This edition first published 2017
© 2017 Claudia Zeisberger, Michael Prahl and Bowen White
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Library of Congress Cataloging-in-Publication Data
Names: Zeisberger, Claudia, author. | Prahl, Michael, author. | White, Bowen, author.
Title: Private equity in action : case studies from developed and emerging markets / Claudia Zeisberger, Michael Prahl, Bowen White.
Description: Hoboken : Wiley, 2017. | Includes bibliographical references and index. |
Identifiers: LCCN 2017013990 (print) | LCCN 2017029759 (ebook) | ISBN 9781119328001 (pdf) | ISBN 9781119327998 (epub) | ISBN 9781119328025 (paperback) | ISBN 9781119328001 (ebk) | ISBN 9781119327998 (ebk)
Subjects: LCSH: Venture capital–Case studies. | BISAC: BUSINESS & ECONOMICS / Finance.
Classification: LCC HG4751 (ebook) | LCC HG4751 .Z425 2017 (print) | DDC 332/.04154–dc23
LC record available at https://lccn.loc.gov/2017013990
A catalogue record for this book is available from the British Library.
ISBN 978-1-119-32802-5 (hardback) ISBN 978-1-119-32800-1 (ebk)
ISBN 978-1-119-32799-8 (ebk)
Cover design: Wiley
Cover image: Skyline image: © Leontura/iStockphoto; World Map image: © pop_jop/iStockphoto
Private equity (PE) certainly has no shortage of critics, having been referred to as “capitalism on steroids,” its general partners (GPs) or fund managers called “locusts” and their preferred deal cycle as a “quick-flip.” Attention is generated when the media portray PE as a fast way to multiply invested capital by reducing jobs and overleveraging companies. It is time to clear the air, remove soundbite biases and set perceptions straight by showing how the industry frequently removes inefficiencies and turns underperforming companies into healthier, more dynamic ones or supports fast-growing enterprises with capital and expertise, while taking measured risks other financial players are ill-equipped to pursue.
The sheer complexity of PE deal making often obscures the mechanisms of success from casual observers and the theoretical concepts alone rarely do justice to the reality of investing in private companies. A clear understanding of the PE model is long overdue and this book provides detailed case studies to give senior executives and professionals a ringside seat to the day-to-day challenges tackled by partners in PE and venture funds, in both developed and emerging markets.
Private Equity in Action is the practical companion to Mastering Private Equity—Transformation via Venture Capital, Minority Investments & Buyouts, a rigorous textbook providing the theoretical foundations that the case studies bring to life. While this case book can very well be read on a standalone basis, newcomers to the world of PE will certainly benefit from working with both books in parallel and taking advantage of their synergies.
This case book offers a selection of rich, real-life case studies that demonstrate the application of core PE concepts by providing a unique behind-the-scenes look into the investment practices of PE and VC funds. It helps students and executives comprehend the complex processes associated with investing in private companies, from start-ups to mature businesses, and understand the inner workings of the PE model. While academic concepts build the necessary foundation, practical application and execution of these concepts are the critical link that leads to a successful learning outcome.
This book provides a wealth of opportunities for the reader to put oneself into the shoes of leading PE investors and face a range of actual managerial challenges. With a focus on the all-important executional element that is at the core of successful PE investing, it helps to explain how theoretical concepts translate into investment success. After all, the competitive advantage of PE investors arises from the diligent application of global best practices in their portfolio companies—and a lot of hard work.
All case studies have been written in conjunction with leading PE and VC firms, their senior partners, or with advisors who work closely with the industry; they provide insights into real issues faced and tell real war stories about actual (yet at times anonymized) investments. Each case explains how the actions taken by the PE investors contributed to the transformation of companies in practice with examples covering investment situations not only in the established US and European markets, but also in the emerging (or already emerged) growth markets of Asia, Africa and Central Europe.
The first section of the book focuses on the classic “GP–LP” fund model and shows how the relationship between institutional investors and PE fund managers is changing. The cases then move on to share examples from venture capital, growth equity (or minority) investments and leveraged buyouts in various settings (Sections II–IV).
Turnaround situations and distressed investments certainly test the mettle of PE investors—be they majority or minority owners. Dealing with short-term cash constraints, allegations of fraud and disgruntled creditors or (at times public) stakeholders certainly shows whether the operational partners in a PE fund can live up to expectations (Section V).
Given their positive demographic profiles and access to new customers, emerging markets are becoming attractive target destinations for PE. However, investing in these economies comes with additional risks related to the lack of legal certainty, governance frameworks and consistently applied best practices in deal making and execution (Section VI).
All cases in this book have been subject to the rigors of classroom debate and continue to be taught in INSEAD’s MBA, EMBA and executive education programs, as well as in other top business schools; some have won prestigious case awards. They add color to the theoretical foundations laid in the text book, provide context, clarify theoretical concepts and give the reader a chance to step into the shoes of PE and VC professionals, as they deal with issues from fundraising to deal execution and effecting operational change to exiting their investments.
The selection of cases in this first volume leverages INSEAD and its faculty’s international reach, network and connections, especially with professionals in the up-and-coming emerging markets. The settings of the case studies cover PE investing in:
One of the competitive advantages we have is we have a large balance sheet, and economies of scale allow us to build big internal teams. We also have very long term time periods, so we never have to sell an asset unless it’s at our choosing. We don’t need the liquidity. Why aren’t we looking for opportunities to invest higher up the capital stack and take advantage of that?
—Gordon J. Fyfe, CEO and Chief Investment Officer, British Columbia Investment Management Corp. (bcIMC) and INSEAD Alumnus
This case follows Jack Draper, Managing Director of the Beroni Group, a private equity family of funds, as he manages his growing business and tries to satisfy his investor base. It deals with the issues arising in private equity firms once multiple funds have been raised from various limited partners and are being managed by a related set of general partners. Beroni has just closed its third fund successfully and has started to explore investment opportunities as the financial crisis of 2008–2009 reaches its apex and changes some of the fundamental assumptions for its investor base.
The case is set in a difficult economic environment, which raises some very interesting investment possibilities as well as problems. Jack strives to manage two competing groups of investors seeking exposure to these possibilities, as well as the cash flow problem at one of his leading investors.
The case highlights the different motivations of existing investors: some of them invested in both Funds II and III, others in only one or the other. As Jack starts to address the issue of the composition of the advisory committee (AC), queries regarding overlapping staff resources for both funds and pressure for a reduction in management fees, he is faced with a potentially critical issue: one of his investors is in serious financial distress and has asked to be given preferential treatment to avoid default.
The case explains the importance of a professional relationship between investors and managers in a private equity fund and discusses possible solutions that managers can offer to investors facing financial difficulties.
It sets the scene to critically debate investor demands and expectations with regard to the time managers allocate to individual funds and their overall commitment to managing a family of funds.
To make the most of this case study, we suggest the following additional sources to provide context and background information:
Beroni Group:
Managing GP-LP Relationships
03/2015-5594
This case was written by Greg Blackwood, Senior Research Associate, in close co-operation with Andrew M. Ostrognai, Partner at Debevoise & Plimpton LLP in Hong Kong, and under the supervision of Claudia Zeisberger, Senior Affiliate Professor of Decision Sciences and Entrepreneurship and Family Enterprise at INSEAD, with revisions by Rob Johnson, Visiting Professor at IESE Business School. It is intended to be used as a basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.
Additional material about INSEAD case studies (e.g., videos, spreadsheets, links) can be accessed at cases.insead.edu.
Copyright © 2009 INSEAD. Revision © 2014 INSEAD
COPIES MAY NOT BE MADE WITHOUT PERMISSION. NO PART OF THIS PUBLICATION MAY BE COPIED, STORED, TRANSMITTED, REPRODUCED OR DISTRIBUTED IN ANY FORM OR MEDIUM WHATSOEVER WITHOUT THE PERMISSION OF THE COPYRIGHT OWNER.
Jack Draper had just completed the initial close of his third private equity fund for the Beroni Group, a family of funds based in Hong Kong and investing across Asia. As Managing Director, Jack had been with the group for nine years since its founding in 2000, and with his two partners had successfully steered the Beroni Asia Fund (BAF I) to a successful conclusion, creating the opportunity to establish follow-on funds in the same mould. BAF II was approaching the end of its investment period, after which remaining capital could only be invested in follow-on investments. BAF III had received US$500 million in commitments from its limited partners (LPs) by late summer 2008, before the fundraising environment for private equity funds became difficult. Notwithstanding these difficult conditions, Jack was able to get to a first closing, and expected to raise an additional US$300 million by the final close. He took pride in their ability to hit fundraising targets despite the difficult fundraising environment. It was typical of what he and the other principals who managed the fund on a day-to-day basis had achieved over the years.
With success, however, had come some unexpected issues. While managing each fund in isolation required essentially the same skills and processes, he was discovering that managing a group of funds required careful strategic (and sometimes political) manoeuvring. Just the day before, he had received final information about a proposed deal that he planned to present to the investment committee the following week. BAF II still had US$135 million in remaining capital that could be deployed (and another year left on the investment period), and BAF III’s funds were now available. The seller in the proposed deal was in deep distress and the investment committee felt that the pricing on the deal was exceptionally attractive – it was likely to be one of the most successful deals ever sourced by the Beroni Group. But there were a number of other complications:
Jack knew he would end up doing the deal one way or another – he just needed to resolve some of these issues first in order to avoid creating future problems with the LPs.
Another problem facing Jack was that EUBank, one of the Beroni Group’s earliest and largest investors, was (as with many financial institutions) having cash flow problems of its own, and was unable to fund its capital commitments to BAF II and BAF III. As is common in the private equity industry, the limited partnership agreements for BAF II and BAF III had extremely severe penalties for a defaulting limited partner, including forfeiture of half of its interest in the fund. EUBank had proposed to the Beroni Group that it be allowed to suspend making any further capital contributions to BAF II, that its capital commitment to BAF III be reduced from US$120 million to US$60 million, and that none of its interest in either BAF II or BAF III be forfeited. The GP of BAF II had some discretion over enforcement of the forfeiture provision, but there was no mechanism in the limited partnership agreement for BAF III to reduce capital commitments in this way. Nonetheless, in light of the long and otherwise happy history of EUBank and the Beroni Group (and in the hope that EUBank would recover and be a large investor in BAF IV when it was raised), Beroni Group wanted to be as accommodating as possible.
Jack and his partners had founded Beroni in 2000, closing BAF I with US$250 million contributed by three LPs (see Appendix A). Over the following four years, Beroni successfully deployed all of the capital and went on to exit all portfolio companies in a relatively short six-year timeframe from closing, achieving a remarkable 42% IRR over the period. Shortly after fully investing BAF I’s assets, and with a few credible exits under their belts, the Beroni GPs successfully closed BAF II in 2004 at US$350 million. All of the original LPs participated to some extent, and a further two LPs came on board (see Appendix B).
The firm had been less able to deploy BAF II’s capital due to a dearth of quality deals, with only approximately US$215 million invested as of the initial close of BAF III. The deals in which the company had invested, however, had again generated spectacular returns, estimated to be around 30% IRR (including unrealised gains) – which in turn had further attracted LPs to BAF III. Prior to the meltdown of the financial industry in late 2008, LPs committed US$500 million to BAF III at the first closing. Even though the fundraising environment had become exceptionally difficult, Jack and his partners believed they could secure an additional US$300 million in further commitments by the final close of the fund (see Appendix C), largely because a number of liquid and savvy LPs believed that there were historically good buying opportunities in the market.
Jack now found himself with two active funds and several issues to manage:
Disparate LPs
Because one of the LPs participating in BAF II had elected not to participate in BAF III, and because a number of first-time LPs had subscribed to BAF III, the LP structures of the two funds were significantly different. Jack knew the LP that had opted out of BAF III (Gulf Developments, a sovereign wealth fund with considerable assets and influence which he could not afford to upset) wanted BAF II to fully invest its remaining assets before BAF III began to deploy its capital (particularly because they believed that asset values were now at an all-time low), and would therefore vehemently oppose any investment by BAF III before that time. On the other hand, the BAF III LPs were eagerly looking forward to their first deal in this attractively repriced market, so if a very attractive opportunity went to BAF II in preference to BAF III, Jack risked upsetting his new partners.
Differing AC compositions
Because the investor that had not subscribed to BAF III was on the advisory committee of BAF II but not on the AC of BAF III, and because some of the first-time LPs were on the AC of BAF III but not BAF II, Jack had different ACs to manage. Complicating matters was the fact that for the upcoming deal, Jack would have to engineer approval from both committees in order to receive the go-ahead on a co-investment – and this would generate tension depending on which LPs participated in each AC.
Overlapping human capital
Like many families of funds, Beroni employed the same staff across all three funds. The same senior staff, investment managers and associates that had executed deals for BAF I and who were currently working on BAF II would also manage BAF III; the synergies of information and experience were obvious, and utilising his staff in this way allowed Jack to generate higher management fees per headcount. Of course, each fund’s LPs preferred staff to be 100% focused on their fund to the exclusion of the other, whether it was BAF II or BAF III.
Reduction in management fees
Because some of the LPs had invested in all three funds, they felt that Jack should reduce Beroni’s management fees in some way to reflect the fact that the group as a whole was able to utilise the same staff to manage each successive fund. In addition, because each successive fund required neither additional office space nor additional administrative staff, the LPs felt certain that costs could be cut – providing additional justification for a reduction in management fees. Moreover, because of the difficult economic context, a number of LPs felt that the Beroni Group should “tighten its belt” and pass some of the cost savings along to LPs.
EUBank default
Beroni was faced with an imminent default by one of its largest and oldest investors, which would not only create cash flow problems for BAF II and BAF III (and might even jeopardise the ability of these funds to consummate the investment they were currently considering), but would also create some embarrassment for EUBank and for the Beroni Group. EUBank had put a proposal on the table that would mitigate some of these problems (and yet not leave EUBank in a good position), but accepting the proposal would not only anger other non-defaulting LPs (since they would not receive the forfeited interest to which they had a legitimate claim), but also create a moral hazard should other LPs try to extract a similar deal from the fund GPs. Also, it was not clear whether granting EUBank’s requests would violate the GPs’ fiduciary duty or even breach the limited partner agreements themselves.
Appendix A Table of LPs (BAF I)
LP Entity | Amount Invested (US$ million) |
Advisory Committee Seat (Yes/No) |
Gulf Developments | 100 | Yes |
EUBank | 80 | Yes |
La Famiglia Inc. | 70 | Yes |
Appendix B Table of LPs (BAF II)
LP Entity | Amount Invested (US$ million) |
Advisory Committee Seat (Yes/No) |
Gulf Developments | 120 | Yes |
EUBank | 70 | Yes |
La Famiglia Inc. | 40 | Yes |
Pensions-R-Us | 70 | No |
StateFund | 50 | Yes |
Appendix C Table of LPs (BAF III)
LP Entity | Amount Invested (US$ million) |
Advisory Committee Seat (Yes/No) |
EUBank | 120 | Yes |
La Famiglia Inc. | 30 | Yes |
Pensions-R-Us | 100 | No |
StateFund | 80 | Yes |
New LP 1 | 90 | No |
New LP 2 | 80 | Yes |
*New LP 3 | 75 | No |
*New LP 4 | 75 | Yes |
*New LP 5 | 75 | No |
*New LP 6 | 75 | No |
*Denotes anticipated funding as of the final close of the fund.
Source: Fictitious data