John Gilligan and Mike Wright
August 2008
An initiative from the ICAEW Corporate Finance Faculty
ISBN 978-1-84152-603-4
111 pages
duplicated

Contents
Page
About the authors v
Acknowledgements vi
List of figures,tables and findings vii
Overview 1
1.The private equity market 9
1.1 An introduction to the private equity market 10
1.2 What is private equity?10
1.3 How big is the private equity market?10
1.4 How significant are larger deals in the private equity market?12
1.5 What have been the biggest UK deals?13
1.6 How significant are public to private transactions in the private equity market?14
1.7 What is the rationale for a public to private transaction?14
2 Who are the participants in a private equity transaction?17
2.1 Introduction 18
2.1.1 Who’s who?18
2.2 The private equity fund 19
2.2.1 What is a private equity fund?19
2.2.2 How are private equity funds structured?19
2.2.3 What do private equity fund managers do?20
2.2.4 How does a private equity fund differ from a quoted equity fund?21
2.2.5 How does a private equity fund differ from a group of companies?22
2.2.6 What are hedge funds and how do they differ from private equity funds?23
2.2.7 Emerging and converging alternative asset investors 24
2.2.8 Where do private equity fund managers operate?25
2.2.9 Why are European private equity funds based predominantly in the UK?25
2.2.10 How are UK private equity fund managers rewarded?27
2.2.11 Management/advisory fee 27
2.2.12 Carried interest 27
2.2.13 Other fees 27
2.2.14 Broad principles of UK fund taxation 28
2.2.15 Taxation of carried interest 28
2.2.16 What was taper relief and how did it affect the incentives of
private equity fund managers?28
2.2.17 Non-UK domiciled persons 29
2.2.18 Competition for funds by private equity managers 30
2.2.19 Can a private equity fund or a private equity manager fail?30
2.3 Investors in private equity funds 30
2.3.1 Who are the investors in private equity funds?30
2.3.2 Are institutions long-term investors in private equity funds?31
2.3.3 What are the average returns of the private equity market for investors?32
2.3.4 What is the range of returns for investors?33
2.3.5 How can individual investors invest in private equity funds?34
2.4 Banks 35
2.4.1 What role do banks play in private equity?35
2.4.2 How has the banking market changed?35
2.4.3 How much leveraged lending have banks undertaken?36
2.4.4 What are collateralised debt obligations,collateralised loan obligations
and structured investment vehicles?36
2.5 Advisers 37
2.5.1 Who are the advisers in the private equity market?372.6 Employees and other stakeholders 37
2.6.1 What is the impact of private equity transactions on wider stakeholders?37
2.6.2 What is TUPE and when is it applied?37
2.7 Taxation 39
2.7.1 The wider impact of leverage on UK tax revenues 39
2.8 Refinancing and exits 40
2.8.1 Types of exit 40
2.8.2 What has been the pattern of exits from private equity deals?41
2.8.3 Secondary buy-outs 42
2.8.4 Leveraged recapitalisation 43
Evaluating and structuring a private equity investment 45
3.1 Value and pricing 46
3.1.1 What is‘value’?The difference between enterprise value and equity value 46
3.1.2 What is‘financial engineering’?46
3.1.3 What is a‘Newco’?47
3.1.4 How do you decide whether to buy shares or assets?48
3.1.5 Pricing a transaction 48
3.1.6 A financeable offer 49
3.2 Senior debt and mezzanine 49
3.2.1 How much debt?49
3.2.2 What is payment in kind debt?50
3.2.3 Can Newco repay the borrowings?50
3.2.4 What security will the banks have?51
3.2.5 What are the potential sources of cash flow to repay borrowings?51
3.2.6 Increasing post tax profits 51
3.2.7 Reducing working capital 52
3.2.8 Fixed assets:to own or lease?52
3.2.9 Asset stripping and financial assistance 53
3.2.10 What protections exist for publicly quoted companies?53
3.2.11 The risks of leverage:financial covenants and events of default 54
3.2.12 One-to-one cash covenant 54
3.2.13 Net assets covenant 54
3.2.14 Interest cover covenant 55
3.2.15 An event of default and corporate failure 55
3.2.16 How can the risks of leverage be mitigated?55
3.2.17 What is mezzanine?56
3.3 Institutional and management equity 57
3.3.1 How much institutional equity?57
3.3.2 Internal rates of return 57
3.3.3 Debt:equity ratio 58
3.3.4 How much equity do management get in a buy-out?58
3.3.5 What is a ratchet?59
A detailed worked example of a leveraged buy-out 61
4.1 Illustrative operating projections 62
4.2 Funding requirement 63
4.3 Funding structure 64
4.4 The impact of leverage on profits and cash 65
4.5 Taxation:how much tax is paid by private equity-backed companies?68
4.6 Summary of corporation tax impact 69
4.7 Due diligence and sensitivity analysis 69
4.8 Exits and returns 71
Appendix:Summaries of studies of buy-outs and private equity 75
References 86
Glossary 92