A THOROUGH UNDERSTANDING OF PRIVATE EQUITY

RETOUR SOMMAIRE

A CACEIS PRODUCT DEVELOPMENT PUBLICATION - 2010

INDUSTRY OVERVIEW

and dismantling them, as was their rap in the 1980s, private equity firms… squeeze more profit out of underperforming companies. But whether today’s private equity firms are simply a regurgitation of their counterparts in the 1980s…or a kinder, gentler version, one thing remains clear: private equity is now enjoying a Golden Age. And with returns that triple the S&P 500, it’s no wonder they are challenging the public markets for supremacy.” 4 This buyout boom was not limited to the United States, as industrialised countries in Europe and the Asia-Pacific region also experienced new records set. Post bubble, private equity firms were looking for investment opportunities where the business has proven potential for realistic growth in an expanding market, backed up by a well researched and documented business plan and experienced management. Furthermore, with depressed markets and company valu- ations, private equity funds were able to cut better deals at lower prices. T he credit crunch and the ensuing economic downturn (2007-2009) In July 2007, the turmoil that had been affecting the mortgage markets spilled over into the leveraged finance and high-yield debt markets. By the end of September, the full extent of the credit situation became obvious as major lenders including Citigroup and UBS AG an- nounced major write-downs due to credit losses. Once again, private equity was entering a bust cycle. Fund raising collapsed following the credit crunch and in the first half of 2009, was occurring at half the rate of 2007 and 2008 levels. At the same time, private equity firms were forced to use less leverage in the acquisition of companies. In the following section, themain concepts of private equity will be explained to provide readers a clearer picture of the mechanisms of this complex asset class: limited partnerships, investee companies, fund raising, capital calls and investment periods, management fees, distributions, fund structures, primary and secondary funds will be covered. L imited partnership The private equity investment model is based on the alignment of interests 5 between a pri- vate equity firm/manager ( the General Partner – GP ), its investors ( Limited Partners – LPs ) and the management teams they support 6 . These parties are generally linked together by a legal structure called a limited partnership , used by many private equity funds. A limited partnership usually has a fixed duration: the GP manages and monitors the invest- ments in order to obtain the highest value at the time of exit. If some of the investments run beyond the fund’s maturity date, the limited partnership can be extended until all invest- ments are realised (i.e. trade sale, Initial Public Offering (IPO), or recapitalisation). When all investments are fully divested, the limited partnership is wound up. A private equity fund is typically governed by its limited partnership agreement , which states the economic and contractual rights between the GP and the LPs. Among the im- portant terms and conditions generally found in a limited partnership agreement are target investments and investment restrictions which set forth what the fund is expected and per- mitted to invest in, the terms on which the LPs may replace the GP and the fund’s govern- ance structure, as well as the contributions terms and the timing and manner in which a 4 Source: USA Today, “Private equity firms spin off cash” by Matt Kranz, March 16, 2006 5 Nota: In November 2009, the International Organisation of Securities Commissions (IOSCO) released a consultation report on private equity conflicts of interest, setting out a number of principles for effective mitigation of conflicts of interest in private equity. 6 The roles and responsibilities of these players are described in chapter 2.1. Main concepts of private equity

1.1.3

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