenant) or refrain
from doing something (negative covenant), binding on the party who gives it
Possible positive covenants: Possible negative covenants:
• Provide financial information on request • Not to issue new shares
• Inform about break of warranty • Not to dispose any material assets
• Maintain Debt/EBITDA below 3x
Veto rights
• A veto right is the right of a party to withhold its approval to a proposed course
of action or decision that requires its consent
Possible veto rights on:
• Issuing or selling shares
• Making capital expenditures over $X
• Taking loans over $X
• Terminating employment with key employees
Source: Goltsblat, Salans 73
74. Drag along and tag along
Drag along
• A drag along right allows a shareholder of
a company to force the remaining
Buyer shareholders to accept an offer from a
third party to purchase the whole
company.
• The other shareholders are then
‘dragged along’ and forced to sell their
shares at the same time and price.
• Used to give liquidity and an exit route
on an assumption that most buyers will
Party A Party B
want to acquire 100% of the company
shareholding
• The offer may also need to match or
3. Party B is exceed a minimum agreed price or
shareholding forced to
accept minimum time period before the drag
and sell its along right can be triggered
shares
Company
• The other shareholder may be given a
right to match the offer and buy the
shares itself (Right of first refusal)
Source: Goltsblat, Salans 74
75. Drag along and tag along
Tag along
• Tag along provision is a corresponding
right that entitles shareholder to
Buyer participate in a sale by the other
1. Party A shareholders at the same time and at
decides the same price per share.
to sell its
shares • The minority shareholder then ‘tags
along’ with the majority shareholder’s
sale.
• Can state that, if the tag along
procedures are not followed by the
Party A Party B
purchaser, then its attempt to buy any of
the shares is not valid and will not be
shareholding
2. Party B registered
shareholding can force
the buyer to
buy its
shares as
well
Company
Source: Goltsblat, Salans 75
76. Good leaver/ Bad leaver provisions
• Leaver provisions are contractual Possible provisions
mechanisms covering employees Good Intermediate Bad
who are also shareholders in a Leaver Leaver Leaver
company
Death Serious/ Resignation
• When an employee leaves the permanent prior to
company, he is required to transfer illness an agreed
his shares back to the company of spouse minimum
period
• Typically used for the shares granted
Serious/ Resignation Dismissal for
to managers as a motivation scheme
permanent after an gross
• Good leavers tend to receive market illness agreed misconduct
value for their shares, whereas the minimum
price paid to bad leavers tends to be period
heavily discounted Retirement at Dismissal on Dismissal for
retirement grounds of fraud
age poor or dishonesty
performance
Redundancy Breach of
restrictive
covenants
Source: Goltsblat, Salans 76
77. Other SHA tools
Upside sharing
Deadlock mechanism
Anti-dilution
Preferred shares/Liquidity preference
Corporate governance rights
77
79. Corporate governance issues
Management
Structuring Board of
compensation and
Directors
incentives programs
Corporate governance
Monitoring CEO replacement
Influence on strategy
80. Board of Directors
Structuring Board of Directors
Board size Board composition Board committees
Key point while deal 3 categories: Two main committees:
structuring (as well as entrepreneurs (founders), compensation and audit
board composition) investors, independent Compensation committee
Smaller boards – more directors area: salaries, stock option
effective in decision PE investor does not have for top managers (chaired
making a majority of board seats by independent director,
Typical PE-backed as a rule excludes CEO)
company Board – 5-7 Balanced composition: 2 Audit committee area:
members (half of a size of managers, 2 investors, 1 – compliance with legal
a public company Board) independent director (the requirements on financial
Monthly frequency of swing vote) reporting (members with
Board meeting is common Composition changes accounting expertise
for early-stage companies subject to company independent from
performance management)
81. Companies monitoring and value creation
I. Monitoring process
High frequency of interaction with Medium to high frequency of Low frequency of interaction with
management. Level: analyst + interaction with management. management. Level: VP/director +
Level: analyst/associate +
Weekly operational reports
Monthly reporting packs
BoD, committees presence, general reporting forms review
Start-ups Profitable growing Mature company Maturity of a
businesses business
II. Value creation
Negotiations
Fund team – in- Fund raising: Synergy
with external
house other funds among
consultants,
consultants for a assets as a portfolio
bankers, legal
company pledge companies
and government
authorities
82. Management incentive tools
General incentive scheme
Bonus scheme
Management share in
IRR
additional payment
min max
0% 15% 0%
16% 20% 0%
21% 25% 0%
26% 30% 0%
30% 35% 0%
35% 40% 30%
40% 50% 50%
50% 100% 70%
Example
Bonus & IRR calculation
Enterprise value $mln 423
Equity value $mln 422
Fund share $mln 396
IRR (Fund) % 57%
min IRR % 35%
Additional gain to the Management $mln 114
real IRR (Fund) % 39%