PRIVATE EQUITY

Viney Sawhney <sawhney@fas.harvard.edu> Introduction Course Description This course is the study of private equity money invested in companies that are not publicly traded on a stock exchange or invested in as part of buyouts of publicly traded companies. The objective of the course is to provide an comprehensive overview and in-depth understanding of the private equity markets. Private equity finance will be explored from a number of perspectives, beginning with the structure and objectives of private equity funds; followed by the analysis and financing of investment opportunities; and finally crafting harvesting strategies for investments. There has been an increase in both the supply of and demand for private equity. On the supply side, the amount of private equity under management - by partnerships investing in private equity, growth investments, leveraged buyouts, distressed companies, real estate, etc. - has increased dramatically in recent years. On the demand side, an increasing number of individuals and companies are interested in starting and growing their respective businesses. Collectively, small and medium businesses are focused in gaining access to Private Equity and understanding the dynamics of this unique funding source. Course objectives The main objective of the course is to provide students with the necessary theoretical and conceptual tools used in private equity deals. The course provides the intellectual framework used in the private equity process, valuation in private equity settings, creating term sheets, the process of due diligence and deal structuring. Other learning objectives include building an understanding of harvesting through IPO or M&A, public-private partnerships and sovereign wealth funds. The final objective of this course is to show how corporate governance, ethics and legal considerations factor into private equity deals. Appropriate for Students Pursuing: This course is appropriate for students pursuing a career in private equity and for students who wish to broaden their understanding of finance by applying financial concepts and techniques to analyze activities and enterprises in the private equity market. Main Topics 1) Private Equity Process 2) Valuation and Term Sheets 3) Deal Structuring 4) Harvesting 5) Due Diligence 6) Public-Private Partnerships 7) Sovereign Wealth Funds 8) Legal, Ethical and Governance Issues in Private Equity Settings

Course Evaluation The grading of the course will be based on the following weighting scheme: Class Participation: 20% Discussion on Financial Articles: 30% Mid-term Group Presentation: 20% Final Group Case Presentation: 30%

The course will be taught in the form of lectures together with case studies intended for in class discussion. Each week students shall be e-mailed three select articles from leading financial publications, e.g., Financial Times, Wall Street Journal, New York Times. Each student will be part of a study group made up of at least three members. Weighting for class participation will be derived from individual assignments and class discussion on case studies. Teaching Method This course will have a number of different dimensions including: Lectures Case Analysis Guest speakers from industry and academia Group Presentations Course Textbook Cendrowski, Harry, Martin, James P., Petro, Louis W., and Wadecki, Adam A, Private Equity: History, Governance, and Operations (Wiley Finance) (May 1, 2012)

SYLLABUS

Session 1: THE PRIVATE EQUITY PROCESS This session introduces the private equity process, the terms and how value is created. This session covers the private equity process from initially determining the size of the fund, through fund raising, sourcing portfolio investments, acquiring the portfolio companies and converting equity value back to cash by liquidating portfolio holdings. The means by which private equity firms create value and enhance the valuation of their portfolio is also covered. Required Reading: A Note on Private Equity Partnership Agreements, 1994, HBS publication 9-294-084 Cendrowski, Harry, Martin, James P., Petro, Louis W., and Wadecki, Adam A, Private Equity, History, Governance, and Operations, John Wiley & Sons (New York, NY, 2012), Ch 1 A Note on Private Equity Fund-Raising, 2000, HBS Publication # 9-201-042 Cases: Gobi Partners: Raising Fund II, 2007, HBS Case #9-807-093. The three founding partners of Gobi Partners, a venture capital fund investing in early start IT and digital media companies in China, are planning to raise a second fund. The first $51.75 million fund is close to being entirely invested and the portfolio companies are doing well, with two having raised subsequent financings at significantly increased valuations. The firm itself has increased its headcount and opened a second office, but it has not, however, exited any of its companies. How much money should the partners hope to raise, and from whom? The stakes are high, as none of them has taken a paycheck in three years. Session 2: THE PROCESS OF INVESTMENT Provides a broad overview of the evolution of the private equity industry. Introduces the objectives and perspectives of institutional investors in private equity funds and highlights the incentive and information problems that private investors in private equity funds face and their responses to these problems. Required Reading: A Note on Private Equity Securities, 1999, HBS Publication # 9-200-027 Case: Yale University Investments Office: August 2006, 2007, HBS Case # 9-807-073 The Yale Investments Office must decide whether to continue to allocate the bulk of the university's endowment to illiquid investments-hedge funds, private equity, real estate, and so forth. This case considers the risks and benefits of a different asset allocation strategy and highlights the choice between different subclasses, e.g., between venture capital and leveraged buyout funds.

Session 3: VALUATION AND CAPITAL STRUCTURE

This session covers valuation techniques in a highly leveraged setting, including a discussion of how private equity firms create value and how deals are structured to realize such value. Required Reading: A Note on Valuation in Private Equity Settings, 1996, HBS Publication # 9-297-050 Case: Hertz Corporation (A) and (B), 2007, HBS Case #9-208-030. Examines the leveraged buyout of Hertz in 2005, a complex, high-profile deal and a good example of cutting-edge practice in private equity. The first of a two-part series on the Hertz LBO, adopts the perspective of Clayton, Dubilier & Rice, the leader of a private equity consortium bidding to buy Hertz from Ford in an auction. Set at the final round of the auction, the immediate problem for the consortium is how much to raise its previous bid. A reasonable bid must be based upon how much value the private equity consortium can create through improvements in Hertz's global operations on the one hand, and a more efficient capital structure on the other. Session 4: STRUCTURING TERM SHEETS This session covers the elements and characteristics of term sheets. Also seeks to sharpen students' understanding of how to compare term sheets and how to select the best term sheet given the likely evolution of a venture. Case: Term Sheet Negotiations for Trendsetter, Inc., 2004, HBS Case #9-801-358 Describes two aspiring entrepreneurs who have just received offering documents for venture funding (known as term sheets) from two venture capital firms. Neither of the entrepreneurs have experience in raising capital and they are wondering how to compare the two proposals and which one to choose. They need to make a decision fast. The documents contain two complete term sheets which are similar in structure but different in important ways. Both term sheets have advantages and disadvantages for the entrepreneurs. Choosing one over the other requires a careful analysis as well as a certain set of assumptions about the growth of Trendsetter, Inc. Session 5: HARVESTING INVESTMENTS THROUGH IPO This session describes the Initial Public Offering process and the role private equity firms in harvesting investments through IPOs. An exit mechanism of harvesting a growing and profitable business is going public and selling the stock in the open market through an IPO. Exiting shareholders and incoming investors have the marketplace, as the ultimate valuing mechanism, to determine the share price. This session examines how a successful IPO can provide high valuation and can generate an infusion of cash for the firm's future growth. Required Reading: Cendrowski, Harry, Martin, James P., Petro, Louis W., and Wadecki, Adam A, Private Equity, History, Governance, and Operations, John Wiley & Sons (New York, NY, 2012), Ch 4 Note on the Initial Public Offering Process, 1999, HBS Publication # 9-200-018 Case: Warburg Pincus and emgs: The IPO Decision (A), 2007, HBS Case #9-807-092. Two partners of Warburg Pincus, a global private equity firm, are trying to decide whether to take a portfolio company public, and on what exchange. The company, Norway-based ElectroMagnetic GeoServices (emgs), has developed a market-leading technology that determines whether an undersea rock formation contains oil--prior to the oil company drilling a hole. With its high-growth characteristics, emgs is very different from the typical oilfield services company, and would be more suitable for floating on the NYSE or LSE, where liquidity and valuations would also be greater than on the Oslo Bors, the other possibility. Yet floating in the U.S. would involve greater compliance expense and

might also require the management team to move to New York or Houston, something the team is reluctant to do. The partners need to decide what to do before the IPO window for energy-related companies closes.
Session 6: EXIT STRATEGIES FOR MULTIPLE STAKEHOLDERS This session introduce students to exiting an investment To raise the questions of when to exit an investment and why To introduce a variety of exit options and to discuss the pros and cons of each To introduce the concept of multiple stakeholders in a company who do not necessarily share the same attitude towards the exit, but whose concerns need to be satisfied or at least addressed To provide the opportunity to analyze market conditions as they relate to exit alternatives To consider valuation in different scenarios To consider the impact of terms negotiated at the time of making an investment. Required Reading: Cendrowski, Harry, Martin, James P., Petro, Louis W., and Wadecki, Adam A, Private Equity, History, Governance, and Operations, John Wiley & Sons (New York, NY, 2012), Ch 5 Case: Workbrain Corp. - A Case in Exit Strategy, 2007, Publication 907N07. The chief financial officer (CFO) of Workbrain Corporation must prepare a memo for the upcoming board of directors meeting. Workbrain, a venture-backed company, has grown substantially since its founding in November 1999. Now the CFO must communicate to the board whether it is time to consider an initial public offering (IPO) and, if so, in which exchange market the stock should be offered. The company must also consider what financing alternatives are available (including maintaining the current venture financing arrangement) and whether the company needs to raise money at all. Session 7: DUE DILIGENCE This session covers the intellectual framework necessary to perform due diligence in private equity settings. All potential issues must be uncovered because they affect the price investors will pay for the company. This session discusses the challenges to due diligence in the private equity environment and provides the framework and guidance to conduct private equity investment due diligence. Required Reading: Cendrowski, Harry, Martin, James P., Petro, Louis W., and Wadecki, Adam A, Private Equity, History, Governance, and Operations, John Wiley & Sons (New York, NY, 2012), Ch 9 A Guide to Private Equity Fund Investment Due Diligence, 2005, Private Equity International Cases: AIT Group Plc., 2003, HBS Case # 9-803-104. A U.S. venture capital firm has just learned that the deal structure for purchasing an illiquid U.K. software firm is unacceptable to institutional investors. The group must decide if it still wants to go through with the deal. This decision hinges on whether the investors are confident that their due diligence has uncovered all the issues that affect the price investors will pay for the company.

Session 8: MID-TERM ASSIGNMENT AND PRESENTATION

The mid-term will be a study group activity, and the deliverable shall be a group presentation. Each study group will be assigned a private equity case, and each group shall give a presentation to demonstrate their understanding of the techniques and key issues of in private equity investments. The duration of presentations in classroom shall not exceed 20 minutes per group. Session 9: PUBLIC INFRASTRUCTURE INVESTMENTS This session introduces Public-Private Partnerships (PPPs) and describes situations in which they are better than conventional, regulated privatization. This section examines the PPP framework for infrastructure development and addresses obstacles and benefits in the worldwide applications of PPP. Lastly, institutional requirements for a successful PPP are examined, including study of the proper structuring and governance of a PPP contract. Required Reading: Towards a Comprehensive Understanding of Public Private Partnerships for Infrastructure Development, 2009, HBS Publication CMR-418 A Note on Private Equity in Developing Countries, 2007, HBS Publication # 9-208-037 Case: IDFC India: Infrastructure Investment Intermediaries, 2010, HBS Case 9-210-050. Indian financial intermediary matching international capital to local infrastructure decides how to balance range of services, risk adjusted return, margin pressure, and nation building. IDFC was chartered with partial ownership from the Indian government to help evaluate policy and be a model for how private finance could be attracted to public infrastructure. As the nation and company grow, the firm also grows and embarks on a strategy of rapid expansion, offering a wide new range of financial products, and participating in many aspects of the supply chain. Session 10: SOVERIGN WEALTH FUNDS The session describes the various types and origins of sovereign wealth funds (SWFs), their orientation, and their recent intensive investment activity in the global financial-services sector. The transparency of SWFs and their role in the global financial system as liquidity-providing long-term players is also discussed. This session also covers the factors to be considered when making a decision to issue capital and place it with sovereign wealth funds. Required Reading: The Case of Sovereign Wealth Funds: A New (Old) Force in the Capital Markets, 2008, HBS Publication # UV1059 Case: Capital Alliance Private Equity: Creating a Private Equity Leader in Nigeria, 1999, HBS Case # 800104. This case describes the creation of the first private equity fund in Nigeria and the fund's potential first investment in GS Telecom, a Nigerian telecommunication service company. The fund's managers are keenly aware that a bad first investment could create a vicious circle for the fund. Thus, whether to invest and under what terms is of crucial importance.

Session 11: PRIVATE EQUITY INVESTMENTS IN DEVELOPING MARKETS

This session provides a basis for discussing what private equity is, how a private equity firm operates and how private equity investments in developing markets differ from those in developed markets. Required Reading: Note on Private Equity Deal Structures, Tuck School of Business at Dartmouth, 2005, Case # 5-0006 Case: Southern Cross Latin America Private Equity Fund, 2008, IES198. The case provides a basis for discussing what private equity is, how a private equity firm operates and how private equity investments in developing markets differ from those in developed markets. Session 12: PRIVTE EQUITY, CORPORATE GOVERNANCE AND ETHICS This session is devoted to cultural, legal, ethical and moral issues surrounding the use of private equity. Matters of confidentiality, transparency, corporate governance, self-regulation and legislative acts are addressed. Also examined are the legal and ethical responsibilities of corporate directors and officers, executives, managers and employees at all levels. Required Reading: Corporate social responsibility, corporate governance, and financial performance: Lessons from finance, 2008, HBS Publication # BH304. Case: Governance Failure at Satyam, 2011, Publication # W11095. This case illustrate types of corporate governance problems; examine how related party transactions can be used as a tool for committing fraud; examine ethical standards and obligations of the board of directors with regard to its monitoring and supervision role; explore the issues related to directors' remuneration; examine the role of internal as well as external auditors; examine the effectiveness of the presence and composition of various board committees; explore the possibilities of how to improve the existing legal system; suggest what steps should be taken to prevent such fraud.

Session 13: SOURCING OF PRIVATE EQUITY DEALS AND MANAGEMENT OF PORTFOLIO COMPANY EXPECTATIONS The buyout funds goal of deal sourcing is to find high quality deals. This session covers the types of deals, the models for finding deals and that the factors that lead to deals with high returns. Sourcing, and evaluation, firm reputation, specialization and competitive advantage are addressed. Required Reading: Evaluating a General Partners Deal Flow Considerations for gauging this important determinant of success. Megrue, John F., Jr. Case: Carlyle Japan (A), 2008, HBS Case # 9-508-092. Carlyle Japan wants to formulate a strategy to improve his firm's ability to source high quality deals at competitive valuations. Since the profitability of a buyout depends on finding high quality deals, the firm has focused on leveraging its contacts in the Japanese banking business. These contacts have brought to Carlyle a number of good quality companies, but the volume of buyouts done by Carlyle in Japan is low.

Session 14: NEGOTIATION IN A HOSTILE TAKEOVER SETTING

In a team environment and students will participate in a mock negotiation session. Roles will be assigned and a format shall be distributed in advance describing the framework of negotiations. Learning objective: To provide an opportunity to explore the factors influencing the market for corporate control and the boardroom dynamics of hostile takeovers. At issue is whether Cyanamid's board will endorse AHP's hostile offer even though management does not support the offer and instead supports a lower-valued friendly asset swap with SmithKline Beecham.. Case: American Cyanamid (A) Boardroom Response to a Hostile Takeover Offer & (B) Managements Response (Combined Case Studies A & B) 1997, HBS Case # 9-898-120. American Home Products' (AHP) $9 billion hostile takeover of American Cyanamid (Cyanamid) was the largest merger-andacquisition transaction in 1994, and made AHP the fourth largest pharmaceutical firm in the United States. At the time of AHP's offer, Cyanamid had already begun to restructure by selling its consumer products businesses, spinning off its chemicals division, and entering into asset swap negotiations with SmithKline Beecham. AHP entered the fray, at least in part, to block the asset swap deal. The case takes students inside the board room and describes the tension generated by the different views of Cyanamid management and its outside directors on the desirability of the takeover. After a tense and painful board meeting that lasted several days, the board voted unanimously to support the offer. A rewritten version of two earlier cases.

Session 15: GROUP CASE WRITE-UP AND FINAL PRESENTATION

Study groups research would require analysis of a particular private equity investment. Time permitted for each group presentation is restricted to 30 minutes. The cases will be distributed two weeks in advance.