III

Executive Summary

I. Executive Summary

The majority of companies are in need of investment capital to pursue their growth strategies. Also, a large number of companies only display a low equity ratio and as a result possess bad credit worthiness. In this regard, Private Equity represents a good alternative solution providing investment capital. It allows companies to make investments to solidify or improve their position among the competitors on the market. In times where banks and credit institutions exercise restraints, the interest of companies in Private Equity even increases. Nevertheless, particularly in Germany the growing importance of Private Equity is accompanied by great controversy. One group argues that often the Private Equity investors in their function as majority shareholders neglect the sustainable development of their portfolio companies in favor of their temporary value increase. On the other hand numerous studies indicate that companies benefit from Private Equity investments. According to these studies, companies, which have entered cooperation with Private Equity investors, comparatively, display stronger revenue growth and productivity and also generate more jobs. 1

In this respect, the quality of the partnership between the portfolio company and the Private Equity investment association is a decisive success factor and must not be underestimated. Private Equity deals only generate win-win-situations if both parties are professionally engaged. Lack of preparation can either lead to a one-sided relationship - leavingone party at a disadvantage -, or even to a bad overall business, in which both sides incur losses.

This paper takes the perspective of each party and points out which specific aspects they have to consider in order having good chances of benefiting from a Private Equity deal. This leads to the analysis of several critical stages within the investment process: investment stages in general, transaction process, due diligence, business valuation and exit. Prior the meaning, history and significance of Private Equity are described.

¹ In the studies the revenues of PE financed companies are compared to those of Non-PE financed

companies, cf. Deutsche Beteiligungs AG (2004), p. 16; Schäfer/Fisher (2008), pp. 55; PWC/BVK

(2005), p.9.

IV

Table of Contents

Table of  Contents  

I.  EXECUTIVE SUMMARY  III

II.  LIST OF FIGURES  V

III.  LIST OF ABBREVIATIONS  VI

1.  INTRODUCTION  7

2.  PRIVATE EQUITY IN GERMANY - BASICS  

   8

2.1  DEFINITION OF PRIVATE EQUITY  8

2.2  HISTORY OF PRIVATE EQUITY  9

2.3  BENEFIT OF INVESTMENTS FOR PRIVATE EQUITY COMPANIES  11

2.4  ECONOMIC IMPACT OF PRIVATE EQUITY  12

3.  PRIVATE EQUITY INVESTMENT  13

3.1  PRIVATE EQUITY INVESTMENT FROM A COMPAN´YS VIEW  13

3.2  PRIVATE EQUITY INVESTMENT FROM AN INVESTOR´S PERSPECTIVE  16

3.3  STAGES OF PRIVATE EQUITY INVESTMENTS  17

3.4  PRIVATE EQUITY TRANSACTION PROCESS  19

3.5  DUE DILIGENCE  21

3.6  BUSINESS VALUATION  23

3.7  DIVESTMENT PHASE AND EXIT  25

4.  CONCLUSION  27

V.  BIBLIOGRAPHY  XXX

VI.  ITM CHECKLIST (360-DEGREE ANALYSIS)  XXXIV

V

List  of Figures  

II.  List of Figures  

Figure  1: Classification Private Equity  

Figure  2: PE Investment and Fundraising Development in Germany  

Figure  3: PE Financing Stages of Companies  

Figure  4: Stages Prior to Due Diligence  

Figure  5: Main Transaction Process and following Phases  

Figure  6: Fields of Due Diligence  

Figure  7: Free Cash Flow of Continental AG  

Figure  8: Formula for WACC  

Figure  9: Determination of Business Value with the DCF-Method  

Figure  10: Exit Strategies of PE investments  

VI

List of Abbreviations

III. List of Abbreviations

BVK Bundesverband Deutscher Kapitalgesellschaften e.V.

CCA Comparable Company Analysis

cf. confer / see

DCF Discounted Cash Flow

EBITDA Earnings before interest, taxes, depreciation and

amortization

ed. Edition

Ed. Editor

e.g. exempli gratia

et al. et alii / and others

etc. et cetera

EV Enterprise Value

EVCA European Private Equity and Venture Capital

Association

fig. figure

FCF Free Cash Flow

GDP gross domestic product

HR Human Resources

i.a. inter alia

ibid. ibidem / the same

IPO Initial Public Offering

LOI Letter of Intent

p./pp. page/pages

PE Private Equity

ROE return on equity

ROI return on investment

SME small and medium-sized enterprises

USP Unique Selling Proposition

Vol. volume

WACC Weighted Average Cost of Capital

WFG Deutsche Wagnisfinanzierungs-Gesellschaft mbH

7

1. Introduction

1. Introduction

The Private Equity industry has come a long way in Europe - from the 1970s where the institutional market started to establish itself to its rise in the 1990s and its volatile performance in the 21 ^st century. However, in the recent years private equity capital has become increasingly interesting for a certain group of companies. This is partly related to the fact that banks have become more and more hesitant to grant loans - not only during financial crisis as the recent credit crunch, also due to the effects of Basel II. Partly, PE investment associations managed to fill the gap credit institutions left, attracting especially SME and Start-Ups, but also established companies for various reasons. 2

One of the true advantages of PE investment lies in the increase of the company´s equity capital and the improvement of their balance sheet structure, which again has a positive impact on their credit ratings and their negotiating position. But perhaps even more important, it provides stability and liquidity during investment-intensive years. As a result companies are able to develop their products and grow continuously. On the other hand, with PE capital established companies are in the position to manage transitions such as geographical expansion or restructuring more efficiently and effectively.

But as the public discourse on finance investors and the PE industry indicates, the relationship between PE investment associations and the portfolio company is not always about peace and joy. And the win-win-situation which the PE industry often proclaims is to be questioned.

Against this backdrop, this paper assesses the PE investment process from various angles. Starting point is a brief definition of PE and overview of its history followed by the economic impact of the PE industry. On this basis a close up focus on the perspective of both parties - the PE investor and the portfolio company - and their specific requirements is taken. In a further step the stages of the investment process in

² Cf. European Commission (2006), p. 14.

8

2. Private Equity in Germany - Basics

general, as well as the transaction process in detail are described. Considering their critical value the due diligence and business valuation are separately evaluated. At last, the exit strategies of PE investment are drawn up.

2. Private Equity in Germany - Basics

This chapter gives an overview of the function of PE. By defining PE, at first, a common understanding for the further scientific discourse is established. Secondly, a short glance at PE´s history will be taken, while the emphasis is on Germany. Based on this, it is pointed out how PE companies benefit from equity deals. Finally, the aims of PE or better yet the usage of PE funds are described.

2.1 Definition of Private Equity

The term Private Equity was not characterized by science, instead it was established in the Anglo-Saxon finance world. In addition, neither in science nor in the public discussion the term is used in a uniform manner. First, PE is used as generic term for all types of private equity capital: this includes i.a. Venture Capital, Buyouts and Mixed Financing. ³ While Venture Capital represents the finance of young companies with high growth potentials and high risks, Buyouts are understood to be takeovers of already existing companies. Furthermore, PE is used synonymously for Buyouts. 4

The understanding of PE also varies in terms of the recipient of PE capital, which idealtypical is supposed to be a non-listed company, although there is no reason why listed companies per se should be left out of PE. ⁵ Concerning financing, there is also a narrow and a broad understanding as, according to the experts, PE not only includes pure equity capital - in consequence the investment companies become associates -, but also related types of financing, such as Mezzanine Capital, which is very common in practice. 6

³ Cf. Ernst (2010), p. 4.; Jesch (2004), p. 22.

⁴ Cf. Ernst (2010)., p. 5.

⁵ Cf. Gündel/Katzorke (2007), p. 27.

⁶ Cf. ibid., p. 27.