Private Equity Financing: A Comprehensive Guide

This document provides a comprehensive guide to private equity financing, including the acquisition process, funding sources, and exit strategies. It discusses the importance of valuation and factors to consider for successful investments. Case studies and examples are included to illustrate key concepts. The document also explores the role of management fees and the challenges faced by limited partners in private equity firms.

PRESENTATION
Private Equity Financing
Private equity entails the acquisition of firms by private investors. The act is mostly
developed in the existence of a financial crisis within a business where the management
works out for the business survival. On the other hand, the investors within the business do
lookout for an exit from which they will get the chance to invest in a more profitable business
since their main interest is making profit out of their shares within a business. As a result, the
management sources for the funding from private entrepreneurs since banks cannot undertake
a risk with a non-stable business. The decision results in private equity finance where the
company is bought by a private investor who predicts that it will do better in the future
earning him or her profit. The investor develops the fee for the purchase to include the
payment for the business shares thus providing an exit to business stakeholders. After the
acquisition the ownership is transferred to the investor allowing for changes to be executed
within the business to enhance its productivity.
As seen from the case study, the Dell equity which is $ 24, 156 comprises of 30-40%
of the LBO financing. The largest percentage of LBO financing is made up of Debt. In this
case, the Dell LBO had a debt of $9,034 (is this represents the 20%-30%? If yes, then it
shouldn’t be 9034). To determine whether an investment is worth buying out, the acquisition
firm calculates the internal rate of return with a minimum of 30% but for larger deals it can
even be 20%. As it can be witnessed from the case, it is important for the acquiring company
to evaluate the risk ratio (debt-equity ratio). This is a leverage ratio which computes the debts
and liabilities against equity. For a successful LBO, the risk ratio should be greater than 1-2x
(what do you mean by 1-2x?). in the case of Dell LBO, the risk ratio is 3.6x (from where
did you get this risk ratio?). Debt to equity ratio is given the following formula; Debt to
equity ratio =total liabilities/total equity. In the case of Dell LBO
Total liabilities = $ 24,784
Total equity = $ 24,156
Debt to equity ratio = 24784/24156
= 1.1
The debt to equity ratio of 1.1 means that the business creditors and investors have an
approximately equal stake in the assets of the business, and this mean that the company
should enter into such an investment as it indicates that the company is stable with significant
cash flow generation. and the means that the company should/shouldn’t enter in such an
investment as it….. (Please continue the conclusion here whether the company should do
for such an investment based on the Debt to equity ratio or no?)

Factors of consideration in private equity
For investors to decide on the company to extend their investment they should
consider the valuation of the current condition of the company to avoid over valuation. The
valuation of Dell Company serves as a good example of an investment valuation as illustrated
in the appendix. The company was valued to be worth 23.72 billion dollars which helped the
investor Silver Lake Partners to work out the value at which they would purchase their
company valuing it at 24.4 billion dollars in order to cover for the company assets and for the
shares of the company. The investor should also consider the expected future performance of
the company. In the consideration, the investor should develop ways to improve the
performance of the business. 3G company serves as a good example of an investor who
considers improving the performance of Burger King after purchase. In the consideration, the
investor focuses on lowering of the company expenses made during production and to the
shareholders. Investors should consider the financial status within the period of investment. A
practical example can be derived from the application of Taylor rule in the case study where
it determines the monetary policy taking into consideration the price stability and the
economic output. To calculate the monetary policy the following Taylors rule formula is
applied: nominal fed fund rate= real federal funds rate + rate of inflation + 0.5 (rate of
inflation – target rate of inflation) + 0.5 (logarithm of real output – logarithm of potential
output). This is simply presented as i= r* + pi + 0.5 (pi-pi*) + 0.5 (y-y*). However, in the
case study, the emphasis is given to nominal interest rate simply derived via the formula Rf =
4% + 1 (inflation – 2%) + 0.5(output). This can be analyzed in that an increase in inflation
above 2% means an expected increase in nominal interest rates with over one for one.
Similarly, the investor should consider availability of debt for servicing their investments. In
addition, they should consider a rise in stock market since it ensures high profits from an
investment. Furthermore, should develop a plan to illustrate the source of their finances as
illustrated below in the case of Silver Lake Partners.
Another factor to be considered is the management fee. This comprises of an annual
fee calculated as a fixed portion of the firm’s assets which is managed by the general partner.
Bain capital issued three management fee structures. It is from these structures that the
limited partners had to choose. Xuan, a manager represent a company that is a limited partner
of Bain capital was at crossroad as the terms in the new structures differed with that which
was originally given by the firm. Her company was a sovereign wealth fund with a basic
requirement of generating positive returns. Bain capital considered low management fee as
been efficient as it allowed incentive alignment with the limited partners. This kept Xuan at
crossroads. The dilemma is being faced by different limited partners of Bain capital.