PRIVATE EQUITY INVESTING OUTLINE
SHERMAN – SPRING 2015
1) Key Parts
a) Economics of:
i) LOI
(1) Cost – $5,000 to $25,000
(2) Goal – Define key deal points; avoid deal risk
ii) Definitive Agreements
(1) Cost – $50,000 to $1 million or more
(2) Goal – outline with specificity the terms of the investment
iii) Definitive Agreements
(1) Cost – $50,000 to $1 million or more
(2) Goal – often contemporaneous with definitive agreements
2) Car Hypo
a) Buying a Car. Assume that you and I bumped into each other at restaurant waiting for a table. You mentioned that you were looking for a jeep Wrangler. I told you that I had a 2008 Jeep Wrangler that I wanted to sell. Assume I told you I wanted $12,500 for the jeep, but then got my table and had to run. I told you to call me if you were serious about buying it…
i) This is framing it around the price
ii) What would you want to know around the $12,500?
(1) You would want to know if it is a reasonable price
(a) Could do some price research to determine the value of the car
iii) First step is based on price
(1) If you say that the price seems to high after research, I would say that it is right based on this car and would make some statements about the car that affects the price
(a) I would be touting the car – framing the assets – making representations about the asset
iv) Arrive at a price of $11,000 but have condition that driving Jeep now and need it until graduate in May. Further assume that you love the Jeep and want to accommodate me. What would you do?
(1) You would place restrictions on what they could do with the Jeep
(2) I would be making covenants – agreements to do something or not to do something
(a) To drive normally, not to wreck it, maintain it in ordinary course
(3) Closing conditions
(a) Where you could get out of deal if I do something in the interim that you don’t like
(i) i.e. breach any of the promises; drive it over 5,000 additional miles
v) Structure of Agreement
(1) Basic Agreement – I agree to sell a 2008 Jeep Wrangler to you for $11,000 in cash, subject to adjustment of closing.
(a) Comment – This is the essence of the transaction.
(2) Representations/Warranties – these are statements made by a seller to a buyer (and vice versa) at a particular point in time. These statements are represented and warranted to be true.
(a) Where really have to stand behind the statements in writing. All the puffing and touting of the car leading up to this that are not put in writing are not representations and warranties.
(b) Seller – grey, good working condition (might be too vague), never been wrecked, 51,000 miles, no liens, accessories
(c) Buyer – financial wherewithal
(d) Comment – This frames the particulars of the asset being purchased.
(3) Covenants – promises to do something (positive covenant) or not do something (negative covenant), typically made by the seller
(a) Typically govern a transaction after the agreement
(b) Seller – how drive until closing, normal maintenance
(c) Buyer – use reasonable efforts to obtain financing
(d) Comment – In a transaction, these can either be pre-closing (like the ones above) or post-closing (i.e. covenants to not compete)
(4) Closing conditions – in most agreements, the buyer and the seller are obligated to close upon meeting certain conditions
(5) Closing – Exchange of car, clean title, and cash
3) Asymmetry Concept
a) Private Equity vs. Public Equity
i) Public Equity – you buy stock in a company from the seller through an exchange (e.g., the NYSE). The stock is marketable and can be bought and sold freely. No negotiation on price.
(1) Buyer and seller do not set price
(a) Price generally set by the company
(2) Market presupposes all the germane information is in the public
(a) Symmetrical information
(b) For the public market to work, have to assume symmetrical information
(i) Achieved through Securities Act of 1933 and Securities Exchange Act of 1934
(c) Insider trading occurs when there is asymmetrical information
ii) Private Equity – you buy stock in a company from another holder directly or from the company. The stock is almost always subject to restrictions on transfer (via securities laws and often corporate documentation). Can negotiate everything – especially price.
(1) Almost always have asymmetrical information
(a) Because company selling the equity almost always has better information because they are running the company everyday
(b) Have to assume the seller has better information about what he is selling than the buyer
(c) Whole point of going through this process is for the buyer to gather information about what he is buying so they can frame the contract based on this
(d) Getting the information is much harder in private equity
(i) Unless you ask him questions about his company, he doesn’t have to tell you anything about his company – no duty unless per contract
1. Only duty is to not commit fraud
(ii) Private Equity process if very much about going through gathering information, then defining terms, then gathering more information and documenting the information
(2) Can be defined as basically everything else other than public equity
iii) Biggest Difference – 1. Manner of transfer (process), 2. Negotiation of terms, 3. Documentation and 4. Access to information (symmetry or asymmetry)
b) Private Equity – Asymmetry of Information
i) Goals of Private Equity for Buyer
(1) To determine the upside, the downside (risks), and then try to document the transaction efficiently to ensure the benefit of the bargain
(2) The contract/documentation is they way
Article
i) Continuing Guaranty
(1) Means guarantor will be liable for all of the borrower’s obligations to the lender, including current debts, future debts, and the renewal or extension of such debts
(2) Makes guarantor liable for:
(a) Borrower’s debts which existed prior to the guaranty
(b) Borrower’s loan which he is in the process of obtaining, and
(c) Any future loans or debts b/w the borrower and the lender
(3) No termination date
(a) Guarantor can give written notice to terminate for additional obligations but will remain liable for the then existing obligations
ii) Unlimited Guaranty
(1) Not limited to particular time period or amount
iii) Lender’s right to set-off
(1) Allows lender to take funds from any other account of the guarantor to satisfy the guarantor’s obligations under the guaranty (except certain IRS or trust accounts for which set-off is prohibited)
(2) Effect is lender can demand repayment of full amount of guaranty upon default by borrower and then directly and unilaterally take the guarantor’s personal funds to pay the debt by withdrawing them from the guarantor’s accounts and crediting the withdrawn funds to the lender’s accounts
iv) Liability Continues After Death of a Guarantor
(1) Continue to be liability of the guarantor’s estate until the guaranteed obligations are paid in full or until the guaranty is released by the lender
(2) Lender has no obligation to release a guarantor’s estate from liability and typically will only do so if a new guarantor, satisfactory to the lender, is willing to take the place of the deceased guarantor
6) Engagement Letter – Things liked, as applied to other agreements
7) Confidentiality Agreement
a) Risks of Supplying Initial Information
i) Competitive Risks
(1) Buyer will likely ask for financial information first, which will provide margin and other data
ii) Distraction
(1) Dealing with a transaction, even in early stages, can be a distraction and can cause a business owner or executive to take her eye off the ball
iii) Angst Among Employees
(1) Huge risk and factor – employees can become extremely concerned about change and/or job security
iv) Leaks of Discussions Out to Marketplace
(1) Customers might hear about discussions
