Key difference between VC (Venture Capital) Private Equity and Buyout (LBO) Private Equity
Question 1 (3 points)
What are the key difference between VC (Venture Capital) Private Equity and Buyout (LBO) Private Equity ?
Question 2 (8 points, 4 points each)
Interesting Microsoft transactions took or are taking place recently. Let’s find out about the actual prices/multiples paid (as per data available on the announcement date). Using publicly available information (and publicly available financial statements) your task is to calculate LTM (last twelve months) transaction multiples (/Revenue; /EBITDA; /EBIT) for:
1. Microsoft’s (proposed) acquisition of Activision Blizzard (announced on January 18th 2022);
2. Microsoft’s (completed) acquisition of Nuance Communications (announced on April 12th 2021);
Show your calculations. We are interested in FV/EBITDA; FV/EBIT, FV/Revenue multiples.
Question 3 (2 points)
Describe a typical acquisition capital structure in Leveraged Buyout transactions?
Question 4 (2 points)
Comment on the validity of the definitions of Minority Interests (MI) & Minority Interests Provisions (MIP) listed below ?
MI - Asset item showing our minority ownership in an entity > 50% owned by someone else.
MIP – Portion of the net income (losses) of entities that are > 50% owned by someone else.
Question 5 (2 points)
You are looking at a potential LBO target. It has no debt on its balance sheet, What impact will this fact have on expected returns (increase, decrease, no impact) to the financial investor?, and why ?
Question 6 (3 points)
ROE can be expressed in terms of ROIC (Effect of leverage).
A. How ?, show the relationship between the two performance metrics.
B. Explain the key conclusions (from Equity/Private Equity perspective) that flow out of the relationship.
Question 7 (3 points)
What is the difference between bank debt and high-yield debt?
Question 8 (2 points)
In an LBO transaction, is it possible for debt investors to get a higher return than the PE sponsor firm? Why or why not ?
Question 9 (2 points)
Explain the difference between contractual and structural subordination ?
Question 10 (3 points)
List/describe three initiatives buyer can undertake post buyout closing that are completely under his/her control. Explain how each will either lead to value creation or will prevent value destruction.
Question 11 (2 points)
From a Private Equity (Seller) perspective, list (in bullet points) key advantages and key disadvantages in arriving at the final equity price by using the Locked Box (vs. Completion Accounts) mechanisms.
Question 12 (2 points)
In a standard SPA (Share Purchase Agreement) …
A. What is a “covenant” ? Give example of one.
B. What is a “indemnity” ? Give example of one.
Question 13 (2 points)
Discuss the relative merits, strengths and weaknesses, (from the selling PE perspective) between exiting an investment via a sale to a financial buyer and a leveraged recapitalization.
Question 14 (7 points)
At closing there is a (verifiable) shortage in the Employee Pension Fund of $50.
Target owns 90% of a subsidiary company with a market capitalization (assume at closing) of $100.
Signing of the SPA is anticipated for June 30th 2023;
Closing of the transaction is anticipated for October 31st 2023 and the B/S data (above) are as expected at closing;
Closing W/C balance is equal to 1x the LTM average. LTM average is what both parties agreed to.
Verification of Company financials at closing showed that the average monthly Capex & Marketing spent between signing and closing was 50% of the $6/month agreed to and listed as a covenant to in the SPA).
Parties have agreed that within a week after closing the Buyer will make to a $20 bonus payment to the current/exiting management team.
Between Signing and Closing the business generates $10/month of FCF which is accumulating on the Balance Sheet.
Assuming that the seller and the buyer are both rational individuals and that they will manage to negotiate what economically belongs to each of them ... what will be the:
1. Price listed in the SPA;
2. Will it (point 1 just above) be a Firm Value or Equity Value price listed in the SPA?
3. Ultimate price or price/share paid to the seller at/around closing.
Sample Solution
Venture Capital (VC)- Investment Stage: VCs invest in early-stage companies, typically with high growth potential. They provide capital for these companies to develop new products or services, expand into new markets, or make other strategic investments.
- Investment Horizon: VCs typically have a long-term investment horizon, as they may need to wait several years for their investments to mature.
Full Answer Section
- Expected Return: VCs typically expect to generate high returns on their investments, as they are taking on a higher level of risk.
- Investment Stage: LBOs typically invest in established companies, often with profitable businesses. They acquire these companies through leveraged buyouts, which means using debt to finance the acquisition.
- Investment Horizon: LBOs typically have a shorter investment horizon than VCs, as they are looking to generate profits in a shorter period of time.
- Expected Return: LBOs typically expect to generate lower returns on their investments than VCs, as they are taking on a lower level of risk.
| Feature | Venture Capital (VC) | Buyout (LBO) |
|---|---|---|
| Investment Stage | Early-stage companies | Established companies |
| Investment Horizon | Long-term | Short-term |
| Expected Return | High | Low |
| Risk | High | Low |
| Leverage | Low | High |
| Exit Strategy | IPO, trade sale | Trade sale |
- VCs typically focus on industries with high growth potential, such as technology, healthcare, and life sciences.
- LBOs typically focus on industries with stable cash flows, such as consumer staples, industrials, and financial services.
- VCs typically invest in companies with strong management teams and clear growth strategies.
- LBOs typically invest in companies with undervalued assets or that can be improved through operational changes.