Analysis of Private Equity Finance: A Comprehensive Case Study

This case study analyzes private equity finance, focusing on corporate buyouts and investment strategies. It examines how private investors acquire firms, often during financial crises or underperformance, and restructure them to increase profitability. The study explores leveraged buyouts, debt-to-equity ratios, and the role of debt financing in these transactions, using examples like the Dell LBO and Burger King's acquisition. It delves into the benefits of private equity, including improved management and cost-cutting measures, and discusses exit strategies for investors. The case also touches upon the application of Taylor's rule in determining monetary policy and the importance of risk assessment in investment decisions, highlighting the potential for high returns but also the associated risks. The case study provides a comprehensive overview of the private equity landscape, offering insights into the dynamics of corporate acquisitions and financial restructuring, making it a valuable resource for finance students and professionals.

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Private equity is 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 or when investors of private equity feels that the company’s stock is
underperformance. The company’s management decides to look for an exit strategy to curb
the financial crisis affecting the company. They thus decides to look for an investment
opportunity where the company will realize more profits. They get the best alternative of
private equity financing.
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Private Equity
Abstract
Private equity is the act of buying and restructuring of companies by a private firm.
Following the purchase, the company ownership is made private in order to allow for
restructuring. Among the activities developed in the restructure process include cutting the
cost of production within the company, enhancing development through development new
products, enhancing growth and changing the company’s management. Private equity
includes the leveraged buyout that allows for private investor to take control of a firm. In
most cases, the investors consider investing in firms that are expected to improve and realize
significant growth in the future earning profits for the investor. The investor may consider to
sell the business later after it has realized a significant growth making profit in return. The
paper discusses factors involved with private equity financing. The discussion will
disseminate knowledge that is important for application in the business field.
Private Equity
Introduction
Private equity finance entails the act of raising equity capital by investors to
companies with high growth rate over a long period of time (Gatauwa, 2014, 15). The
financing strategy is mostly developed for small and medium business to whom access to
finances for funding their development is hard to acquire from family, friends and banking
institutions.
The financial strategy also helps to exploit opportunities and enhance growth by
providing financial support to investments facing difficulties in attracting financial support.

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Furthermore, the financial strategy has ensured the recovery of many businesses that were
initially struggling with financial challenges. As a result, many businesses have realized
continued growth and increased competitiveness in the business field. The investors who
undertake private equity finance always look out for businesses that promise high return in
order to attain their desires, that is, profits from the business. The finances can be offered at
different stages within the business growth which include starting, developing and already
developed businesses. In the funding the finances are categorized into groups, that is, seed
capital that is offered to beginning businesses and later stage capital that is offered to already
developed businesses.
Private equity finance offers the investor with a chance to transfer his or her capital to
a different business through the divestment process. As a result, investors are provided with
high chances of return since they can use the strategy to exit falling investments into a
thriving one. In addition, the investors are allowed access to debt financing that reduces the
corporate tax charged. As a result, the investors are assured of high profits from their
investments since they have few deductions to make.
Case description
What the case shows
The case shows the application of private equity within the business field where
private companies acquire existing firms through buyouts. A buyout entails the process of
acquisition of an existing firm through specialized investment of a small amount of equity
and huge investment in debt servicing. Under private equity investment, buyouts are
developed through the attainment of control over an existing firm by a private equity firm
(Kaplan & Stromberg, 2009, 121). In the case study, the private investor buys the shares of a
publicly owned firm transferring it into a private company. For example, Bieber Capital
bided Texas Utilities (TXU) for 40 Billion dollars claiming its ownership in early 2007. The
fee made included payment of a debt of 13 billion dollars that had been made by the company
to enhance its financial stability. The investment was valued as one of the best during the
year since it was expected to generate huge returns owing to the company’s size, market
share and favorable investment conditions, that is, low interest rate, availability of debt for
servicing the investment and high stock market observed in the year 2007. In 2006, a group
of investors acquired the hospital chain (HBA). The team spent 32 billion dollars developing

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mega buyout. The buyout services often take place when interest rates are low, credits for the
purchase are available and when there is a rise in the stock market. For example, due to the
high prices for target companies the borrowing rate increased with the availability being
ensured and the interest rates for the borrowed money remaining low. The debt availability
was ensured by the presence of junk bonds that were being offered by portfolio companies
(Gompers & Kim, 2014, 2).
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 (what do you mean by over one for one). In addition, the lending power increased in
the year 2007 helping investors to easily access debt financing for their investments. The
accessibility can be identified from the increase in amount borrowed. In the year 2007 the
amount borrowed was 4.1 trillion dollars owed to an increase in the number of borrowers
(Gompers & Kim, 2014, 2).
Another practical example is the Dell LBO equity finance. 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. 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. 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

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= 1.03
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 the means that the company
should enter such an investment as it indicates that the company is stable with significant
cash flow generation.
For a successful LBO, the risk ratio should be greater than 1-2x. in the case of Dell LBO, the
risk ratio is 3.6x, which means, that the shareholders equity contribution is 3.6x the creditors
contribution.
Primary subject matter of the case
The primary subject matter in the case is acquisition of firms by private investors at a
given fee, that is, private equity finance. The financing is made so as to reclaim companies
from their financial struggles and to enhance their development. The investors take advantage
of struggling firms more so the declining ones and those with huge debts so as to fix the fee
that will assure maximum profit from the investment in future. The acquisition of the
Brandon Hills Teachers Retirement Fund serves as a good example where the investor Silver
Lake Partners valued it at 24.4 billion dollars. According to stakeholders of Dell company,
the investment was undervalued though they gave in since it would serve as an exit to the
depreciating investment and would help avoid the collapse of the company since the
company shares were consistently depreciating. The depreciation was a result of poor sales
by Dell company that led the company to incur losses and to lose of value for its assets as
illustrated in the appendix. The investors in dell company had noticed its high declining rate
that led to the decline of its rivals from competing with dell that is Blackstone Group that
withdrew in 2013 after dell recorded a 14% decrease in its market share. As a result, it was
necessary for the company to receive financial support and restructure through private equity
investment to ensure its success and development more so to regain its lost market share. The
investors do develop ways of ensuring success of their new investments. The developed
measures may be based on improving the major undoing of the previous owner. The
acquisition of the Burger King company by 3G Capital assured in a new era that developed
changes within the company in a bid to realize its real potential. The company share had been
fluctuating before started depreciating calling for changes within the company. Among the
changes developed include cutting of the company expenses by reducing company employees
and reducing the company expenses (Gompers & Kim, 2014, 4). The money saved from the

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developed strategy was estimated to be around 1 billion dollars. The saved amount was used
to develop the company in order to enhance its competitivity in the market with its
competitors. Similarly, the investor would focus the profit earned to developing the business
other than distributing the same to the shareholders as was the case before the purchase.
Related topics in the case discussed in the case
The case presents the exit process of existing investors from a business through
divestment where they get the value worth their investment asset. The act is mostly
developed in order to allow the investors to shift their attention to new investments that will
result in profits. The acquisition of Brandon Hills Company that was under Dell company
made cash for the shareholders share in its acquisition fund of 13.65 billion dollars (Gompers
& Kim, 2014, 2). The funds would be used to repay the investors their funds that they had
initially used to support the company. The payment would offer the investors the freedom to
exit the declining dell company and reinvest their funds in better promising company where
they will be assured of profits. Similarly, the case study has outlined the various ways
through which investors assure the success of a declining company that may be as a result of
financial struggles. Burger King serves as an example where the acquisition assured its
development by changing the management and reducing cost made on salary and
shareholders payment. 3G Company focused on development and enhancing the company
competitivity in the market field.
Issue involved
Development of private equity finance is based on long term profits expected by the
investor from a given business (Witte & Brown, 2018, 2). Investors do purchase companies
with great potential for development but have not yet been able to unleash the power due to
financial constraints. The investor offers to purchase the company and fund it with his or her
own funds increasing the productivity of the firm and the competitiveness of the firm in the
business market. As a result, the business is able to realize maximum profits which is the aim
of the investor. However, the growth is made by reducing the expenses made by the business
which includes cutting of the business employees leading to unemployment. Burger King
serves as a good example where employees were reduced in a bid to lower the expenses of
the company after its acquisition by 3G Company. The future consideration of the business
also helps determines the expected return from a business that is expected return = (dividends

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paid + capital gain)/price of stock. In general, the investor considers the potential of a
business in determining the investment to be made.
The issue of management fee is captured in the case study under the subtopic ‘limited
partners dilemma.’ In this subtopic, the Bain capital made a management fee offer to its
potential limited partners. The management fee comprises of an annual fee calculated as a
fixed portion of the firm’s assets which was managed by the general partner. Xuan, a
manager representing a potential limited partner was in a dilemma in choosing on the best
alternative from the offer given. She was comfortable with the terms of the sole management
fee structure which was initially given by Bain capital but she wondered if the new offer were
congruent to her company goals. Her company was a sovereign wealth fund with a basic
requirement of generating positive returns. Whereas Bain capital preferred low management
fee with an aim of aligning its incentives with the limited partners, Xuan was at crossroad as
low management fee could me negative returns for her company. This was the dilemma
which faced limited partners of Bain capital.
Benefits of the case and to whom
Private equity investment has several benefits more so to the investor. Among the
benefits include, the investor has the potential to purchase a company at a cheap price
following its current condition where the company is struggling within the market field due to
poor performance and losses. During the struggle process the company shares losses value
and its valuation depreciates. The cheap acquisition assures the investor of huge returns once
the business stabilizes. The acquisition of the Brandon Teachers Retirement Fund by Silver
Lakes Company was made at a cheap price owing to the poor performance of the Dell
Company in the market. The low acquisition led to protests from Carl Icahn and the company
CEO Michael Dell. Similarly, private equity finance offers the investors in a declining
investment the chance to transfer their funds into new investment.
Case synopsis
What is the story
The case develops financial crisis as a major problem facing the business sector. The
challenge hinders growth and development of a business resulting to losses. Following the
poor performance made by the business most of its investors tend to transfer their support
into a more profiting business that will assure them profit upon investment. Similarly, the

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business finds ways to coup up with-its financial challenge to avoid extinction from the
business field. In the case Brandon Hill Retirement fund serves as a good example of our case
since it was struggling financially after poor performance of Dell company being one of the
shareholders of Dell (Gompers & Kim, 2014, 2).
Solution prescribed by the case
Following the struggles developed by poor performance the company had to source
for funding from private investors since its poor performance would discourage banks from
offering support. Furthermore, the investors in the company had to be compensated their
invested funds in order to shift from the company to a more profitable one. As a result, the
senior director of the company Isaac Scott proposed for the company to be sold to a private
company that is Silver Lake Partners that had offered to buy the company at a 24.4 billion
dollars (Gompers & Kim, 2014, 2). The fee would include 13.65billion that would serve as a
repayment for shares owned by the various business stakeholders. The compensation would
allow for the exit of the business investors for reinvestment purposes in more profitable
businesses.
Major finding
It has been identified that most private equity investors mostly make huge profits. The
profits may be attributed to the low expenses made in the investment for a business that is
expected to realize tremendous growth in the future. The case identifies that Brandon Hill
company was purchased at a low-price owing to its financial status and poor performance in
the market which led to protest by Dell CEO and Carl Icahn (Gompers & Kim, 2014, 2). As a
result, the business was expected to offer the largest possible amount of profit since it had
less expenses to make. More so the huge amounts of profits realized may be attributed to
access of debt financing that lower the taxes made upon investment. In addition, the purchase
would serve as an exit plan for the shareholders within the business.
Importance of the approach taken in the case
The preference of private equity financing serves as a way to rescue the company
from collapsing. The investor would ensure the revival of the business through the
restructuring method applied thus helping maintain the competitiveness of the business. In
addition, the solution provided would provide an exit plan to the business stakeholders since
they would be refunded their money which would enable them to invest in other businesses.

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Conclusion
Private equity is one of the best investing opportunities. The opportunity is worth
risking since it offers a chance for reinvestment once a business depreciates. In addition,
investing in private equity assures of huge profits since the buyout is conducted for a business
that is expected high returns in future following the changes put in place after the purchase is
done. Furthermore, the investors are offered an opportunity to use debt financing to make
their investments. As a result, private equity should be a factor of consideration for any
investor since it promises of high returns in the long run. The financing strategy can also be
taken to account by investors in a case where their company of preference undergo losses and
lose its market value.
Work Cited
Gatauwa, M. “A survey of private equity investment in Kenya.” European journal of business
and management, Vol. 6 Issue 3 (2014): 15-20
Gompers, A. & Kim, D. “Private equity finance vignettes.” Harvard business school. (2014):
1-8
Kaplan, N & Stormberg, P. “Leveraged buyouts and private equity.” Journal of economic
perspectives, Vol. 23 Issue 1 (2009): 121-146
Witte, P. & Brown G. “Understanding PE impact on the economy.” Institute for private
capital. (2018): 1-7