Private Equity

MODULE 1
PRIVATE EQUITY
AND VENTURE
CAPITAL
By Professor Stefano Caselli
Universit Bocconi and SDA Bocconi
Content
1. What Is Private Equity and Venture Capital?
2.
Why Companies Need Private Equity And Venture Capital
3.
Private Equity Clusters: Through the Fund's Life Cycle
4.
Seed, Startup, and Early Stage Financing
5.
Expansion Financing
6.
Replacement Financing
7.
Vulture Financing
8.
Private Equity and Venture Capital: Today and Tomorrow Interview

with Fabio Sattin
Preliminary Definitions
The definition of Private Equity (PE) is based on two aspects, each related to the
two man characteristics of the PE relation:
PE is a source of financing: It is an alternative to other sources of
liquidity, (such as a loan or an initial public offering (IPO)) for the
company receiving the financing.
PE is an investment made by a financial institution: Private Equity
Investor (PEI) in the equity of a non-listed company (i.e. not a public
company).
Throughout the course, the definition of PE will be used in its broad meaning, which
also includes Venture Capital.
Venture Capital is a very specific case of PE. It is the investment in the very early
stages of a companys life.
3
The Need of Financing

How does the relationship between the PEI and the venture-backed company (i.e.
the company financed by the PEI) work?
The investor gets shares of the equity of the

company in return for the inflow of cash.
Venture-Backed
Company
Debt
Assets
es
shar
Equity
Private
Equity
Investor
cash
The Consequences the Financing

As a consequence, the relationship between the venture-backed company and the
PEI is based on some relevant issues:
A company needing money for a certain and clearly identified reason;
The company collects money with the issuance of equity on the private market,
the company does not pay any interest expenses to the PEI;
The newly issued shares will be bought by the PEI;
The professional investor will not only become a shareholder but will contribute
to the management of the company. The smaller the company is, the larger the
contribution of the PEI in the business management will be;
The professional investor will create profit only through the generation of capital
gain, i.e. exiting from the investment by selling shares to someone else on the
market.
The most critical aspect in PE is the strict
relationship between the investor and the
entrepreneur.
5
The Dierence between: PE and Investing in

a Public Company
PRICING
LIQUIDITY
MONITORING
Public
The price is driven

by the market,
either upwards or
downwards.
Liquidity is very high.

Whenever an investor wants
to sell the shares of the
public company there is
always a buyer.
When trading on the stock

exchange, there is always a very
high level of protection for the
shareholders, regardless their
stake in the company.
Private
The price is the

result of the
negotiation process
which be both easy
or hard.
Selling the shares is not so

easy. Since there is no stock
exchange, finding a new
shareholder can very hard
and time consuming.
The shareholders (the PEI) have

to protect themselves and the
values generated by the
company. All of the rules will be
stated in a formal agreement.
Content
1.
What Is Private Equity and Venture Capital?
2. Why Companies Need Private Equity And

Venture Capital
3.
4.
5.
Expansion Financing
6.
7.
Vulture Financing
8.
Private Equity and Venture Capital: Today and Tomorrow Interview with
Fabio Sattin
Why Would a Company Need PE?

PE is based on two aspects:
PE is a source of financing;
And PE is an investment.
but why would a company need PE? Why should a company let an external investor
sit on its board of directors and make managerial decisions? (Note: The bank would
have been an outsider.)
The venture-backed company wants to

enjoy some direct and indirect benefits
that a company can exploit when financed
by a PEI.
1. Certification Benefit
2. Network Benefit
3. Knowledge Benefit
4. Financial Benefit
8
1. The Certification Benefit

Due to the long screening phase before deciding to invest in a company, if the PEI
finally does choose to invest in the venture-backed company, in a way, that confirms
the very high quality of the companys accounts.
This can give a sign of great health of the company and this high quality can be used
as a kind of promotion for the venture-backed companys brand.
2. The Network Benefit

The PEI can give the company a very strong network, in terms of suppliers,
customers and banks therefore multiplying its possible contacts.
10
3. The Knowledge Benefit

The PEI can transfer knowledge to the company:
Soft Knowledge: the capability to manage the business
Hard Knowledge: the specific-field knowledge of a business, this applies
particularly to high-tech or pharmaceutical industries
With this knowledge, an investor can even carry the company through very hard and
difficult steps, such as a merger and acquisition (M&A) process.
The PEI plays the role of an advisor and mentor.
11
4. The Financial Benefit

The financial benefit is generated through the injection of cash in return for shares
of the venture-backed company.
The increase generates the following effect on the cost of capital:
EQUITY
RATING
Positive effect on the cost

of capital
If a company needs at least one of the four benefits,

then PE is the only choice; if not, there are other
sources of financing, each suitable for the life stage
where the company has that specific need.
12
Financing and Life Cycle of a Company

Founder
& Family
Other
Partners
Angels
Private
Equity
Banking
System
Trade
Credit
Financial
Markets
These sources are not right for the company

does not yet exist at this stage
Development
The risk is too

high for banks
(capital
requirements)
Startup
Early Growth
Mature Age
To do
something
complex
Expansion
Crisis or
decline
It goes back
to them
Maybe for an
IPO
They
disappear
13
Content
1.
2.
3. Private Equity Clusters: Through the Fund's Life Cycle

4.
5.
Expansion Financing
6.
7.
Vulture Financing
8.
Private Equity and Venture Capital: Today and Tomorrow Interview with
Fabio Sattin
The Taxonomy of PE Clusters

The life cycle of the company is important in two ways:
1. To understand if a company can use PE to accomplish its needs;
2. And to identify the different kinds of PE investment (and the right one).
As said in the first clip, the definition of PE is an umbrella definition: It identifies
as many clusters as the numbers of the companys life cycle stages as long as it (the
company) is not listed.
15

Venture Capital
Mature Age
Expansion
Early Growth
Startup
Development
Startup
Financing
Seed Financing
Time = 0:
Birth of the
company
Replacement
Financing
Expansion
Financing
Early Growth
Financing
Crisis or
decline
Vulture
Financing
Time
16

The six life stages each related to the suitable private equity investment are as follows:
1. DEVELOPMENT
The life cycle starts with development. It is the moment in which the founders start to
create and try to develop the business idea.
The corresponding investment of the PEI is seed financing.
2. STARTUP
This is when the business actually starts. For this phase, the PE investment is called
startup financing.
3. EARLY GROWTH
This represents the moment when the company start its growth. In the professional
world, this is known as the financing of the day after. The PE investment is the early
growth financing.
These kinds of investment make up the
venture capital subsample.
17

4. EXPANSION
In this phase, the sales keep on growing at a very high rate. The corresponding
investment of the PE is called expansion financing.
5. MATURE AGE
This is the moment when sales growth is stable. The PE investment is called
replacement.
6. CRISIS
In the end, when (and if) the company comes across its decline, in this case the PE
investment will be very hard and it is called vulture financing.
In each stage there is a different market and a different risk-return profile.
18

The PEI can either be a minority or a majority shareholder and depending on which
it is, approach can be different:
Hands-On: The investor provides the support a company requires under the
forms of the four benefits seen in the second clip and in addition they operate
together
with the entrepreneur.
Hands-Off: The investor provides the support the company requires in the forms
of the four benefits seen in the second clip but the PEI does not give any
additional
support.
19
Content
1.
2.
3.
4. Seed, Startup, and Early Stage Financing

5.
Expansion Financing
6.
7.
Vulture Financing
8.

with Fabio Sattin
The Venture Capital Fundamental
Venture Capital
Mature Age
Expansion
Early Growth
Startup
Development
Startup
Financing
Seed Financing
Time = 0:
Birth of the
company
Replacement
Financing
Expansion
Financing
Early Growth
Financing
Crisis or
decline
Vulture
Financing
Time
21
Seed Financing
The Seed Financing is the most complex and riskiest activity among the PE
investment.
It is the investment of an idea or of an research and development (R&D) project, it is
in fact very industry-oriented: it usually deals with the biomedical, IT, and the
pharmaceutical industries / sectors. Under seed financing, the uncertainty of the
project is high because the investor has to trust the idea of the entrepreneur. This is
why the managerial role of the investor is very limited.
There are two levels of risk:
1. The capability for the idea to generate on output
2. If there is an output: does this output have a marketability?
22
Seed Financing
Because this phase is very risky, there are three golden rules an investor needs to
know:
1. 100/10/1 RULE
The investor has to screen one hundred projects, finance ten of them and be lucky (and
able) enough to find the one successful one.
The activity is risky that you must invest on much more that one project. The investor
needs to invest a huge amount of money. The psychological threshold is one billion .
By the time the investors find the winning project they will have lost much of their
beginning investment.
2. SUDDEN DEATH RISK
Because this investment occurs before the company is founded, the investors have to
protect themselves in case the person owning the projects idea suddenly can no longer
preform his or her job.
The solution to this risk is in the Incubator Strategy, an ad hoc infrastructure in which
the inventor can work without worrying about his or her ideas being stolen.
23
Seed Financing
3. SIZE OF THE MARKET
The investors usually invest in the markets they know the best.
Despite this, in some cases, the idea may be a good one without a market willing to buy
it.
Such is the case in which the investors look for venture philanthropy, set up by nonprofit institutions with the investors themselves.
24
Startup Financing
The Startup Financing is the financing of a new company starting its own initial
operations.
The entrepreneurs and the founders need of cash derives from the necessity to buy
the necessary equipment to start (e.g. equipment, inventory, building, etc.) the
business. In this kind of financing the risk is still very high, leading to a high level of
protection for the investor.
The level of risk depends on the fact that the PEI is betting on a business plan.
Because the investor is neither a non-profit organization nor a High Net Worth
Individual (HNWI), there are several ways in which this can occur.
1. PUT OPTION
This tool is used to sell back to the entrepreneur the shares the investor bought. This
tool is quite dangerous: it assumes that if the business plan does not work, the founder
will still have money to pay off the PE. For this reason, the put option may be used
together with a second tool
25
Startup Financing
2. COLLATERAL
This is a pledge for the investor over some valuable assets of the newly founded
company and this is usually used together with the put option.
3. STOCK OPTIONS FOR THE INVENTOR
Another way to reduce the risk the business plan is not accurate and reliable is to grant
the inventor some stock options. In this way the entrepreneur will also enjoy the
profitability of the company.
4. BALANCE BETWEEN MONEY AND SHARES
The PEI needs to find the right combination between not losing all its investment (such
is the case when the PE owns 95% of the equity) and not having any say in the
management of the business (such is the case when the PEI owns 2% of the equity)
For instance, for the investor the right balance would be owning 48% of the company.
In such case the PEI would have the right to
lead the company but the founder is the
owner of the company.
26
Early Growth Financing

Early growth Financing is the financing of the first phase of growth of a new company that
has started generating sales.
The entrepreneurs and the founders need of cash derives from the necessity to buy inventory
and to sustain the gap existing between cash flow and money needed. In this phase, the cash
flow is still negative, but not as much as in the previous stages of life of the company.
The risk is still high for the PEI since it is investing in a very young company and when they make
the injection, they do not exactly know how the company will turn out.
In this phase, there is a very hands-on approach. If the PEI thinks that the company is based on a
good idea, but the business plan is not adequate, it helps rewrite the business plan (
knowledge effect, see Clip 2).
For this reason the PEI usually has a high amount of shares in the equity of the company.
On average this financing occurs up to the end of the first three year after the startup stage.
In this kind of investment, the PEI may also not have any protections, due to the high stake in
the equity of the company and to the adoption of a hands on approach.
27
Conclusion on Venture Capital

After an overview on the venture capital different clusters, we can define some
common features for this subsample:
1. The investment is often characterized by a high level of risk.
2. The PEI needs to have a hands on approach.
3. The PEI must have a very deep knowledge of the field where the company
operates in.
28
Content
1.
2.
Why Companies Need Private Equity And Venture Capital?
3.
4.
5. Expansion Financing
6.
7.
Vulture Financing
8.

with Fabio Sattin
The PE Clusters
In clip 4 the venture capital has been presented. In the following Clips (5, 6, and 7), we will see
the other clusters belonging to the PE family which are made for the phases of expansion,
mature age, and crisis.
Venture Capital
Mature Age
Expansion
Early Growth
Startup
Development
Startup
Financing
Seed Financing
Time = 0:
Birth of the
company
Replacement
Financing
Expansion
Financing
Early Growth
Financing
Crisis or
decline
Vulture
Financing
Time
30
Expansion Financing
The expansion financing takes place in the fastest phase of growth of a firm to consolidate
its position in the market.
The investment is only used to sustain the (reducing) gap existing between the cash flow
and money needed.
In this phase, the level of risk is moderate (and it mostly depends on the business) because
the trend of development of the business is well known.
In this cluster the stake held by the PE is not usually very high.
The expansion financing deals are about the growth of a company.
In an adult company, growth can be:
1. Internal (or organic)

2. External
According to the growth a company finds
itself in, the role of the PEI changes.
31
Expansion Financing
Internal Growth
We say that a company grows via internal growth when it plans to grow by itself.
This means that investments in fixed assets and in working capital will be made.
The role of the PEI: the investor needs to provide money to the venture backed company in order
to buy and/or sustain the procurement of working capital and to purchase new assets.
Because this kind of deal is not difficult for a PEI, the offer is very wide and there is a very
high number of investors providing this financing.
This kind of financing can be an alternative to a loan.
Why should a company choose PE over a bank?
Because the need for extra money comes with other
needs which can be accomplished with one of the
four benefits seen in Clip 2.
There may be the need for the PE network or the
need to build a good reputation.
32
Expansion Financing
External Growth
We say that a company grows via external growth when it plans to grow by acquiring another
company (i.e. carry on an M&A) in order to enhance the level of sales and exploit the synergies
coming from this operation. This path is much more complicated than the internal growth and it
may be undertaken by an adult company in order to enter a new market.
The role of the PEI: the investor has to sustain the M&A and in this case, they not only have to
provide the venture-backed company with the money necessary, but they also have to:
a.
b.
c.
d.
Screen and scout the market

Support the negotiation with the potential target
Provide the Venture-backed Company with money
Support the M&A process
e.
f.
(also from a legal and a fiscal point of view)

Legal and taxation support
The integration process after the operation
Hands on approach
33
Expansion Financing
External Growth
The injection of money can be done in two ways:
1. The PEI invests in the venture-backed company, from which it gets shares and the
company has to get enough money to carry on the M&A. If the process is successful
the venture-backed company and the target will merge.
Venture-Backed
Company
Debt
TARGET COMPANY
Assets
Equity
Equity
PEI
34
Expansion Financing
External Growth
The PROs
The venture-backed company will merge with the target and the company will
benefit from the synergies.
The CONs
The venture-backed company is going to give the investor a portion of the synergies
created.
In order to address this drawback, there is another way to do and M&A using PE.
35
Expansion Financing
External Growth
2. The second way in which this M&A can be done is as follows:
The PEI builds a Special Purpose Vehicle (SPV). The SPV is an empty box built
only for the purpose of a specific extraordinary operation. This company does not
have any assets nor liabilities and equity before the operation takes place.
The PEI and the venture-backed company collect money from the banking system
and put the cash collected in the SPV.
In this way, they will have enough capital to buy another company.
This option can be used in two cases:
a. When the venture-backed company has got a huge financial need and it does not want
to further increase the amount of debt.
b. The company wants to keep the SPV as a separate entity, this happens when the
company does not want the PEI to share the gain deriving from the M&A process.
36
Expansion Financing
External Growth
Venture-Backed
Company
SPV
cash
cash
Debt
Equity
Assets
PEI
Equity
cash
cash
BANKING SYSTEM
37
Expansion Financing
External Growth
In this way, the PE will not benefit from the synergies created.
On the other hand:
This second option is more expensive than the first one;
The PEI has a minor incentive in creating synergies (this may entail that lower
synergies will be created)
The company has to obtain financing from banks to invest in the SPV:
38
Content
1.
2.
Why Companies Need Private Equity And Venture Capital?
3.
4.
5.
Expansion Financing
6. Replacement Financing
7.
Vulture Financing
8.

with Fabio Sattin
PE Clusters
Replacement Financing occurs when a company is beyond the phase of fast growth
and is in the mature age stage.
Venture Capital
Mature Age
Expansion
Early Growth
Startup
Development
Startup
Financing
Seed Financing
Time = 0:
Birth of the
company
Replacement
Financing
Expansion
Financing
Early Growth
Financing
Crisis or
decline
Vulture
Financing
Time
40
Replacement financing takes place in the mature age of a company and the
role of the PEI is that of replacing an existing shareholder.
A company needs replacement financing when it wants to face strategic decisions
linked either to governance, status, or corporate finance decisions.
The level of risk is moderate and linked to the quality of the strategic process that
has to be put in place.
There are three kinds of operations belonging to this cluster:
1. Leverage Buyout (LBO)
2. Private Investment in Public Equity (PIPE)
3. Corporate Governance (CG) Deals
These deals do not derive
from the arise of need of
money of a company.
41
Leverage Buyout
LBO is very commonly used, especially in the Anglo-Saxon world, where they
account for 45%.
The role of an investor is not only to finance the company but to identify the target
company that the venture-backed company has to buy at 100%.
This operation takes place in the following steps:
1. When the PEI identifies the potential target, the PEI itself creates an SPV (for the
SPV definition, see clip 5) of which it becomes the full owner (i.e. 100%
shareholder).
2. The PEI collects money up and highly leverages the SPV up to a ratio of 90% debt
and 10% equity.
3. The SPV receives a huge amount of cash through which it is able to purchase the
target company.
42
Leverage Buyout
4. The SPV buys the target company either through a negotiation process or
through a hostile process and trough an IPO on the stock exchange. The
aggressiveness of the operation depends on the level of debt used by the
PE to buy the target company.
5. The PE fully owns the target company.
After the acquisition, the PE will sell the target to anther company.
43
Leverage Buyout
The target company usually has:
Relevant Cash Flow
Low D/E ratio
Assets that can be easily be sold on the market
SPV
BANKS
TARGET COMPANY
Debt
Cash
Debt
Assets
Equity
100%
Equity
PEI
44
Private Investment in Public Equity

PIPE is a investment made in a company listed in a stock exchange.
Even though the investment is made in a public entity it still belongs to the PE
world: the profit mechanism is still not related to the stock exchange.
This deal is not done with trading purposes. The purpose is to buy a minority stake
and then to sell it to another potential shareholder at a price not based on the stock
exchange (which usually is three - four times bigger). This stake has to be big enough
to become the biggest shareholder.
To make this deal work the PEI has to understand the small amount of shares which
is necessary to be the owner of the company. For this reason, these deals can
become very aggressive.
45
Corporate Governance Deals

CG deals, just like PIPE, do not derive from financial needs of the company.
The PEI invests in a company to manage the redesign of the corporate governance.
These operations occur particularly when there are problems in the management
succession.
In the case of corporate governance deals there is a reputational risk, rather than a
financial one.
46
Content
1.
2.
3.
4.
5.
Expansion Financing
6.
7. Vulture Financing
8.

with Fabio Sattin
PE Clusters
This is the final clip related to PE clusters.
The final stage of the life cycle of the company will be presented: Vulture (or
distressed) financing.
Venture Capital
Mature Age
Expansion
Early Growth
Startup
Development
Startup
Financing
Seed Financing
Time = 0:
Birth of the
company
Replacement
Financing
Expansion
Financing
Early Growth
Financing
Crisis or
decline
Vulture
Financing
Time
48
Vulture Financing
Vulture financing takes place in the final stage of a companys life cycle,
when it enters its decline phase or, worse, a crisis.
Money is used to sustain the financial gap generated from the decline of growth. The
financial aid coming from the PEI is used to launch a survival plan.
Due to the life stage, this activity is very risky, even though the level of risk also
depends on the sector of the venture-backed company. For this reason, the PEI fully
understand the field in which the company operates.
49
Vulture Financing
There are two deals included in this definition:
1. Restructuring financing (or turnaround)
2. Distressed financing
The separation of the vulture financing in two different kinds of deals derive from
two different ways to differently regulate the deals.
50
Restructuring financing
Distressed financing
Restructuring Financing
In restructuring financing, the company is facing a crisis, but is still alive.
The need of financing derives from the settlements of debts with banks and with
suppliers. At the same time, money can be used to re-launch the business, therefore
in some cases money can be used to buy further assets or invested to redesign the
business plan.
The company needs the strategic support from the PEI
These strategic needs make the PEI not only a financer for the troubled company but
also an advisor.
51
Restructuring Financing
Because the risk is very high due to the strategic nature of the role of PE, the
investor is a majority shareholder: there is a very strong hands-on approach and
this needs a majority stake in the equity of the company.
For the high difficulty of the deal and due to the elevated riskiness of these
projects, it is very difficult to find a PEI investing in such deal, it is more of an
investment banking activity.
52
Distressed Financing
Contrarily to replacement financing, distressed financing is a very common deal
for PEI and it occurs when the company is dead.
This may look a bit contradictory to the other clusters of PE in which the main goal
of a PE deal is to finance a company finding itself in the need of money.
The aim of PE is not in fact to merely finance the company, rather to buy the
relevant (and valuable) assets of the company.
In this case, an investor is going to buy:
Patents
Brands
Contracts
Equipment
53
Distressed Financing
Why would a PEI want to buy the assets of a defaulted company?
1. In some cases, the PE may be a trader of assets. This means that the investment is
made only to sell such assets to a third buyer.
2. In other cases, the PEI buys the assets because it inserts them in other venture-backed
companies in its portfolio.
The assets are bought before a court, and the negotiation process can be tough between
the court and the investor. As a matter of fact, it is a desire of the court to maximize the
liquidity of a company when it goes bankrupt, so that it can pay off its debts.
Sometimes the court implements the poison pill. This means that the PEI is going to buy
a valuable asset mandatorily together with another less valuable assets or together with a
debt of the company.
These deals work differently according to the different countries. In the US, these deals
work very well: there is a chapter in the United States Bankruptcy Code dedicated to the
distressed financing (Chapter 11) (find out more about Chapter 11 at this link).
54
Content
1.
2.
3.
4.
5.
Expansion Financing
6.
7.
Vulture Financing
8. Private Equity and Venture Capital: Today and

Tomorrow Interview with Fabio Sattin
Who Is Fabio Sattin?

Founder of a Private Equity Firm: Private Equity Partners
Chairman of the EVCA in the past.
Professor of Private Equity and Venture Capital at Bocconi University
Q&A
Today, what is state of the art in private equity and venture capital all around the
world?
Today PE is an engine for the economic growth, especially for Europe and Italy.
As for Europe, one of the main hurdles is made up of the big role the banking system plays
(huge difference with respect to the US).
In Europe, There is the need to create a new financial intermediary, not bankingrelated, which should possess specific knowledge on companies and their development
and this is why PE can be (and is) so important in Europe.
Nowadays we can see an increasing interest in private debt, again standing as a signal that
PE in Europe plays a fundamental role.
Q&A
According to you, are Europe and the US are two different worlds concerning private
equity?
There is a European way to play PE which is very different from the American one.
I recall that years ago the, then Italian Ambassador, a big PE player in the US, once said
that Europe is a completely different market.
Why is that? Europe (excluding the UK) can be taken as one very big country with many
family businesses and PE can help them to develop this changes the approach a PE has
when investing in a family business.
We can say that PE has adapted also to invest in each specific country. Basing on my
experience in the US, I can tell that in continental Europe, PE players support
generational change: again, a different way to do PE.
Q&A
What are the key trends in the market for private equity and venture capital?
After the financial crisis, today PE is definitely changing like many other industries.
In the first place there is a problem at the fundraising level, which has become more
difficult and PE firms had to come up with new strategies to do fundraising, like club
deals, co-investments, SPACs.
The second problem is the fees structure. The fact that the fees are calculated on the
committed capital is under a review process by many funds.
Again, I see many sovereign funds investing in PE.
On the deal-side, in Europe SMEs are the main target for PE investments ( 45 bio
invested each year).
In the future, I think that the investments may have a different structure.
Q&A
The industry is changing: new strategies are coming up, in the US we see majority
investments, whereas we see minority investments in Europe. How do you see the
market in terms of strategic choices of the biggest players in the market, as the
company of yours?
One of the most important aspects is the fact that in Europe most deals are not very
large. In addition, minority investments will still make the majority of the deals.
For these reasons, PE firms are boosting their industrial skills in order to enhance their
industrial know how PE is not a replacement for the managers, they are active owners,
not active managers.
Having said that, it is necessary for the PE investors to have a solid knowledge of the
company and of the sector in order to help companies to develop their strategies.
This must be done without overlapping the role of the management team.
MODULE 2
PRIVATE EQUITY
AND VENTURE
CAPITAL
Content
1. Private Equity Investors: The Map to Investigate

2.
Closed-End Funds in Europe: An Overview
3.
Closed-End Funds in Europe: Lifetime of a Fund
4.
Management Fees and Carried Interest
5.
Investment Firms and Banks in Europe
6.
Limited Partnerships in the US
7.
The SBIC Experience in the US
8.
Funds and VCT in the UK
9.
Taxation around the World
10. New Solutions: SPACs, Private Debt Funds, Venture Philanthropy, and Crowd Funding
11. Calculating Returns (Exercise)
Introduction
In the previous module we have seen:
When a company needs the intervention of PE
The deals a PEI can undertake to provide the financial aid a company needs
We need to explore the world of the investors.
In this module we will discover:
Who can be a PEI
How an investor works
How the regulation works for PE
The remuneration of PE
The Formats
Regardless where the deal occurs, there are two formats, each having its regulation
and players:
1.The European Union format: This format is regulated by a Directive of the
European Union.
2.The Anglo-Saxon format: This format is regulated by US and UK laws.
Using one of the two formats does not
necessarily mean that the deal occurs in the
area of the format.
The European format has been adapted and is now used in, Brazil, and Russia, and
others; whereas the Anglo-Saxon format is also used in India and Australia.
The European Union Format

In the European Union, there are two Directives regulating PE activity and, at the
same time, they regulate the entire financial system in the European Union:
The Banking Directive
The Financial Services Directive
Behind these directives lies the idea that the financial system in Europe has to be
managed with stability, for this reason, before a financial institution becomes active,
there must be an approval by both the local and central authorities.

Within this framework, there are three players that can be a PEI:
1. Banks
In Europe they are universal and they

can provide any kind of financial service
Regulated by the banking directive
2. Closed-End Funds
They have an ad hoc structure and they are

The most suitable player that can be a PE investor
3. Investment Firms
Regulated by both:
- the financial services directive
- the new AIFM (Alternative Investment
Fund Managers) directive
The Anglo-Saxon Format

The main difference between the two formats is the idea that each has of PE.
In the Anglo-Saxon world, PE is not a financial service (as it is in Europe), rather it is
an entrepreneurial activity.
This idea means that when talking about PE in the Anglo-Saxon world, the regulatory
framework is made up of:
Common law
+
Ad hoc fiscal rules
+
Special regulations for the PE world
In the end, in the Anglo-Saxon format, there is no supervisor.
The Formats
The taxonomy of the formats must be clear and must be applied as follows:
Local players (i.e. the perimeter of the investment is within the country of origin of
the PEI itself: a US PEI investing in the US only is a local player) must apply the legal
framework of the country of origin of the investor.
Global players (i.e. the perimeter of the investment is outside the country of origin of
the PEI itself) can opt for one format or the other one according to the needs of their
portfolio.
Content
1.
Private Equity Investors: the Map to Investigate
2. Closed-End Funds in Europe: An Overview

3.
4.
5.
6.
7.
8.
9.
Taxation Around the World
10. New Solutions: SPACs, Private Debt Funds, Venture Philanthropy, and Crowd Funding

As anticipated (module 2 clip 1), PE in Europe is a financial activity regulated within
the financial system legal framework and there are three vehicles that can be a PEI in
Europe:
1. Banks
In Europe they are universal and they

can provide any kind of financial service
Regulated by the banking directive
2. Closed-End Funds
They have an ad hoc structure and they are

The most suitable player that can be a PE investor
3. Investment Firms
Regulated by both:
- the financial services directive
- the new AIFM (Alternative Investment
Fund Managers) directive
In this clip, the attention is focused on closed-end funds.

10
Banks
Closed-End Funds
Investment Firms
Closed-End Funds
An investment made through closed-end funds consider a two-level system involving two
different institutions:
Asset Management Company (AMC)
Closed-End Fund
The AMC is a financial institution.
It can host many funds at the same time (they can be both closed and open-end) and it can
manage financial services as defined by the Financial Services Act (i.e., personal management
of savings, dealing, brokerage, advisory).
The closed-end fund is a separate entity that invests money for a pool of investors.
AMC
When referring to closed-end funds,
there are three players to consider:
Closed-End Fund
Investors
11
Banks
Closed-End Funds
Investment Firms
Closed-End Funds: Players

AMC
Closed-end
Funds
Investors
Financial institution approved and supervised by the local

authority, whose task it is to manage the fund.
The AMC shares some characteristics with a consulting
company. In fact, it is not a financial institution but a cluster
of people advising.
There are AMCs owned by banks, private individuals
(boutiques of PE), and the government.
There are no constraints in terms of shareholders, except for
the commitment the AMC must own in every fund, which must
be equal to 2%.
12
Banks
Closed-End Funds
Investment Firms

AMC
A fund is a separated amount of money, given by the

investors, managed by the Asset Management Company.
This amount of money can be used to invest into financial
assets or in other assets such as real estate, gold, etc.
Closed-end
Funds
Investors
A fund can be open end or closed end, where the distinction

is driven by two parameters:
The maturity (fixed or not)
The amount of money to invest (fixed or not).
These funds can never use debt
Closed end funds have a fixed
maturity and a fixed amount of
money to invest.
13
Banks
Closed-End Funds
Investment Firms

AMC
Closed-end
Funds
Investors
Investors put money in the funds and from the moment when
they do that, they automatically lose any right to have a
tailor-made investment. Their investment will be managed by
the AMC together with the other money belonging to the fund.
When they invest, they receive a certificate with the value
they invested in the fund.
Typically investors are:
- High net worth individuals
- Banks
- Insurance companies
- Pension funds
- Corporations
- Governments
14
Banks
Closed-End Funds
Investment Firms
Closed-End Funds: Rules for the AMC

The existence of this double level is necessary to analyze the (very few) rules both for the
asset management company and for the closed-end fund - the same all over Europe.
The choice of a short albeit well-organized
system responds to the need to better
regulate a country-specific financial system.
For the AMC, the set of rules concerns:
Minimum requirements to operate

Governance rules
The rules are verified by

the country supervisor,
checking over the whole
life of the AMC
Management rules
15
Banks
Closed-End funds
Investment Firms
Closed-End Funds: Rules for the Fund

For closed-end funds, the set of rules concerns three items:
General rules
Internal code of activity
Investment policy
16
Content
1.
2.
Closed-End Funds in Europe: an Overview
3. Closed-End Funds in Europe: Lifetime of a Fund

4.
5.
6.
7.
8.
9.
Taxation around the World
10. New Solutions: SPAC, Private Debt Fund, Venture Philanthropy, and Crowd Funding
Banks
Closed-End Funds
Investment Firms
Closed-End Fund
In the previous clip, closed-end funds were presented, together with the relative
regulatory frameworks and the players they interact with over their life (i.e. the investors
and the AMC).
The goal of this clip is to understand how those funds work.
All the rules concerning the functioning of a closed-end fund are stated in the set of rules
called internal code of activity (see module2, clip2), approved by the authority.
18
Banks
Closed-End Funds
Investment Firms
Closed-End Funds in Europe

Closed-end funds are the most important vehicle in Europe for PE.
Their length is fixed, meaning that the investors can invest in the beginning and
divest in the end of the fund.
The liquidity is no problem for the investors nor the AMC. For this reason closed-end
funds are the perfect tool to undertake a PE investment.
Typically, the average size of a fund is 100-300 million and this amount is divided
into tickets an investor can buy. Each ticket typically has a value of 1 million.
For instance, if the amount of money of the fund is 100 million, and each ticket is
worth 1 million, the fund needs (as a maximum) 100 investors.
19
Banks
Closed-End Funds
Investment Firms
Closed-End Fund: Lifetime of a Fund

When presenting the lifetime of a closed-end fund, some milestones must be set. In
its lifetime the following moments are the most important:
Time
Time
Time
Time
-1.5
0
3
N 0.5
N+3
(where N is the end of the fund)
Fundraising
Draw down period
N 0.5
Getting to time N
N+3
Extra time
20
Banks
Closed-End funds
Investment Firms
Closed-End Fund
Fundraising
-1.5
Fundraising
Before launching any activity, the AMC needs the approval by the
authority, where the approval depends on three criteria:
The size of the fund
The value of every ticket
The investment target.
Once the approval is granted, the AMC has as a maximum 18 months

to collect the all of its money.
Generally, 4-5 months is the average time taken by an AMC to collect
the whole capital that will be invested. As a matter of fact, if the AMC
does not collect money before the time allowed, they usually stop
beforehand, otherwise they would lose their reputation.
In fact, 50% of the funds all over Europe do not manage to get to time
0.
21
Banks
Closed-End Funds
Investment Firms
Closed-End Fund
Draw Down Period
3
Draw Down Period
At time 0, the fundraising phase comes to an end.

In this period the AMC has the possibility ask the investors to deposit
a percentage of their commitment (e.g. 10%).
The time is set at 3 years, because collecting all the capital from the
investors will take much more time than it does in capital markets.
In the time going from time 0 and the third year, the closed-end fund
has to cash in all the money previously subscribed by the investors,
who can also deposit their investment with installments.
22
Banks
Closed-End Funds
Investment Firms
Closed-End Fund
Getting to Time N
3
N 0.5
Getting to Time N
At time 3, the investors have to have entirely injected all the money equivalent to
their tickets. So, after the three years, the AMC keeps on investing until the end of
the fund. In fact, some investing activity can have already taken place before Time 3
but, not using the entire amount.
The length of the fund can be defined by the AMC, as long as it is shorter than 30
years. Usually, 90% of the funds have a maturity of 10 years. As a matter of fact, for
an AMC, 10 years is a maturity long enough to make two investments:
1. Year 0 - 3: first investment
2. Year 3 - 5: exit from the first investment
3. Year 5 - 7: second investment
4. Year 7 - 10: exit from the second investment
23
Banks
Closed-End Funds
Investment Firms
Closed-End Fund
Extra Time
N
N+3
Extra Time
After the end of the closed-end fund there is the possibility to use
up to three year of extra time.
As was presented in the first week, PE tends to have low liquidity,
and as such sometimes an AMC does not have the whole liquidity it
would need to pay off the investors right away.
When the fund finally comes to an end, the AMC valuates the fund
and spreads this value among all the investors coherently with the
amount of tickets bought by each investor in the beginning of the
fund.
24
Content
1.
2.
Closed-End Funds in Europe: an Overview
3.
4. Management Fees and Carried Interest

5.
6.
7.
8.
9.
Taxation Around the World
Banks
Closed-End Funds
Investment Firms
The Economic Mechanism of an AMC

In closed-end funds there is an interaction between the investors and the AMC.
Investors will be paid, and a gain or loss will be generated at the end of the fund
(i.e. either at time 10 or at time 13 (see module2 clip3)).
What about the managers of the funds?
The goal of this clip is to understand how the AMC is remunerated over the funds
lifetime.
26
Banks
Closed-End Funds
Investment Firms
The Economic Mechanism of an AMC

Over the life of the investment, the AMC receives two different kinds of
remunerations:
1. Management fees
2. Carried interest
Please note: the rules that will be

presented are also valid for fund
managers operating in the US as long as
they operate in PE deals.
27
Banks
Closed-End Funds
Investment Firms
1. Management Fees
Management fees correspond to the amount of money an AMC receives every year
from closed-end funds.
Closed-end funds are the vehicles generating:
Revenues, in the form of capital gains
Dividends coming from the companies in which the investment is made
Losses, in case the deal is not successful
The management fees is a fixed percentage of money calculated on the value of the
closed-end fund in the beginning of the fund itself.
For instance, in the case of a closed-end fund being worth 100 million bearing
management fees at 2%, every year the AMC receives 2 million from the fund.
28
Banks
Closed-End Funds
Investment Firms
1. Management Fees
The management fees must be precisely calculated for they have to cover:
Operating costs
Remuneration of the advisor helping the AMC in the consulting activity
Remuneration of the technical committee
The percentage of the management fees is in fact computed with the capital
budgeting approach. That means that it is computed replying to the question: Is the
amount enough to properly cover all expenses?
The reply is in fact not in the percentage per se, rather it stands in the absolute value
of these fees.
29
Banks
Closed-End Funds
Investment Firms
1. Management Fees
In case an AMC belongs to a bank, all the above-listed costs will be easily covered.
On the contrary, if the AMC is an independent entity, covering all the above-listed
expenses can be very tough.
For instance, in venture capital, AMCs are owned by professionals and not by financial
institutions, because they need a workforce who can fully be devoted to the venturebacked company.
30
Banks
Closed-End Funds
Investment Firms
2. Carried Interest
The second source of remuneration for the AMC is made up of the carried interest.
Maximizing the carried interest is the
ultimate goal and desire of an AMC.
It is computed only at the end of the closed-end funds life cycle.
CARRIED INTEREST = % x (Final IRR Hurdle IRR)

IRR: it is a discount rate that equals
the investments with the present
values of the future returns of such
investments.
31
Banks
Closed-End Funds
Investment Firms
2. Carried Interest
The carried interest is the spread between the final IRR and a hurdle (a.k.a. threshold) IRR
multiplied by a fixed percentage.
Usually, the fixed percentage ranges between 25-30%; the hurdle rate ranges between 7-8%.
This means that, at the end of the fund, the AMC will receive a carried interest if and only
if the final IRR is larger than 7-8%..
The carried interest formula is also called the waterfall mechanism.
This mechanism can be used either with or without catch-up, where the choice to calculate
IRR one way or the other is up to the AMC and must be agreed in the Internal Code of
Activity.
Without catch-up: The carried interest is computed on the difference between the final
IRR and the hurdle rate.
With catch-up: The carried interest is directly computed on the final IRR.
32
Content
1.
2.
3.
4.
5. Investment Firms and Banks in Europe

6.
7.
8.
9.
Understanding Taxation Around the World
PE Players in Europe
As anticipated in clip 1 of this module, PE in Europe is a financial activity regulated
within the financial systems legal framework and there are players players that can
be a PE investor in Europe:
1. Banks
2. Closed-end funds
3. Investment firms
In this clip, the attention is focused on the other two players of the European format.
34
Banks
Closed-End Funds
Investment Firms
PE Players in Europe: Banks

In Europe, banks are universal: They can undertake any kind of financial activity
except for the following ones:
Collective asset management activity

Insurance activity
Non financial activities
However banks can hold equities of AMCs, insurance companies, and non financial
firms.
35
Banks
Closed-End Funds
Investment Firms

When a bank wants to directly invest in the private equity of a company (whether it
be listed or non), not only does it have to follow very strict constraints and rules
but it is necessary for the bank to set aside a lot of regulatory capital, due to the
strict regulation constraints imposed on banks by Basel II and III.
This means that the capital gain obtained through the investment can be
counterweighted by the regulatory capital it has to set aside.
36
Banks
Closed-End Funds
Investment Firms

For the reasons mentioned above, it is very rare that a bank invests directly and
become a PEI.
Banks usually invest in closed-end funds to ultimately participate to some PE
activities.
Banks only directly invest if there needs to be an urgent intervention to save a
company in a certain industry or area or if the venture-backed company is of
particular importance.
37
Banks
Closed-End Funds
Investment Firms
PE Players in Europe: Investment Firms

Investment firms in Europe are regulated by the Banking Directive and can undertake
the same activity as banks with the exception of collecting money through deposits.
According to the regulation they comply to, there are two kinds of investment firms.
38
Banks
Closed-End Funds
Investment Firms

Type 1 Investment firms
They do not have any specific constraints to manage their activities and the
supervision impact is quite soft.
They do not undergo any regulatory capital rules.
Type 2 Investment firms
They face the same constraints set for banks and for them the supervision impact is
hard. In this case, all investments undertaken by the firm entail a regulatory capital
as if they were banks.
In Europe, the most widespread kind

of firm is the second type.
39
Banks
Closed-End Funds
Investment Firms

The balance sheet of an investment firm.
Private
Equity
Investments
Debt
Cash
Equity
A-Shareholders
B-Shareholders
Collected through
Debt and Equity
40
Banks
Closed-End Funds
Investment Firms

The role of the two kinds of shareholders is necessary to replicate, in the investment
firm, the relation existing between an AMC and the investors within closed-end
funds.
As a matter of fact:
A-shareholders: act as an AMC. They are remunerated with the management fees
and with a yearly carried interest (it is computed every year because the
investment firm does not come to and end, unlike the closed-end fund).
B-shareholders: act purely as investors and cannot influence the management of
the investment. They are remunerated with the difference between the profits
and the carried interest given to A-shareholders.
41
Banks
Closed-End Funds
Investment Firms

There may be at least two main reasons to use investment firms to invest PE:
Investors may want to leverage (closed-end funds cannot use debt).
A small group of investors may want to create a captive vehicle and they do not
want to comply to very strict regulations. Such is the example of the so-called
family offices, a group of family members who want to invest their own money.
42
Content
1.
2.
3.
4.
5.
6. Limited Partnerships in the US

7.
8.
9.
PE Players in the Anglo-Saxon World

With this clip, we will start looking at the Anglo-Saxon world. We will see the
mechanisms according to which PE works in the US.
Looking at the Anglo-Saxon markets, its can be noted that investments in PE are not
regulated by a regulation framework, rather they are market-related.
This derives from the Anglo-Saxon idea that the market discipline is more powerful
and important than a financial authority regulation.
44
PE Players in the US
The US financial market is driven by common law and great importance is covered
both by the local courts work and by the federal courts work.
Some federal acts have created a general framework for the financial system. This
framework is not based on financial institutions but on relevant financial activities.
The pillars are represented by:
Discipline on stock exchange and securities
Corporate governance rules
Discipline for insurance and pension funds
General rules for banks
45
VCF
SBIC
Banks
Corporate Venture
Business Angels
PE Players in the US
In the US system, there is evidence of:
1.
2.
3.
4.
5.
Venture Capital Funds (VCFs or simply, funds)

Small Business Investment Companies (SBICs)
Banks
Corporate Venture
Business Angels
The two institutional

vehicles in the US market
46
VCF
SBIC
Banks
Corporate Venture
Business Angels
Venture Capital Funds

Venture capital funds are the most popular PE instruments in the US. Regardless of
the name, they can operate in every PE deal.
The legal entity supporting a VCF is called the limited partnership (LP).
An LP is one of the typical structures to create a company in the US, whereas
common organizational forms are: sole proprietorship, partnership, limited-liability
partnership, limited partnership, S-corporation and C-corporation.
That means PE investment is considered a business activity and not a financial
activity as it is in Europe.
47
VCF
SBIC
Banks
Corporate Venture
Business Angels

An LP is the legal entity with the mandatory presence of two different groups of
shareholders:
LP
Debt
Assets
Equity
Limited
Partners
General
Partners
The Limited Partners (LPs) must own 99% of the equity of the LP, whereas the
General Partners (GPs) must own 1% of it. This is set by US law.
48
VCF
SBIC
Banks
Corporate Venture
Business Angels

Limited Partners are solely investors. They do not manage the company and are
limitedly liable to the extent of their investment.
General Partners are the managers of the company and they are fully liable for the
LP liabilities. This means that in the worst-case scenario they lose everything.
COMPARISON WITH EUROPE

LPs are like the investors in closed-end funds.
GPs are like the AMCs in closed-end funds.
Even though the holding stake is different
49
VCF
SBIC
Banks
Corporate Venture
Business Angels

What does being fully liable mean?
It means that the GPs are responsible for the liabilities.
Full liability is something that is not stated in the rules of the closed-end funds
(Note: remember that closed-end funds can not leverage). The fact that a fund can
leverage makes it a hedge fund, entailing a higher risk-return combination than the
one in Europe.
The functioning of a fund is regulated by a Limited Partnership Agreement and it is
made by GPs and LPs, where the content is very similar to the one of the internal
code of activity, except for the parts referring to debt policy.
The only difference with the fact that in Europe, it is a code, therefore in case of a
legal battle they go before a Supervisor. On the contrary in the US it is a contract,
then they go before a Court.
50
VCF
SBIC
Banks
Corporate Venture
Business Angels

In addition the GPs want to protect themselves due to the full liability. This is why
GPs usually is a management company and it operates via a Limited Liability
Partnership (LLP) working just like an AMC in Europe.
GPs want to be protected, but the LPs do not want them to be too safe. This is why
the assets of the LLP will be a collateral of the debt of the VCF.
51
VCF
SBIC
Banks
Corporate Venture
Business Angels

LP
LLP
Debt
Debt
Cash
Equity
1%
Assets
General
Partners (100%)
Equity
99%
Limited Partners
Investment 1
Investment 2
Investment n
52
VCF
SBIC
Banks
Corporate Venture
Business Angels

Limited partners are typically banks, insurance, pensions funds, private investors,
etc.
The great success of limited partnership is due both to the simple scheme of
functioning and to the tax transparency.
The US government decided to have a tax law with specific reference to PE. This
entails that if in any US State there is a PE investment, taxes = 0% provided that:
The fundraising lasts 1 year
The maturity is 10 years
The maximum extra-time is 2 years
In all other cases, investors pay taxes.
These benefits can be enjoyed if you do not operate in the US, as long as the VCF is
in the US.
53
Content
1.
2.
3.
4.
5.
6.
7. The SBIC Experience in the US

8.
9.
VCF
SBIC
Banks
Corporate Venture
Business Angels
PE Players in the Anglo-Saxon World

With this clip, we continue the overview over the US players within PE with
particular attention on SBICs and some final considerations made concerning
corporate ventures, business angels and banks.
55
SBIC
VCF
Banks
Corporate Venture
Business Angels
SBIC
SBICs were created through the Small Business Investment Company Act of 1958.
They are considered the beginning of the PE development in the US because they
were created to stimulate the VC market.
It is a legal entity, in which one of the two shareholders must be a US Public Admin,
while the other shareholder can be any kind of shareholder (it is usually a bank,
corporation, or individual).
Debt
Assets
Shareholder 1
(50%)
Equity
Shareholder 2
(50%)
Sharing stands
for a joint
venture
56
VCF
SBIC
Banks
Corporate Venture
Business Angels
SBIC: Duties and Rights

The Public Admin that holds 50% of the equity of the company is a pure investor: it
cannot manage the company. On the contrary, the non-public admin investor has the
duty and the right to manage the investments and the whole company.
Both shareholders receive a management fee, but the profit distribution (calculated
with the carried interest approach) is asymmetric: the US PA will get the
remuneration up to a threshold stated in the SBIC Agreement, whereas the extra
profit generated through the investments belongs to the other shareholder. Losses
are equally distributed.
57
VCF
SBIC
Banks
Corporate Venture
Business Angels
SBIC: Duties and Rights

33% of debt can be borrowed from the Federal Reserve System at a very low and
fixed rate which is set yearly.
Capital gains and other revenues are free from tax and the taxation starts with the
distribution of earnings. This kind of free-from-tax vehicle can not be
implemented in the European Union because within the European Union there is a
rule of non-State aids even if both in Europe and in Asia the introduction of a
similar mechanism is a highly discussed topic.
This mechanism is very popular in the US, because with a partner belonging to the
Public Administration, some investors feel they can invest even in riskier deals. SBICs
are considered among the best models of PPPs (Public-Private Partnerships).
58
VCF
SBIC
Banks
Corporate Venture
Business Angels
Other US Players
Banks
Also in the US, banks can invest in PE although like in Europe they have many
constraints, therefore it is very rare that they directly invest in PE. They usually act
as either GPs or LPs in VCFs.
Corporate Ventures
They are not proper legal entities, rather they are a division or a department of a
corporation which wants to invest in venture capital. The only aim of the CV is to run
seed and start-up financing.
The investment is done to promote R&D, outputs, patents and unlike in VCFs, the aim
is not to generate IRR but to enhance the value for the corporation.
59
VCF
SBIC
Banks
Corporate Venture
Business Angels
Other US Players
Business Angels
They are PE investors without any professional skills. Example of such could be
foundations, universities, and individuals.
They can also be high net worth individuals, charities, and foundations, and in this
case can benefit of the QSBS rule (Qualified Small Business Stock). This means that if
they invest in PE and, at the end of the investment, the capital gain is immediately
invested in another private company under the form of PE, taxes are not paid. This
is a huge incentive for PE investments.
They are mostly active in venture capital, mostly with seed and start-up financings.
60
Content
1.
2.
3.
4.
5.
6.
7.
8. Funds and VCTs in the UK

9.
Players in the Anglo-Saxon World

After having seen how the PE market works in the US, we shift focus to the UK whose
mechanisms are more similar to the US rather than to the rest of Europe.
As with the US, the UK financial market is driven by common law and great
importance is played by the courts.
However, it is possible to use the schemes designed through EU Banking and
Financial Services Act: that means we find out a great variety of solutions/typologies
of equity investors.
62
VCF
VCT
Banks
Business Angeles
Local PPP
PE Players in the UK
In the UK system, there is evidence of:
1.
2.
3.
4.
5.
Venture capital funds (VCF)

Venture capital trusts (VCT)
Banks
Business Angels
Local PPPs
63
VCF
VCT
Banks
Business Angeles
Local PPP

UK VCFs are not built under the European scheme of closed-end funds but are legal
entity operating like LPs like in the US.
As a matter of fact the UK and the US aim to attract the same investors, also in
terms of investors risk-return profile.
As in the US, limited partners generally are private investors, banks, pension and
insurance funds, and corporate investors; and they are allowed to leverage.
A UK fund must have a set maturity of 10 years.
64
VCF
VCT
Banks
Business Angeles
Local PPP
Venture Capital Trust: The General Definition

Venture Capital Trusts (VCTs) were introduced in 1997 and have had a great success
in the UK market. Started in the UK but nowadays it has become a sort of format,
and there is evidence of this tool in India and in Australia.
They are based on the concept of the UK Trust.
A trust is a very old British institution (there is evidence of the first trusts in the 11th
and 12th century) and it is an entity, not a company. The trust was born in the first
place for succession issues, as a matter of fact through this mechanism the owner
(called the settlor) does not have to manage the assets, for a third player will do it
(the trustee) and that is fully liable. In case the VCT has a maturity, at the end of
the VCT the owner gets back the assets belonging to the trust.
65
VCF
VCT
Banks
Business Angeles
Local PPP
Venture Capital Trust: Application in PE

In terms of PE, trusts want to combine retail investors with PE activity (unlike with
closed-end funds). GPs create a trust with a term (the VCF term) and they set a
portion of their assets in the trust which they use as a collateral to show the LPs the
commitment in the management of the fund.
Investors become the settlers, whereas a management company becomes the
trustee. The trust does not own any assets, rather it just has the cash injected by
the investors used to make VC investment.
66
VCF
VCT
Banks
Business Angeles
Local PPP

TRUST
Debt
Investors
(Settler)
cash
Cash
Investors (99%)
Equity
Management
Company (1%)
Investment 1
Management Company
(Trustee)
Investment 2
Investment n
67
VCF
VCT
Banks
Business Angeles
Local PPP

Every time investors invest in trust, they receive a certificate listed in the stock
exchange; this ensures to investors a high level of liquidity.
The trust is like an empty box that does not publish any financial reporting.
The investors trust the reputation
of the trustee.
A trust can invest in listed securities, but at least 70% of the cash collected among
the retail investors must be used to invest in non-listed companies.
In the end, fiscal incentive are granted to the investors.
68
VCF
VCT
Banks
Business Angeles
Local PPP
The Other UK Players

Local PPPs
They are not as popular as they are in the US within SBICs. They operate at a local
level and they do not have to comply to certain rules, rather they have to comply to
local laws.
Business Angels
See the USs case.
Banks
See the USs case.
69
Content
1.
2.
3.
4.
5.
6.
7.
8.
9. Understanding Taxation Around the World

Taxation within PE
After having seen the key elements of the different vehicles through which an
investor can invest in PE, it is time to understand how the taxation works for these
investments.
To see how taxation works within PE, provided that taxation differs in every country,
two are the perspectives:
Players involved into taxation in PE
Areas of impact on taxation
Not every combination player-area of impact is relevant from the fiscal point of
view. We will focus only on those combinations which are.
71
Taxation within PE
Vehicles
Taxation on capital Relevant to increase
gains NAV and IRR
Taxation on Relevant to increase
dividends NAV and IRR
Investors
Relevant for personal
taxation profile (final net
IRR)
Venture-backed
Company
Not relevant
Relevant only for gains

given trough earnings
Not relevant
Not relevant
Not relevant
Relevant to reduce company

tax rate
Incentive to R&D
Not relevant
investment
Not relevant
Relevant to reduce company

tax rate
Comparative
incentive D vs. E
Not relevant
Relevant to compose capital

structure within net WACC
Incentive to startup
Not relevant
72
Taxation on Capital Gains

For the taxation on capital gains, there are two
relevant players: the vehicles and the investors.
Taxation on Capital Gains for the VEHICLES

Three standards may be applied:
a) Participation Exemption (PEX): It is a mechanism identifying a threshold in the taxation.
When some conditions occur, the tax burden on the vehicle is lower than the general
taxation in the country.
b) Flat tax: It works like the PEX, only without any conditions. The tax rate is lower that the
tax rate in the country (like for Close-end Funds in Europe for which the tax rate is 20%).
c) Tax Transparency: This is a special case of flat tax making the tax rate equal to 0%. Plus
this entails that losses can be deducted as if they were costs. Regardless of the tax
transparency on the vehicle, the investors have to pay taxes in their home country (this is
the case of VCF both in the US and in the UK and of SBICs).
73
Taxation on Capital Gains

Taxation on Capital Gains for the INVESTORS
In this case, the tax burden derives from a mix of the fact that an investor is either a
domestic or a foreign investor (with respect to the vehicle) and if the investor is a
legal entity or a private individual. You will have 4 different combinations as
reported in the matrix below, whose content will differ by country.
Domestic
Foreign
Private
individual
Legal
Entity
74
Taxation on Dividends
For the taxation on capital gains, there are two
relevant players: the vehicles and the investors.
Taxation on Dividends
In this case, the rules that are applied to investors and to vehicles concerning the
taxation on dividends are the same as in the case of capital gains.
Although, one very important difference between this case and the previous one
stands in the fact that dividends are not the primary goal of the PE activity, the
generation of capital gain is.
75
Incentives to R&D and Startups

Concerning the fiscal incentives to undertake R&D
activities and to invest in startup, there exists
three mechanisms, relevant only to VBCs.
Three incentives (from the least to the most sophisticated):

a) Mark Down: The tax rate is reduced to incentivize these investments without any
parameter of investment (e.g.: in the first three years of a startup, the company
does not have to pay taxes.). The risk is that such a mechanism can create
vicious cycles.
b) Shadow Costs: The company can use some debt expenses to generate tax
benefits.
c) Tax Credit: This is a tax voucher that the company can use in other fiscal years.
76
Taxation and Incentives to D/E Ratio

Concerning the fiscal incentives to the D/E ratio,
there are two mechanisms relevant to the VBCs
only.
Two incentives
a) Thin Cap: There is a limit for the company to use interest rate paid on debt to
reduce the fiscal burden.
b) DIT: Double Income Taxation gives tax incentives if the company collects money
trough equity.
77
Content
1.
Private Equity Investors: The Map to Investigate
2.
3.
4.
5.
6.
7.
8.
9.
10
10. New Solutions: SPAC, Private Debt Fund, Venture Philanthropy,

and Crowd Funding
10
New Trends in PE
Innovation in the instruments and mechanisms of financing is very important in PE.
As a matter of fact, the market signals and trends stimulate new solutions in the way
of doing PE.
Nowadays, there is the definition of 4 new solutions:
1) Private Debt funds
2) Crowd Funding
3) Venture Philanthropy
4) Special Purpose Acquisition Companies (SPACs)
79
10
1. Private Debt Funds

Vehicles used in private debt are the same as in private equity (investment firms,
closed-end funds,). The only difference is that the investment is made in private
debt.
This new instrument is becoming more and more popular lately for two reasons:
1) In Europe there is an increasing tendency among companies to collect debt.
Companies do not want to do so anymore with banks but through the market. For
the companies listed this is easy: they issue bonds on the market. However in
Europe most companies are not listed SMEs.
2) PE already knows how to deal with the fundraising when the company is a private
one.
80
10
2. Crowd Funding
Crowd funding has become very important and widespread nowadays. It is a brand
new and digital way of collecting money.
Different players can launch their own financial needs and make a call on the
internet to collect money through their platform.
PE and VC can be done through crowd funding: for companies who are in the very
early stages of their life, they launch a call on the market to raise money.
Because this is a very recent approach, we can not say with certainty whether this
tool works or not for startups.
81
10
3. Venture Philanthropy
When PE vehicles invest only in businesses generating a string social impact, this is
called Venture Philanthropy.
In these cases, the mechanisms are the same as in the other forms of PE except for
the fact that both investors and the management company accept to get a lower
level off profits in terms of capital gains, carried interest, and management fees.
82
10
4. SPACs
SPACs were born around ten years ago in the US and the idea was so successful that
they started to operate in Europe 3-4 years ago.
They basically are an empty shell a form of an SPV.
20% of the SPV vehicle is held by the promoter, the company is listed in the Stock
Exchange so that they can collect the other 80% of the equity.
The SPAC can collect money only to do one investment: to buy another company.
If the SPAC succeeds, it will merge with the target company, otherwise the investors
will get their money back as this is a one-shot vehicle.
83
Content
1.
Private Equity Investors: The Map to Investigate
2.
3.
4.
5.
6.
7.
8.
9.
11
11.Calculating Returns (Exercise)
11
Introduction
This exercise aims at understanding, in practice, how the calculation of carried
interest and of management fees work for a closed-end fund managed by an AMC.
The exercise will be done following these steps:
1) Presentation of the inputs
2) Investment: presentation on the cash flows deriving from the investment and in
the divestment phases
3) Computation of the IRR
In doing the exercise, we have to remember the formula used in module2 clip4 to
calculate the Carried interest:
85
11
Inputs
INPUT
The committed capital is

the size of the closedend fund.
Management Fee
2%
Hurdle Rate
8%
Carried Interest
30%
Committed Capital (min.)
400
Percentage Managers (GPs)

The percentage is fixed
by law.
2%
OUTPUT
Committed Capital
Capital at the End
400
?
86
11
Investment
To apply the carried interest formula and to compute the remuneration of the managers, we need
to calculate the development of the investment of the closed-end fund.
Investment period
Divestment period
extra
Draw-downs
Years
(+)
Draw-downs
100
200
100
400
(-)
Investment
80
190
130
180
310
360
100
200
50
1600
(+)
Divestment
40
200
320
370
100
250
500
600
700
3080
(-)
Management
fee
88
12
14
16
28
30
32
24
66
508
1100
1792
Cash
10
11
Total
Final amount of the

closed-end fund
(starting from 400)
2% x 400
Note that in the 10th and 11th year no investment

is planned. The focus is on the exit.
Maturity
87
11
Case 1: Global IRR

We have to understand how to split the total amount of the closed-end fund. The
formula can be applied in two ways even if the formula is the same: in the first way,
the carried interest is computed on a global level (global IRR approach) whereas in
the second way, the carried interest is computed on a yearly basis (yearly IRR
approach).
STEPS
Fund Global IRR
348%
Net Global IRR
340%
Carried Interest
102%
For Managers (GPs)
408
For Investors (LPs)
1384
a) The global IRR of the fund:

(Final Amount Committed Capital)
Committed Capital
b) Net global IRR:

Global IRR Hurdle Rate
c) Carried Interest:
Net Global IRR * Carried Interest
88
11
Case 1: Global IRR

We have to understand how to split the total amount of the closed-end fund. The
formula can be applied in two ways even if the formula is the same: in the first way,
the carried interest is computed on a global level (global IRR approach) whereas in
the second way, the carried interest is computed on a yearly basis (yearly IRR
approach).
Fund Global IRR
348%
d) The remuneration for the managers:
Net Global IRR
340%
Carried Interest * Committed Capital
Carried Interest
102%
e) The remuneration for the investors:
For Managers (GPs)
408
For Investors (LPs)
1384
Total Amount Managers Remuneration
Remember that managers invested 2% of the committed

capital, whereas investors invested 98% of it.
89
11
Case 2: Yearly IRR

We are approaching the yearly way to compute IRR.
STEPS
a) The IRR of an investment planning to invest 400 million in time 1 and receiving
1,792 million euros is equal to 16.2%.
b) Net yearly IRR:
Fund Yearly IRR
16.2%
Net Global IRR
8.2%
Carried Interest
2.45%
Fund Yearly IRR Hurdle Rate
c) Carried Interest:
Net Yearly IRR * Carried Interest
For Managers (GPs)
122.2335
d) The remuneration for the managers:
For Investors (LPs)
1669.766
Carried Interest * Committed Capital
e) The remuneration for the investors:

Total Amount Managers Remuneration
90
11
Final Considerations
Note that in both cases we have used the formulas without catch up.
This means that the carried interest is calculated on the difference between the
final IRR and the hurdle rate.
It is possible, on the contrary, to calculate the same results also with catch up and
this means that the carried interest is calculated not on the difference but on the
IRR of the fund.
91
MODULE 3
PRIVATE EQUITY
AND VENTURE
CAPITAL
Content
1. The Managerial Process for Equity Funds
2. Fundraising
3. Investing: The Decision Making Phase
4. Investing: The Deal Making Phase
5. Managing and Monitoring: Supporting the Company
6. Managing and Monitoring: Covenants Usage
7. Exiting
8. Private Equity Advice for Entrepreneurs Interview with Fabio Sattin
Introduction
In the previous week we saw:
The different formats in which an investor can invest in PE
The different regulations and fiscal frameworks for the players involved in the
PE activity
This week is concentrated on the management of private equity and venture capital
funds.
After an overview of the managerial process of an investor we will, in detail, see the
four different steps of this process.
The Managerial Process

Equity investments can be developed through different vehicles and each operate
with a different legal entity, even if the most popular are limited partnerships,
investment firms and closed-end funds.
Even if vehicles are different, managerial practices and typical phases of activity are
very similar.
As a matter of fact, the functioning is based
on two different players: Managers and
investors.
For this reason, it is important to understand the different aspects of the Managerial
Process of private equity.
The Managerial Process

The managerial process is the day-by-day activity of the managers managing the
investment made by the investors.
When highlighting the characteristics of the managerial process, both academia and
practitioners consider this process as made up of four steps:
1)
2)
3)
4)
Fundraising
Investment activity
Managing and Monitoring
Exiting
For each phase there is also a different contribution coming from the management
themselves, the advisory and the board of directors.
Fundraising
This first activity of fundraising is included in the managerial process even if this activity
starts before the vehicle is launched.
The fund-raising activity is devoted to promote the business idea of the new vehicle of
equity in order to find money.
It is in fact a very preliminary activity (Note: remember that in Closed-End Funds this
activity occurs before time 0?) occurring before the actual starting of the investment. In
the case of the Closed-End Funds this takes 1.5 years, whereas for VCF this phase takes 1
year.
If managers are able to collect the whole investment and they are able in this way to get
to time 0, the legal entity starts its activities and then the other three activities
(investment, managing and monitoring, and exiting) start.
Investing, Managing & Monitoring, Exiting

When the fundraising phase comes to an end, the other three phases start.
In the ordinary activity the managers have to decide the investment policies and the
investment target; at the same time they manage and monitor the company in which
the investment is made; and, at the same time, they have the exiting issue; that is
they have to understand when (and if) they will be able to exit.
The exiting moment is in the end the

reason why managers do PE activities.
Investing
Investing is the mission of the equity investment vehicle to create value for the
investor through the scouting, the screening, the choice, the managing and the
exiting of ventures.
From when they decide to invest, managers have two problems: on the one hand,
they have to valuate the company in which they invest; and on the other hand, when
managers and GPs decide to invest they have to negotiate the mechanisms
supporting their management of the company. If the decision of the investment is
made, the managerial process enters another phase: The management and
monitoring phase.
Managing & Monitoring

Managing and monitoring activities concern the involvement of the vehicle in the
selected ventures. These two activities have to ensure the creation of value and to
control the opportunities for the financed venture.
When in this phase, the PE is a shareholder because the PE decided to invest in the
VBC.
The managers have to support and sustain the company in the ordinary activity.
For the managing and monitoring to be successful, the last phase has to come.
Exiting
Exiting concerns the decision to sell the equity owned in the portfolio in order to
have a gain. This single decision has to be planned with a broad portfolio vision.
For this to happen, the PE has to identify another shareholder to which they sell
their stake of the company. Because the liquidity is very low, finding a counterpart is
not easy.
This is the most important phase, because it is only with the exiting that the PE is
able to exit the investment and generate a capital gain (i.e. an IRR for the PE
investor).
10
Content
2. Fundraising
7. Exiting
Introduction
This clip focuses on one specific step of the managerial process: The fundraising
phase.
This phase occurs before time 0, since it is the phase in which the PE firm has to
gather the investors that want to invest in the funds.
This is a very hard phase for the PE. The managers have to convince the investors of
their idea: as a matter of fact, the investors will remain in that project for a very
long time (think of a Closed-end fund whose length is ten years).
12
Fundraising Steps
In the fundraising phase the management company has to sell the proposal launched
to the market.
The proposal is basically a business idea that leads to the creation of a vehicle to
invest in private equity to produce value that will be spread among the promotersmanagers and the investors.
Fundraising is a selling game in which reputation, mutual trust, and love for risk are
the pillars.
As a matter of fact, the success of the fundraising phase depends on the reputation
of the management company: The better it is, the easier this phase becomes.
13
Fundraising Steps II
The typical fundraising activity steps are as follows:
1.
2.
3.
4.
Business Idea Creation

Job Selling
Raising Debt
Closing
Of course, depending on the country and on legal framework, these activities can be
partially or totally driven by law.
14
Business Idea Generation
Job Selling
Raising Debt
Closing
1. Business Idea Creation

Business idea creation is aimed at producing an information memorandum to be
promoted in the market.
Before an information memorandum is produced testing the waters occurs. This
phase is carried on in a very informal way among the professional network of the PE
firm to assess, for instance, whether it makes sense for PE investors to invest in a
specific cluster of PE or not.
After the managers have received an informal consensus about their activity, a more
formal part begins and the information memorandum is produced.
The information memorandum has to explain the rationale of the business idea to the
business community (and to the supervisors, in case the fundraising occurs in Europe)
and has to appeal to the potential audience of investors.
The success of the involvement of an investor into the business idea is strictly linked to
the reputation and to the track record of the promoter.
15
Job Selling
Raising Debt
Closing
1. Business Idea Creation II

The typical content of an information memorandum is as follows:
Choice of the vehicle
Target to invest (countries, sectors, life cycle stages)
Size of the vehicle and minimum amount at which the fund will be closed
Corporate governance rules (i.e. relationship between promoters-managers and
investors)
Size and policy of investments
Internal code of activity / LPA
Track record of the promoters-managers
Usage and size of leverage (in the case of a non-European fund)
Costs
16
Job Selling
Raising Debt
Closing
1. Business Idea Creation III

When this step comes to an end, there are two options depending on the countries in
which a PE firm operates.
If the PE firm operates in

Europe, the PE must
obtain the formal
approval from the
Supervisor and
afterwards, the
information memorandum
is transformed into an
internal code of activity.
In the US and in the UK,

the PE firm does not have
to obtain any approval,
rather the information
memorandum can be
transformed in the LPA
since it is a contract.
17
Job Selling
Raising Debt
Closing
2. Job Selling
Job selling is the phase in which the managers have to convince the investors not
only to give an opinion about the idea, but also to invest in that idea. This is
actualized by the letter of commitment with which the investors declare how they
want to participate in the fund.
This phase often occurs via one-to-one meetings between the promoters and the
potential counterparts (may it be an insurance company, a bank or a high net worth
individual). In some other cases, this phase may be organized in a kind of meeting,
in which more than one investor is involved.
18
Job Selling
Raising Debt
Closing
3. Debt Raising
This phase only occurs if the fund is based either in the UK or in the US.
Debt raising is job selling too, but with a different perspective in which the goal is to
sell a project to a community of financers.
Debt raising is strongly related to the reputation both of the promoter and of the
investors (good signaling effect). In fact this step is difficult for each counterpart
(the investors and the banks) because no one wants to make the first move.
19
Job Selling
Raising Debt
Closing
4. Closing
After all the steps are concluded, whether the fund is located in the Englishspeaking countries or in Europe, the closing phase starts.
The closing phase can be meant in two ways:
A successful closing occurs when the PE firm is able to collect all the money
necessary to begin the PE activity and this was possible thanks both to the
reputation and to the purpose of the initiative
A pure closing occurs when the PE firm is not able to collect the whole money
in the fundraising phase. Such is the case when the managers do not have a very
robust network.
20
Content
2. Fundraising

7. Exiting
Introduction
This clip and the following focuses on another step of the managerial process: The
investing phase.
After the money has been collected by the PE firm, the phase of investing activity
can start.
The investing activity is the core of private equity business and it is the main way to
develop the business idea for the managers on the investors behalf.
22
Investing
Investing is a very broad definition, in which we can distinguish two different
important moments:
1. Decision-Making: the activity of valuation and selection in which the PE has to
assess whether the investing activity makes sense.
2. Deal-Making: the activity of negotiation of the contracts by which the PE firm
can invest and actively participate in the company. These contracts include, for
instance, the calculation of the shares the investor has to buy, the corporate
governance rules
23
Decision Making
Deal Making
Decision Making
Decision making is the capability to understand the market and to pick up the right
opportunities.
This activity is made up of different steps:
Origination
Screening
Valuation and due diligence
Rating assignment
Negotiation
As the process goes on, and the PE goes

towards the decision to invest, both
costs and commitment of the PE firm
increase.
Decision to invest
The decision making process involves all of the players: the management company,
the technical committee, and an advisory company. This path is sequential and the
PE needs a green light in every step to move on to the next step.
24
Decision Making
Deal Making
Origination
In this phase the PE must decide the destination of the money collected.
It is based on two different drivers: some part of the origination is spontaneous, as
you are a PE investor and the whole system knows that you have collected so much
money and that you are looking for a company in which to invest. This is why, the PE
firm has to screen a considerable amount of incoming proposal.
On the other hand, origination is based on a proactive activity. This means that the
managers have to scout the market and find the most suitable solution. This can be
done through the other players (the technical committee and the advisory board)
who can also help and scout the market.
25
Decision Making
Deal Making
Screening
After the origination step, the screening step starts. In this phase about 90% of the
dossiers collected in the origination step will be eliminated (note: remember the
100/10/1 rule in startups?).
The screening is driven by the managers together with the technical committee. The
output of the screening is a very small number of dossiers which the PE firm can
further investigate and study deeply.
26
Decision Making
Deal Making
Due Diligence and Valuation

This phase is the analysis of the business plan which starts right after the screening
phase; since it takes a very long time if done right, the PE should do it only for a
very narrow number of companies.
This phase is dedicated to exclude the proposals that do not make sense for an
investor.
The outcome of due diligence is a small number of proposals which it makes sense to
undertake the rating assignment for.
27
Decision Making
Deal Making
Rating Assignment
In this phase the PE rates and grades the dossiers of the different companies. This is
fundamental to assess the level of risk and is important to understand if (and how)
the PE firm has to collect funds through debt.
For instance, assessing the level of riskiness and of indebtedness during an LBO in
which an SPV has to be financed using debt is of primary importance. If the level of
risk is too high after the rating assessment the deal can not be taken further.
28
Decision Making
Deal Making
Negotiation
Negotiation is not based on the deal design, but it is the negotiation with the
entrepreneur to calculate the numbers of shares a PE owns and the stake to which
they correspond in terms of equity. In this phase the PE understands if there is room
for an external shareholder.
29
Decision Making
Deal Making
Decision to Invest
The managers (the GPs or the directors in an AMC in Europe) have to convince the
whole Board of the PE firm if it is worth to invest in that specific company.
The decision of investing does not mean to invest

immediately in the company, rather it sets the beginning
of the second part of the investing phase: Deal making.
30
Content
2. Fundraising

7. Exiting
Introduction
This clip deals with the second part of the investing phase: Deal making.
In the first part of the investing phase, the managers of the PE firm decided to
invest after the green light of the Board of the AMC or by the GPs.
This second part concerns the deal making activity related to the financial and legal
issues related to the investment in the venture-backed company.
32
Deal Making
Deal making means setting up the contracts between the investors and the company
in which they find the right balance between the need of money of the company and
the expectation of IRR and capital gain for the PE investors.
Finding the right balance is not easy and the

whole process is based on three pillars:
1. Targeting
2. Liability profile
3. Engagement
33
Targeting
Liability Profile
Engagement
Deal Making
Vehicle
Targeting
Amount of Shares
Contract
Designing &
Techniques of
Financing
Liability
Profile
Syndication
Strategy
Debt Issuance
Categories of
Shares
Engagement
Paying Policy
Governance Rules
34
Targeting
Liability Profile
Engagement
Targeting
Targeting is based on two decisions that must be negotiated
with the company.
1. The vehicle in which the PE firm invests
2. The percentage of shares the PE gets
1. The Vehicle
This is the valuation of either a direct investment or in an indirect investment (with
the SPV).
The rationales of a direct investment may be among others: the business is totally
interesting for the investor; the control is complete; the commitment between
investor and company is high and exclusive.
The rationales of a SPV creation may be among others: the investor pays only the
relevant assets; the investment is tailor-made on the business plan. Remember that
this entails the use of leverage, therefore the PE firm has to convince the banking
system too.
35
Targeting
Liability Profile
Engagement
Targeting
2. The Amount of Shares
This negotiation follows the decision taken in the previous
step (i.e. the PE firm decided the vehicle through which it
will make its investment).
This step concerns the decision of the percentage of shares the PE has to buy and
the role it will have within the company equity. There are some key points to be
addressed:
Majority versus minority
Relative and absolute size of investment
Capital requirement impact
Voting rights and effective influence within the board of directors
36
Targeting
Liability Profile
Engagement
Liability Profile
The liability profile, as the name itself suggests, involves
the decision concerning the liability side of the company.
Again, there are two decisions a PE firm needs to make
First choice: The Syndication Strategy
It concerns the decision to find other equity investors with whom build a syndicate
to invest together. At first sight, this decision may sound unfair due to the huge
amount of time the PE firm dedicated to the screening and to get to the final
decision.
Actually, this may be helpful to multiply the investment power and in this way, they
could share the risk borne otherwise only by the PE firm.
37
Targeting
Liability Profile
Engagement
Liability Profile
Second choice: Debt Issuance
It concerns the decision to combine equity investment
(with or without SPV, syndicated or not) with the usage of
leverage, this entails a very hands-on approach towards the
venture-backed company.
This decision is related to the debts of the venture-backed company whether they be
issued with bonds or obtained through loans and mortgages. In the latter case, this
means that the PE firm will have to negotiate with the banking system.
38
Targeting
Liability Profile
Engagement
Engagement
The third pillar of deal making concerns the engagement: in
this moment the PE firm has to set up the rules by which a
PE can govern the venture-backed company. This pillar is
made up of three activities.
Categories of Shares
It concerns the choice of the shares the PE has to buy in order to guarantee the best
way to develop the investment and the following managing phase. Typical choices
concerns:
Common shares
Shares with limited or increased rights
Shares with embedded option: for instance a share with a put option allowing the
PE to sell the shares under some particular circumstances
Tracking stocks
This decision has to be coordinated with the different classes of debt in case of
leverage.
39
Targeting
Liability Profile
Engagement
Engagement
Paying Policy
This concerns the questions a PE firm needs to address
related to the fact that a PEI is buying another companys
shares.
The most important questions that need to be answered in this step are:
Does the PEI need to buy new shares or can it buy also pre-existing shares?
Whats the expectation of the entrepreneur? (to gain money or to have support)
Whats the relationship between the PEI and the existing shareholders?
The main activity of a PEI is to finance a company. In

some cases if the entrepreneur is important, or in case
he or she has a very strong contractual power, the PEI
may have to buy some of the entrepreneur s shares as
well.
40
Targeting
Liability Profile
Engagement
Engagement
Governance Rules
It is the negotiation of the functioning of the board to
ensure the capability of the PE to interact the company in
the best way as possible.
Some among the most discussed issues in this activity are:
Numbers of directors
Can the PEI sitting on the board of directors
The scheduling of the board meetings
41
Content
2. Fundraising
5. Managing and Monitoring: Supporting the

Company
7. Exiting
Introduction
This clip deals with the third part of the managerial process: Managing and
monitoring.
The PE company is one of the shareholders and at this moment the investor has a
conjoint aim: they want to enhance the value of the company as much as possible
and at the same time they want to find another buyer in order to exit and get their
capital gain.
43

Actions to create and to
measure value
Mitigate divergences of opinions

and avoid conflicts between the PE
and the entrepreneur
Rules to protect the created

value
44
Actions to create value
Rules to protect value
Actions to Create Value

Typically the actions taken are dedicated to qualify the presence of the investor
within the managerial process of the venture backed company.
The nature of this presence depends on:
The stage of the investment
The style of the investor and the nature of the investment agreement
In the first case, if we consider the stages of investment moving from the seed to
the replacement financing, the involvement of the investor is decreasing (even if in
the vulture case the involvement is equal to the one in seed financing). Both in seed
and start up, the involvement could be even industrial and strategic, while in
expansion and replacement the support coming from the investor could be reduced
simply to advisory within financial and legal issues.
45
Actions to Create Value II

Concerning the style of the investor and the nature of the agreement signed
between the venture capitalist and the venture backed company, it is generally
characterized by two different profiles:
The hands-on approach
And the hands-off approach
Hands-on stands for a deep involvement both in corporate governance and in
financial and strategic decisions; hands-off stands for a presence in the corporate
governance and involvement only in financial decisions.
46
Actions to Create Value III

Regardless of the stage of life and the involvement of the PE firm, the key activities
that a PEI takes in order to create value are:
Board services
Performance evaluations and reviews
Recruitment management
Assistance with external relationships
Helping to arrange additional financing
Mentoring
47
Actions to Create Value IV

Board Services
Performance
Evaluations and
Review
Active participation in the life of the company with the provision of the proper corporate
governance. Creation of value means to support decisions, introduce professional expertise,
and impose a severe discipline. There is only one case in which this action is not necessary:
when the exit occurs through a put option with a bank.
Development of all the required processes to monitor and measure value inside the company
and between the company and the investor (in terms of accountability, auditing, IT
systems).
Recruitment
Management
The management team could be not adequate in terms of skills. The investors support is
crucial to choose, from the marketplace, the right people to hire; this is particularly true
both for start ups and for SMEs.
Relationship
Management
Both current and strategic activities can benefit from the network of the investor
(customers, suppliers, governmental lobbying, ).
Mentoring
The PE has to be completely and fully available for the entrepreneur 24/7. the entrepreneur
expects the PEIs support to make decisions at any moment. This activity concerns soft
assistance in terms both of technical and personal support to the management and to the
entrepreneur (or shareholders).
48
Content
2. Fundraising

7. Exiting
Introduction
This clip deals with the other side of managing and monitoring.
Besides the creation of value, the PEI has to deal with the protection of such value:
the second moment of the managing and monitoring activity.
These actions are taken in order to protect the divergence of opinions between the
entrepreneur and the PEI and the risk of struggle that may derive from it.
These are rules for the VCB and the PEI to live together in a temporary (albeit very
important) marriage.
50

Actions to create and to
measure value
Mitigate divergences of opinions

and avoid conflicts between the PE
and the entrepreneur
Rules to protect the created

value
51
Actions to Protect Value II

The typical covenants are as follows:
1. Lock up
2. Permitted transfer
3. Staging technique
4. Stock option plan
5. Callable and puttable security
6. Tag along rights
7. Drag along rights
8. Right of first refusal
9. Exit ratchet
52
Actions to Protect Value III

Lock Up
A covenant between the investor and existing shareholders that forbids both existing
shareholders and PEIs from selling for a certain period.
Permitted
Transfer
This is a kind of more sophisticated lock up. It is an agreement between the investor and
existing shareholders that prohibits both existing shareholders and PEIs from selling without the
approval of the other.
Staging
Technique
The injection of capital occurs in installments, with a financial target to be met before the next
installment takes place. This agreement helps ensure that the money is not squandered on
unprofitable prospects.
Stock Option
Plan
An option given to the management of the venture backed company to buy stocks at a favorable
stock price. The provision generates commitment to create value.
Callable and
Puttable
Securities
The issuing of securities in which the PEI has the right to sell the stocks to the existing
shareholders (puttable) and the existing shareholders have the right to buy the stocks from the
PEI (callable). In both cases, the option scheme can be: American or European (i.e., without or
with a specific data to exercise the right) and single or combined (i.e., only callable or puttable,
or callable and puttable together).
53
Actions to Create Value IV

Tag-Along
Rights
A contractual obligation used to protect the minority private equity investor. In case the majority
shareholders sells the stake, then the PEI has the right to follow the transaction and sell its
minority stake on the same conditions and to the same buyer that is buying the majority stake.
Drag-Along
Rights
A contractual obligation used to protect a majority PEI. With this agreement, in case the PEI sells
the stake it has the right to ask the shareholders to sell their stake at the same conditions and to
the same buyer. It is a mechanism to maximize the price of the sold shares: the PEI has the
possibility to sell 100% of the company without owning it and when you can sell the whole
company, you have a higher contractual power.
Right of
First Refusal
A provision by which the PEI can avoid the shareholders selling their stake to undesired
shareholders. In this case, the PEI has to buy the stake of the selling shareholders at the same
conditions offered by the potential buyer.
Exit Ratchet
A provision by which the remaining shareholder has the right to obtain a percentage of the
capital gain deriving from the sale of the shares. This applies both to the PEI and to the
entrepreneur.
54
Content
2. Fundraising
7. Exiting
Introduction
In this clip we will deal with the last step of the managerial process of PE: Exiting.
This is the moment in which the PEI understands if (and how much) value has been
created by the VBC.
Exiting is the most difficult step for a PEI, because there exists both a pricing and a
liquidity issue.
56
Exiting
The exiting activity concerns the decision to sell the stake in order to gain the value
created through the investment and the managing & monitoring of the venture.
Exiting strategies have to be contextualized according to the portfolio strategy of
the PEI. There is in fact a double perspective where the IRR of the investment has to
be coordinated with goals and constraints coming from the whole portfolio.
57
Exiting II
Exiting has to be coordinated with:
The specific rules and covenants of the investment
The timing opportunity driven by the companys business
The timing opportunity driven by the financial market
The capital requirement and pricing constraints
The track record of exiting in the portfolio of the PE firm
Equity investments are made up of different clusters (i.e., seed, start up, expansion,
replacement, vulture) but theory and market trends show there is no correlation
between: the stage of investment, the holding period and the exit way strategy.
This suggests that each case has to be analyzed per se
58
Exiting III
The typical exiting strategies are the following:
1. Trade sale
2. Buy back
3. IPO or sale post IPO
4. Sale to other private equity investors
5. Write off
Even if in many investments the agreement for the exiting is clearly defined ex ante,
only the development of the investment itself can tell the right choice of an exiting
strategy.
59
1. Trade Sale
Trade sale is the exiting in which the private equity investor sells its stake to another
corporation or to another entrepreneur.
This exiting strategy is based on the industrial relation between the private equity
investor, the buyer, and the venture backed company.
The purpose of a trade sale is generally an acquisition to develop a strategic business
plan from the buyer and for that reason trade sale can be developed through
different solutions.
Anyway, this option is not very widespread because usually entrepreneurs do not
want to share their company or their ideas with another company or worse, with
another entrepreneur.
They are common in two cases: in LBO and when the PE_ holds the drag along right
and they sometimes can occur in PIPEs.
60
2. Buy Back
Buy back is the exiting in which the private equity investor sells its stake to an
existing shareholder or to a buyer chosen by the existing shareholders themselves.
Buy back is a trade sale in which the buyer is not a new corporation coming from the
market. It occurs when the shareholders who dont want to leave the company call
for the equity investor to sustain the business.
One of the most used covenants in these cases is the puttable shares (the PE has the
possibility to sell the shares back to the entrepreneur).
This option to exit gives for granted the fact that the entrepreneur has got
liquidity enough to buy the shares, otherwise a negotiation starts between the
entrepreneur and the PE.
61
3. IPO
This way out is the best option a PEI could ever dream of. In this way a PEI can
maximize the capital gain; and this occurs only in 1% of the cases. Through an IPO,
the private equity investor sales its stake in the stock exchange.
That means that an IPO is the condition by which a PEI launches the sale but the
mere sale can either occur during or after the IPO itself. In both cases, the private
equity investor is strongly involved in the IPO process, acting either as a global
advisor or as a manager. The different role depends on the nature of the private
equity investor.
An IPO is very difficult, though, because the company must be ready for it, the
business of the company has to be attractive to be accepted and the entrepreneur
has to be prepared to work and deal with retail investors. IPO launches follow the
so-called bubbles. For instance, going back to early 2000s many IPOs took place.
62
4. Sale to Another Private Equity Investor
The sale to another private equity investor is the exiting in which the private equity
investor sells its stake to another private equity investor.
This exiting strategy is common in the American market and is based on strong
relationship between the private equity investor and the community of private
equity investors.
Although this kind of exit is not that easy due to the fact that different PE investors
have different goals: the first one wants to maximize the capital gain, whereas the
second one wants to buy the participation at the lowest possible price (in order to
maximize in the future the capital gain).
The purpose of this sale is to sell the stake to an investor which operates in the
following stage of investment (i.e., from seed to start up, from start up to
expansion, etc) so that the VBC is walked through its life cycle.
63
5. Write O
Write off is the exiting in which the private equity investor cancels the value of the
stake in its portfolio; it is the worst nightmare of a PEI.
This happens when the company defaults and this may occur in start up and seed
financing because the business plan may be too aggressive.
A write off does not necessarily mean an IRR -100% because the PEI may try to sell
some valuable assets in order to recover from the loss.
Write off process can be driven by a private agreement or by law (i.e. failure
process).
64
Content
2. Fundraising
7. Exiting
8. Private Equity Advice for Entrepreneurs

Interview with Fabio Sattin
Who Is Fabio Sattin?

Founder of a Private Equity Firm: Private Equity Partners
Chairman of the EVCA in the past
Professor of Private Equity and Venture Capital at Bocconi University
Q&A
Lets focus on PE in continental Europe where the minority investments are very
popular and are a means to make the company grow. This means that the
entrepreneur and the investor have to work together.
What are the suggestions for an entrepreneur who has to work with a PE investor?
The chemistry and the personal relation between the PE and the entrepreneur is
fundamental to make the partnership successful.
Suggestions? In the first place, the basic decision: the entrepreneur has to understand
that he/she needs a partner, not just a cash injection. The entrepreneur has to be open to
share his/her decisions and to be transparent about the problems. In addition, an
entrepreneur has to select the right PE firm for the specific needs. Besides the PE firm,
the entrepreneur has to pick the right person for this person will be actively involved in
the ordinary life of the company.
In the end, the entrepreneur has to understand the decision-making process of the
partner (either local or international). Depending on the needs, a local partner may be
more suitable than an international one, or the other way around. Also, the business
model is an aspect the entrepreneur needs to understand (some PE may be more keen on
IPO, rather than trade sale).
Throughout the deal, the entrepreneur has to remember that the PE is an investor that
does not just provide money.
Q&A
Sometimes there may be an overlap between management and when a PE invests in
a company.
How do you think it is possible to work together and successfully within this
interaction?
This is a very crucial aspect, especially for Europe. When an entrepreneur opens the equity
to a PE investor, the entrepreneur needs to remember that the company will still be
managed by the management team. If an entrepreneur is not ready to distinguish her role
and the managers role, this means this in not the right time to open to PE.
The entrepreneur has to bear in mind that if he/she decides to open to PE, she will have to
accept the decisions taken by the PE.
Again, the entrepreneur has to be able to delegate the decisions to the management,
keeping under control the overall process.
It is very important from both sides to be very clear and maybe to write down what the
managers can or can not do, what the entrepreneur can or can not do.
Q&A
You said before that PE is like a marriage and we know that the IPO may be among
the most wanted desires at the end of the marriage. How is it possible to regulate
the marriage and the shared desire of an IPO?
Normally there is a pre-IPO deal. The picture of a PE investor investing as a minority
shareholder for 3-4 years leading a company to be listed is the ideal picture.
If this is the case, the parties need to regulate it from the beginning of the deal, including
it in the terms and conditions.
Also, it should be stated that all shareholders and the management team must take every
decision with that final purpose borne in mind. Also, in the contract it should be defined
when the IPO is supposed to take place and who is selling and who is not and whether there
will be a capital increase.
For instance, in my personal experience, we have rules since our first IPO with Natuzzi in
1993. When there is an IPO, we sell 2/3 of the stake on the day of the IPO and the
remaining third of the stake after one year and this is made clear since day one.
According to me, having rules is the best way to avoid misunderstandings.
MODULE 4
PRIVATE EQUITY
AND VENTURE
CAPITAL
Content
1. Company Valuation Fundamentals
2.
Company Valuation Fundamentals: The Pillars of DCF
3.
A Case of Company Valuation for PE Investment
4.
Applying Company Valuation to PE Settings
5.
Applying Company Valuation to VC Settings: The VC Method
6.
Launching Your Own Startup: Suggestions
7.
PE and M&A Interview with Eugenio Morpurgo
8.
PE and IPO Interview with Luca Peyrano
9.
PE, Turnaround, and Restructuring Interview with Raffaele Legnani
Introduction
This week deals with the issue and concrete application of company valuation.
This clip provides you with an overview of the fundamentals of company valuation,
while in subsequent clips some specific valuation models will be focused on and their
application to PE.
Company Valuation
Company valuation is the assessment of companys value.
Concerning PE, company valuation is a fundamental step since the PEI needs to know
the value of the company in which it is investing to decide to buy either newly
issued shares or already existing.
Company Valuation
The process of company valuation is the core of the investing phase.
We will use corporate finance theory to do that.
However, what is peculiar about PE is that equity has to be calculated in two
different moments:
Time 0: The moment in which the PEI decides to invest and in which the PEI
buys the shares of the private company
Time n: The moment when it exits

These two moments are correlated and they
are related to the generation of IRR.
In the first moment you should minimize
equity value, on the contrary at time n you
have to maximize equity value.
5
Company Valuation: The Macro

Components of a Balance Sheet
Current
Assets
Current
Liabilities
Fixed Assets
NFP
Financial
Investments
Other
Liabilities
Intangible
Assets
Equity
6
Equity Value: The Pillars for Company

Evaluation
The most popular way for calculating the equity value is represented by discounted
cash flow (DCF), where the rationale behind this model lies the assumption that the
value of the company is made up by the present value of the cash flows (CF) that the
company will generate over the following years discounted at the weighted average
cost of capital (WACC).
How do you calculate CF for the following years?
The PEI bases the estimation on a sound and reliable business plan.
Equity Value
The general equation to calculate the equity value for an n-maturity perspective of
investment is:
n
Equity =
t=1
CFt
+ TVn + (SA M NFP)
t
(1 + WACC)
Enterprise Value
Where:
TV is the terminal value at time n
SA are surplus (non-operating) assets
M represents the equity held by minority shareholders
NFP is the net financial position
SA, M and NFP refer (if they exist) to the time in which the valuation is made
8
Multiples
At the same time, the multiples method is also very widespread. This takes into
consideration the company together with its peers.
For this reason, this method is used together with the DCF to develop a fine tuned
valuation.
The most used multiples are:
EV/EBITDA
EV/EBIT
EV/S
Multiples
EV/EBITDA
Enterprise value/EBITDA gives a strong advice about How many times do you have to
multiply the EBITDA to buy the company? It is based on the capability of the firm to
produce gross margin.
EV/EBIT
Enterprise value/EBIT gives a strong advice about How many times do I have to multiply
the EBIT to buy the company? It is based on the capability of the firm to produce
operating profit.
EV/S
Enterprise value/sales gives a strong advice about How many times do I have to multiply
the sales to buy the company? It is based on the capability of the firm to produce sales.
10
Content
1.
Company Valuation Fundamentals
2. Company Valuation Fundamentals: The Pillars of DCF

3.
4.
5.
6.
7.
8.
9.
Introduction
After an overview of the DCF, in this clip we will individually analyze all the parts of
the formula used to calculate the equity value, bearing in mind that the DCF is based
on the generation of cash flow.
Equity =
t=1
CFt
+ TVn + (SA M NFP)
(1 + WACC)t
Enterprise Value
12
Cash Flow
WACC
TV
NFP, M, SA
DCF
The items composing DCF are the following:
Cash Flow
WACC
kd
ke
TV
NFP
Minorities (M)
Surplus Assets (SA)
13
Cash Flow
WACC
TV
NFP, M, SA
Cash Flow
PROFIT AND LOSS (OR INCOME) STATEMENT
+ Sales and other operating revenues
- Operating costs (including R&D)
= EBITDA
Gross margin
-Depreciation
= EBIT
+ Other income
Operating profit
Typically financial and not operating income
- Interest expenses
= EBT
- Income taxes
= NET INCOME OR LOSS
14
Cash Flow
WACC
TV
NFP, M, SA
Cash Flow
CASH FLOW
EBIT
- Income taxes
+ Depreciation
- Increase in net working capital
- capital expenditure
CAPEX
= CASH FLOW
This is the most widespread way to calculate the Free CF for the firm (i.e. the cash flow
available for financers and shareholders without considering a new debt issuance and the old
debt repayment).
Some authors call it also unlevered cash flow or cash flow for the firm to highlight the fact
that it does not provide any information about the capital structure.
15
Cash Flow
WACC
TV
NFP, M, SA
WACC
The concept of cost of capital refers to:
Cost of debt (kd or id)
Cost of equity capital (ke or ie)
That together are necessary to calculate the weighted average cost of capital (WACC).
16
Cash Flow
WACC
TV
NFP, M, SA
WACC:
The Cost of Debt
The cost of debt:
id* = id (1 t)
Where:
id stands for the average weighted cost of capital calculated either by dividing the
interest expenses by the financial liabilities or by taking into consideration every single
rate referring to different financings.
t stands for the corporate tax rate.
id* = interest rate net of taxes

17
Cash Flow
WACC
TV
NFP, M, SA
WACC:
The Cost of Equity
The cost of equity capital is calculated through the Capital Asset Pricing Model (CAPM)
formula:
ie = rf + (rm rf)
Where:
rf stands for the risk free rate (the rate of return yielded by a risk-free investment
coherent in terms of maturity with the investment itself)
rm = rf + risk premium (i.e. the exceeding return investors expect from the market,
measured with historical series, with respect to a risk-free investment)
stands for the degree of correlation between the investment and the market
18
Cash Flow
WACC
TV
NFP, M, SA
WACC:
The Cost of Equity
The coefficient of a stock is a regression of returns of the stock against the returns on a
market index.
When a company is not listed, it is necessary to compute the beta using the data of the
comparable companies. Here follows the steps:
1) Identification of the beta of a comparable (one or more)
2) Deleveraging of the beta with comparable companies data
3) Re-leveraging of the beta using the target company data
Unlever means to exclude the effect of capital structure while relever means to recalculate the beta coefficient using the capital structure of the firm
19
Cash Flow
WACC
TV
NFP, M, SA
WACC:
The Cost of Equity
The procedure to unlever is:
u = / [1+(1 t)(D/E)]
Where D and E are the market value of debt and equity of the chosen comparable
companies.
And the procedure to relever is:
* = u x [1+(1 t)(D/E)*]

* = target company data
20
Cash Flow
WACC
TV
NFP, M, SA
WACC:
The Cost of Equity
Once equity and debt cost of capital have been computed, the WACC is:
iWACC = id* x (D/D+E) + ie x (E/D+E)

Where WACC represents an effective measure of the cost of all liabilities for the company
taken into consideration.
21
Cash Flow
WACC
TV
NFP, M, SA
Terminal Value
The terminal value (TV) is a crucial item necessary to calculate the equity value. The
formula is as follows:
TVn=
CFn x (1 + g)
(WACC g)
(1 + WACC)n
Where g represents the perpetual growth rate by which the company is supposed to grow
every year.
22
Cash Flow
WACC
TV
NFP, M, SA
Surplus Assets,
Minorities, and NFP
In the end, as seen in the previous clip, we need to deduct (if they exist):
Surplus Assets
Minorities equity
Net Financial Position
from the enterprise value in order to obtain the equity value.
23
Content
1.
2.
3. A Case of Company Valuation for PE Investment

4.
5.
6.
7.
8.
9.
Introduction
Through this exercise we will see the application of the equity value through the DCF.
This set of slide presents the solution for the Old Winery case.
Through this case a company valuation within PE is treated through a time horizon of
four years.
This means that the stream of CF has to be calculated over the whole investment
period.
25
Inputs Income Statement

Income Statement (/000): Data presented in the business plan
Sales
Operating Costs
EBITDA
Depreciation
EBIT
Other Income
Interest Expenses
EBT
Taxes
NET INCOME
2015
2016
2017
2018
49,860
39,379
52,756
40,910
56,698
43,782
61,721
45,714
10,481
11,846
12,916
16,007
1,768
2,305
2,305
2,388
8,713
9,541
10,611
13,619
300
36
36
36
8,413
9,505
10,575
13,583
1,648
4,074
4,378
5,710
6,765
5,431
6,197
7,873
26
Inputs
Inputs to compute the Cash Flow Statement (/000): Data presented in the Business plan
2015
2016
2017
2018
1,768
2,305
2,305
2,388
(+)
Depreciation
(-)
Increase in the Working Capital
(-)
9,788
4,500
500
500
(-)
Capex
(-)
3,000
3,975
1,322
500
Comparable companies inputs
Mondavi (US)
Beringer (US)
Southcorp(AUS)
Bodegas (SP)
Campari (ITA)
Antinori (ITA)
Beta
EV/Sales
EV/EBITDA
D/E
0.73
0.94
1.02
0.89
1.23
Not listed
6.2
5.5
8.5
8.5
6.7
4.9
26
22.9
24.9
26.7
24
26.9
9.45
5.25
8.25
8.35
7.35
7.85
27
Inputs
Expected Holding Period (n)
Other Necessary Inputs:
0.25%
g rate /g)
Surplus Assets (SA)
12,000
-
Minorities (M)
Net Financial Position (NFP)
10,000
The aim of the PE in this case is to compute the equity value through the formula:
n
Equity =
t=1
CFt
+ TVn + (SA M NFP)
t
(1 + WACC)
28
Cash Flow
WACC
TV
NFP, M, SA
Cash Flow
Starting with the EBIT, we compute the CF for the
period taken into consideration:
2015
2016
2017
2018
8,713
9,541
10,611
13,619
1,648
4,074
4,378
5,710
1,768
2,305
2,305
2,388
(+)
EBIT
(-)
Income Taxes
(+)
Depreciation
(-)
Increase net working capital
9,788
4,500
500
500
(-)
Capex
3,000
3,975
1,322
500
3,955
703
6,716
9,297
CASH FLOW
29
Cash Flow
WACC
TV
NFP, M, SA
WACC
Following the steps in the WACC calculation, we need to compute:
a. Cost of debt net of tax
id* = id (1 t)
b. unlevered
u = / [1+(1 t)(D/E)]
c. relevered
* = u [1+(1 t)(D/E)*]
d. Cost of equity
ie = rf + (rm rf)
e. WACC
30
Cash Flow
WACC
TV
NFP, M, SA
WACC
a.
Cost of Debt net of Taxes
id* = id (1 t)
b.
2.4%
Corporate tax
35%
Net cost of debt capital
1.56%
beta unlevered
0.159337
beta relevered
0.32116
unlevered
u = / [1+(1 t)(D/E)]
c.
cost of debt
relevered
* = u [1+(1 t)(D/E)*]
31
Cash Flow
WACC
TV
NFP, M, SA
WACC
d.
Cost of Equity
ie = rf + (rm rf)
e.
risk free rate (rf)
1.25%
risk premium rate (rm)
7.75%
beta
0.962
final beta
0.32116
Cost of equity capital
3.34%
WACC
2.25%
WACC
32
Cash Flow
WACC
TV
NFP, M, SA
Terminal Value
Computation of the terminal value (TV), using the following formula:
TVn=
CFn x (1 + g)
(WACC g)
(1 +
WACC)n
9,297 x (1 + 0.25%)
(2.25% 0.25%)
(1 +
2.25%)4
= 425,482.50
33
Cash Flow
WACC
TV
NFP, M, SA
Surplus Assets,
Minorities, and NFP
Expected Holding Period (n)
g rate (g)
Surplus Assets (SA)
Minorities (M)
Net Financial Position (NFP)
4
0.25%
12,000
10,000
(SA M NFP) = (12,000 0 10,000) = 2,000
34
Equity Value
n
Equity =
t=1
CFt
+ TVn + (SA M NFP)
t
(1 + WACC)
Equity = 10,245.54 + 425,482.50 + 2,000 = 437,728.04
35
Content
1.
2.
3.
4. Applying Company Valuation to PE Settings

5.
6.
7.
8.
9.
Introduction
In PE deals as said in the previous clips, there is a double valuation issue regarding
equity.
As a matter of fact the PEI wants the equity value to be as low as possible in the
beginning of the investment while the value has to be as large as possible by the end
of the investment.
37
Inputs
The exercise that follows is based on the assumption that the liquidity is not an issue
for the exit from this investment.
In this company, the business plan is solid and the assumptions are very reliable.
Such is the case for investments made in expansion financing.
38
Inputs
The issue can be addressed by following these steps:
1. Calculating equity at time 0
2. Calculating equity at time n
In this case another business plan would be needed, which a PEI does not have in
this case. So the next step is to calculate the IRR with the numbers available at
the moment of valuation.
39
Inputs Income Statement

Inputs from the business plan
Expected EBITDA at exit
?
3
Expected holding period

Expected NFP at exit
Expected EBITDA multiple at exit
PE Investment
Post money share percentage
?
4
4,500
30%
40
Equity Value at the End of Investment

Business Plan
Holding Period
Because the holding period is three

years, exiting occurs in 2017.
2015
2016
2017
2018
2019
2020
Sales
Operating costs
EBITDA
Depreciation
EBIT
Other income
Interest expenses
EBT
35,000
31,000
4,000
1,500
2,500
120
2,380
39,000
33,000
6,000
1,500
4,500
100
4,400
43,000
37,000
6,000
1,500
4,500
100
4,400
45,000
39,000
6,000
2,000
4,000
75
3,925
50,000
43,000
7,000
2,000
5,000
75
4,925
54,000
46,500
7,500
2,000
5,500
-
75
5,425
816
1,483
1,483
1,308
1,641
1,808
1,564
2,917
2,917
2,617
3,284
Taxes
NET INCOME
3,617
Net Financial position

Increase net working capital
Capex
4,500
1,000
5,000
4,000
1,000
1,000
4,000
1,200
1,000
3,500
1,200
5,000
3,500
1,200
1,000
3,000
1,200
1,000
CASH FLOW
(EBITDA Taxes NFP)
-6,316
-483
-483
-3,808
859
1,692
41

By using a multiple of 4 (as presented in the inputs table) we obtain the EV: 24,000 /
000.
Because the equity value is only part of the enterprise value, we need to deduct the
value of the NFP to get the equity value:
Equity value (/000) = 24,000 4,000 = 20,000
Given that the PE has the 30% of this equity, at the exit it represents 6,000 /000
after having made an investment of 4,500 /000 three years before.
The IRR is 10.06%.
It is good or bad?
Nobody can tell except for the investors themselves.
42

For this reason, when the PEI undertakes an investment, running a sensitivity analysis
is a common practice, by which the PEI combines on the one hand the EBITDA
multiples and on the other hand it combines the holding period.
HOLDING PERIOD
EBITDA MULTIPLES
1
2
3
4
5
6
-6.67%
-3.39%
-2.27%
-1.71%
-1.37%
-1.14%
33.33%
15.47%
10.06%
7.46%
5.92%
4.91%
73.33%
31.66%
20.12%
14.74%
11.63%
9.60%
113.33%
46.06%
28.73%
20.86%
16.36%
13.46%
153.33%
59.16%
36.32%
26.16%
20.43%
16.76%
193.33%
71.27%
43.15%
30.87%
24.01%
19.64%
43
Content
1.
2.
3.
4.
5. Applying Company Valuation to VC Settings: The VC Method

6.
7.
8.
9.
Introduction
The venture capital method (VCM) focuses on the relation among the expected IRR,
the growth of the firm and the percentage of shares the PEI has to buy in order to
become an active owner of the venture-backed company.
This approach can be used (and it is typically used):
For deals where the phase of price setting is fundamental
For seed and startup deals in where it is difficult to determine the percentage of
investment for the equity investor.
45
Step 1
Step 2
Step 3
Step 4
Step 5
The Venture Capital Method

The venture capital method gives an answer to a very simple question: how many
shares does a PEI have to buy considering the investment made and the expected IRR?
This method develops over the following steps:
Step 1:
Step 2:
Step 3:
Step 4:
Step 5:
The
The
The
The
The
future value of the investment

TV calculation
percentage of shares the PEI will own after the investment
amount of share the VBC has to issue
value of the newly issued shares
46
Step 1
Step 2
Step 3
Step 4
Step 5
Inputs
Data Inputs
Value of the Investment

Expected IRR
Expected holding period
Terminal year net income
P/E comparable Ration
Number of existing shares
4,500,000
45%
5
3,500,000
12
100,000,000
47
Step 1
Step 2
Step 3
Step 4
Step 5
Step 1: The Value of the Investment

This activity concerns the calculation of the future value of the investment,
considering the expected holding period and the expected IRR, where the expected
IRR derives from the different constraints the investor has.
Future Value of the Investment = Value of the Investment x (1 + Exp IRR)n

Future Value of the Investment = 4,500,000 x (1 + 45%)5 = 28,843,803.28
48
Step 1
Step 2
Step 3
Step 4
Step 5
Step 2: TV Calculation
This activity concerns the setting of the expected holding period and the calculation
of the terminal value.
The P/E ratio can also be a starting point to calculate the TV, in addition to the DCF
method seen in the previous clips.
TV = Value N Net Income x PE Ratio = 3,500,000 x 12 = 42,000,000
49
Step 1
Step 2
Step 3
Step 4
Step 5
Step 3: The Percentage of Shares

After having computed the company TV, the investors need to compute the shares
they have the right to obtain in return for the investment made.
% PE shares =
28,843,803.28
Future Value of the Investment
=
= 68.68%
42,000,000
TV
50
Step 1
Step 2
Step 3
Step 4
Step 5
Step 4: The Number of Shares to Be Issued

This activity concerns the calculation of the number of new shares the venture backed
company has to issue equaling to the percentage calculated in the previous step.
Number of shares =
Existing Shares x (% of shares)

(1 - % shares)
Number of shares =
100,000,000 x 68.68%
(1 68.68%)
= 219,214.20
51
Step 1
Step 2
Step 3
Step 4
Step 5
Step 2: The Value of Newly Issued Shares

This activity concerns the calculation of the price of newly issued shares for the
investor.
Price of new shares =
Value of the Investment

Number of New Shares
4,500,000
219,214.20
= 20.53
52
Content
1.
2.
3.
4.
5.
6. Launching Your Own Startup: Suggestions

7.
8.
9.
Introduction
In this clip some hints and tips will be presented that startuppers should keep in mind
before launching their own business.
As a matter of fact, nowadays this is a very good moment to launch (well-built) start
up in Europe too.
54
Favorable Conditions
1) The first condition that may allow you to launch your own startup is the huge
amount of liquidity available in Europe together with the fact that interest rates
are lower these conditions make an investor keen on investing in new
projects.
2) Nowadays there is a widespread interest in alternative investments which PE and
VC belong to.
3) On top of that, especially in Europe, there is a need for growth to enhance the
GDP
55
Rules of a Well-Organized Sturtupper

1. Commitment, hard work, and passion
The fact that you, as the founder, believe in your work is a necessary element to
convince external investors and to demonstrate to them that your company is a good
investment.
2. Right team
In order to create a good company you need to hire the right people and the team
should be made up of people as diverse as possible.
3. Promotion of a glamorous idea.
The investor has to fall in love with the idea at the basis of the company because the
investors will trust a good idea provided that the founder believes in that idea too.
56
Rules of a Well-Organized Sturtupper

4. Numbers, numbers, numbers!!!
Passion is important as well as commitment. A startupper should never forget about
the numbers: the VC looks for an IRR in the end. Once the idea of the founder is
translated in numbers, the entrepreneur has to make sure that there is room for an
(interesting) IRR.
5. Be a risk lover
The founders have to demonstrate to the investors that they are ready to face and
share the risk with the venture capitalist.
6. Be able to make other people commit
VC will test the entrepreneurs ability to convince other people, and this means that
the start uppers have to be able to convince their own network.
57
Final Recommendations
If you want to launch your own start up, remember that investors could be very
different being:
Business angels
High Net Worth Individuals
Incubators
Etc. ...
In any case, you have to remember that you have to select the most suitable one
for your project and needs.
58
Content
1.
2.
3.
4.
5.
6.
7. PE and M&A Interview with Eugenio Morpurgo

8.
9.
Who Is Eugenio Morpurgo?

Founder and CEO of Fineurop Soditic S.p.A.
Long experience in the M&A world.
Professor of Investment banking at Bocconi University.
Q&A
What are the key trends in the M&A market today?
In 2014 we observed a positive trend of the M&A market, which continues through 2015, it
is driven by acquisition financing and the liquidity availability of PE funds and corporations.
Generally speaking, we can say we are very optimistic for the M&A market and we will for
the next 6-7 months.
As for the Italian market, it is dominated by foreign investors, both strategic investors and
PE investors Quality assets seem to be what the investors are more interested in.
In addition, multiples speak for themselves, the EBITDA margin multiple was 9: a record
over the last 15-20 years. I do not think that this is an Italian market bubble, again
acquisition financing is very good and there is still room for mid-size acquisition financing
projects, but this will depend on debt capital market, stock market and on the Grexit,
which may affect these markets in the next 3-4 months (note: the interview was taken in
early July 2015).
As for the Italian domestic market, we still see a lack of strategic domestic investments,
Italian investors are very cautious within Italian boundaries. This is a reason why PE is very
important in Italy.
Q&A
PE is one of the main drivers of the M&A market. How do you see the relationship
between PE and M&A today?
PE has a very important share in the worldwide M&A market, in Europe as well
as in the US and this share is going to increase especially in those industries
where corporate strategic barriers are low.
I think that worldwide PE plays a very important role. As for Italy, this is even
bigger for two reasons: in the first place the IPO market is very weak and PE
could replace this IPO market, in addition to that PE can be extremely
important to support domestic groups in consolidation processes.
Q&A
M&A is relevant and complex at the same time. In your opinion, what are the key
issues for a company to manage M&A?
Looking at the buy-side, the due diligence has to be extremely accurate,
especially when it comes to the value of the potential synergies and to what
happens in the post-acquisition process.
Looking at the sell-side, there are some opportunities in the IPO and M&A
market and sometimes sellers concentrate on fundamentals and forget to take
into consideration that the market can be very volatile.
There is an M&A cycle, largely depending on the stock market and the liquidity
availability. Therefore, sometimes the right window opens and closes very
quickly. You should catch the right window!
Content
1.
2.
3.
4.
5.
6.
7.
8. PE and IPO Interview with Luca Peyrano

9.
Who Is Luca Peyrano?

Head of Continental Europe for the London Stock Exchange.
Long experience in managing IPOs.
Great support to SMEs and bigger companies as they enter the financial
markets.
Q&A
An IPO is one of the exit mechanisms for private equity and venture capital. How do
you see the relationship between PE and stock exchange and what are the key issues
for an SME that jumps into the stock exchange?
PE is crucial to capital markets, also they are important to spread an equity
culture. PE stands right before the IPO.
There is now an always strong relationship between us and the PE community,
not only on a local level.
In the past, up to 40% of IPOs derived from PE. In these years, half of the
capital raised from the London Stock Exchange comes from VBCs.
Q&A
What is Borsa Italiana (the Italian Stock Exchange) doing for SMEs and why SMEs are
usually so reluctant to go public?
In Southern Europe there is a huge number of SMEs, not very close to the
capital markets. It is mainly for them that PE plays a bigger role.
The SMEs usually have a bigger perception of the distance between them and
the stock exchange. This is more of a psychological problem rather than a
technical one. Hence, we are creating markets that can be tailor-made for
smaller companies, and we are trying to engage with companies at an earlystage of life.
This is why three years ago we launched ELITE, which has proved to be very
successful. It is not a market but a business support program for SMEs in which
we train and coach companies and their managers.
Q&A
Can you say something more about ELITE that is becoming an exceptional format to
sustain SMEs towards the capital market? What is the challenge for Borsa Italiana
(Italian Stock Exchange)?
ELITE turned out to be a magical solution, not only for Italian SMEs. It is a
quite recent understanding that let us know why companies would not go public.
It is all about creating the right environment. We provide an early-stage
training, together with top business schools, such as Bocconi University; then we
move to a phase in which companies are pushed towards change. We ask them to
explore new areas, such as business areas or their governance mode.
Eventually we present them to our investors. This program does not necessarily
lead to the stock exchange rather to consider all possible options that can
accelerate growth.
Content
1.
2.
3.
4.
5.
6.
7.
8.
9. PE, Turnaround, and Restructuring Interview with

Raffaele Legnani
Who Is Raaele Legnani?

Managing director at HIG capital.
Long experience in restructuring and turnarounds.
Q&A
Restructuring and "special situations" are part of the relevant business for private
equity. How do you see today the relationship between PE and these areas?
PE can help companies throughout their life cycle. PE can turn ideas into
businesses and can support expansion as well. PE funds can also help in their
restructuring and turnaround phases.
In todays world, even if a company has a very sound business plan, it can be
strongly hit by sudden events which change the value of the company.
This is why PE funds that invest in change are more than welcome!
Without such players in the markets these companies overwhelmed by change
would go bankrupt and we would lose their so-called going concern value.
Q&A
What are the key issues for a PE investor that has to manage restructuring and
special situations?
The most important thing is to have the right mindset. The PE has to look at
all those unsuccessful cases and point out those few companies which have a
chance.
This is an important skill for a PE investing in turnaround and restructuring.
Q&A
In your experience and in your opinion, what are the key trends in the market for
restructuring and special situations within the PE world?
In the last few years there is an increasing attention of banks towards
distressed debt. For this, they created dedicated teams and they totally
changed their attitude.
Beforehand, they had a very passive attitude: they were more focused on
legal technicalities. Now, they really want to understand the business and
how they can create value in a company. This is a totally brand new mindset.
On the other hand, banks are quite new to this approach and to this way of
doing business. Therefore, I see a clear trend towards a partnership between
banks and PE funds to work together and help distressed companies.
PE can put in money and help banks in spotting the right companies in which
to invest. This could help not only distressed companies but all of the
economy after a domino effect.

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MODULE 1

Why Companies Need Private Equity And Venture Capital

Private Equity Clusters: Through the Fund's Life Cycle

Seed, Startup, and Early Stage Financing

Private Equity and Venture Capital: Today and Tomorrow Interview

The Need of Financing

The investor gets shares of the equity of the

The Consequences the Financing

The Dierence between: PE and Investing in

The price is driven

Liquidity is very high.

When trading on the stock

The price is the

Selling the shares is not so

The shareholders (the PEI) have

What Is Private Equity and Venture Capital?

2. Why Companies Need Private Equity And

Private Equity Clusters: Through the Fund's Life Cycle

Seed, Startup, and Early Stage Financing

Why Would a Company Need PE?

The venture-backed company wants to

1. The Certification Benefit

2. The Network Benefit

3. The Knowledge Benefit

4. The Financial Benefit

Positive effect on the cost

If a company needs at least one of the four benefits,

Financing and Life Cycle of a Company

These sources are not right for the company

The risk is too

What Is Private Equity and Venture Capital?

Why Companies Need Private Equity And Venture Capital

3. Private Equity Clusters: Through the Fund's Life Cycle

Seed, Startup, and Early Stage Financing

The Taxonomy of PE Clusters

The Taxonomy of PE Clusters

The Taxonomy of PE Clusters

The Taxonomy of PE Clusters

The Taxonomy of PE Clusters

What Is Private Equity and Venture Capital?

Why Companies Need Private Equity And Venture Capital

Private Equity Clusters: Through the Fund's Life Cycle

4. Seed, Startup, and Early Stage Financing

Private Equity and Venture Capital: Today and Tomorrow Interview

The Venture Capital Fundamental

2. SUDDEN DEATH RISK

3. STOCK OPTIONS FOR THE INVENTOR

4. BALANCE BETWEEN MONEY AND SHARES

Early Growth Financing

Conclusion on Venture Capital

What Is Private Equity and Venture Capital?

Why Companies Need Private Equity And Venture Capital?

Private Equity Clusters: Through the Fund's Life Cycle

Seed, Startup, and Early Stage Financing

Private Equity and Venture Capital: Today and Tomorrow Interview

In an adult company, growth can be:

1. Internal (or organic)

Screen and scout the market

(also from a legal and a fiscal point of view)

What Is Private Equity and Venture Capital?

Why Companies Need Private Equity And Venture Capital?

Private Equity Clusters: Through the Fund's Life Cycle

Seed, Startup, and Early Stage Financing

Private Equity and Venture Capital: Today and Tomorrow Interview