Kaplan, Stromberg “Leveraged Buyouts and Private Equity”

Question 1

Features of Private equity firms

Answer 1

• comparatively small

- high-profile teams

Question 2

Features of Private equity funds

Answer 2

• usually closed-end
• raises capital for the firms
• limited lifetime (10 years)

Question 3

Ways of compensation in PE

Answer 3

• annual mgmt. fee
• share of profits (~ 20%)
• deal and monitoring fees from the companies

Question 4

Describe the process how PE works

Answer 4

• buy a firm with premium above stock price
• financed with debt (60-90%)
• new mgmt. team, that also contributes to equity
• take company private
• improve performance
• sell after 6-7 years to
  o strategic buyer
  o another PEF in SEO
  o IPO

Question 5

What is Financial special about Private Equity?

Answer 5

o Mgmt. incentives (give stock, make mrg invest) – equity illiquid, has to perform
o Leverage – pressure not to waste money (reduces AC), increases value through TS, but can’t be too high

Question 6

What is governance engineering special about Private Equity?

Answer 6

o the boards of companies more actively involve, meet more often,
o replace mgrs.

Question 7

What is operational engineering special about Private Equity?

Answer 7

o experts and professionals;

o consulting groups

Question 8

PE influences on:

Answer 8

• Employment (increase efficiency, can lay sb off – employment grows but at a slower rate)
• Taxes (TS due to increased leverage)
• information asymmetries (not really, but can negotiate deal better than others)

Question 9

Trends in activity of PE

Answer 9

• cyclicality
• debt used driven by credit market conditions
• D/E decreases when interest rates rise
• Returns decline when more capital is committed
• More capital committed when past returns higher (engage in worse projects afterwards)

Question 10

Conclusion about PE

Answer 10

• private equity creates economic value on average (AC down)
• no superior returns for investors
  o large premiums at acquisitions
  o large fees
   gross of fees outperform, but not net of fees

Question 11

Future of PE

Answer 11

• less leverage
• more minority stakes (new operational engineering capabilities – better position than in the past)
• decrease in activity due to crisis

Question 12

 Secondary buyout

Answer 12

Situation when a private equity fund exits their old investments and sells portfolio companies to other private equity firm.

Question 13

Asymmetric information

Answer 13

Results on operating improvements can be as an outcome of investors having superior information on future portfolio company performance than previous managers.