Reading 47: Private Equity Valuation-LOS b 习题精选 private, following, companies, div, class

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Session 13: Alternative Asset Valuation
Reading 47: Private Equity Valuation

LOS b: Explain how private equity firms align their interests with those of the managers of portfolio companies.

 

 

 

In a private conversation with his best friend, Harry Veeslay, CFA, makes the following statements:

Statement 1:	Private equity (PE) firms generally focus on short-term results. For example, they frequently use restructuring of acquired companies in an effort to quickly divest them for a profit.
Statement 2:	PE firms also want to ensure that the interests of portfolio company managers and of limited partners are aligned. For example, they frequently tie manager compensation to firm performance and include tag-along, drag-along clauses to give management a stake in the firm under certain trigger events.

With regard to Veeslay's statements:

A) both are correct.

B) both are incorrect.

C) only one is correct.

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Statement 1 is incorrect. PE firms tend to have a long-term, rather than short-term focus in their investment strategies, which often exceeds 10 years. Restructuring is generally a lengthy process and requires a long-term perspective.

Statement 2 is correct with regard to both manager compensation and the use of tag-along, drag-along clauses.

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Pauler Investment Co. (“Pauler”) just proposed to make a sizeable investment in Bada Cork, a recently established Hungarian producer of synthetic wine bottle corks with a patented new technology. Pauler is looking to make further strategic acquisitions in small venture capital companies in the food and beverage industry and has set up a fund to manage the portfolio companies. It has also brought onboard Kristina Sandorf as portfolio manager. Upon receiving her contract, Sandorf complains to a friend of the contract terms proposed by Pauler. In particular, she grumbles that an earn-out clause is inserted, which she believes would give Pauler priority on the earnings and dividends of companies in the portfolio ahead of herself.

In her description of earn-outs, Sandorf is:

A) correct.

B) incorrect, because earn-outs refer to tying the acquisition price paid by Pauler for the portfolio companies to the companies’ future performance.

C) incorrect, because earn-outs refer to Pauler having priority over Bada’s assets in case of bankruptcy or liquidation.

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Earn-outs are typically used in venture capital investments where the acquisition price paid for portfolio companies by private equity firms is tied to the companies’ future performance.

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Private equity firms can maintain control over portfolio companies in a variety of ways. Which of the following contract terms would least likely achieve this goal?

A) Tag-along, drag-along clauses.

B) Priority in claims.

C) Board representation.

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A tag-along, drag-along clause is less a control mechanism for private equity firms and more a tool to tie portfolio manager interests to the portfolio companies. The clause gives portfolio managers the right to obtain an equity stake in the portfolio companies should the private equity firm decide to dispose of its holding.

Priority in claims and board representation are both effective tools that give PE firms greater control over portfolio companies. Priority in claims allows the PE firm to receive distributions before all other owners. Should the portfolio company experience a major event (bankruptcy, restructuring, IPO, etc.), the private equity firm can gain control of the company through board representation.

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Norah Cyly is the recently appointed manager of a private equity fund that invests exclusively in venture capital investments in online fashion and media advertising companies. In a discussion with the fund’s assistant portfolio manager, Cyly makes the following statements on control mechanisms and exit routes:

Statement 1:	Earn-outs are mainly used in venture capital investments. They relate the acquisition price paid by the limited partners to the future performance of the portfolio companies.
Statement 2:	It is generally difficult to value venture capital investments using the portfolio companies’ cash flows or EBIT or EBITDA growth, since both cash flows and earnings are difficult to predict with certainty.

With respect to her statements, Cyly is:

A) correct on Statement 1 only.

B) correct on Statement 2 only.

C) correct on both statements.

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Both of Cyly’s statements are correct. Her description of earn-outs as a control mechanism is accurate. Her comment on cash flows and earnings growth is also correct, given most venture capital firms’ lack of stable cash flow and earnings patterns. This type of valuation is better suited for leveraged buyout investments.