Handbook on Private Equity by DreamLegal
Contents
1. INTRODUCTION TO PRIVATE EQUITY............................................................... 2
1.1 Overview of Private Equity ......................................................................... 2
2. KEY CONCEPTS IN PRIVATE EQUITY ............................................................... 3
3. IMPORTANT DEFINITIONS ................................................................................. 5
4. THE PRIVATE EQUITY LIFECYCLE................................................................... 7
4.1 Fundraising .................................................................................................. 7
4.2 Investment Process ...................................................................................... 8
4.3 Managing Investments ................................................................................. 8
4.4 Exiting Investments ..................................................................................... 9
5. LEGAL AND REGULATORY FRAMEWORK ...................................................... 10
5.1 Key Regulations ......................................................................................... 10
5.2 Jurisdictional Variations ............................................................................. 11
6. TYPES OF CASE LAWS IN PRIVATE EQUITY PRACTICE ................................. 12
6.1 Mergers and Acquisitions (M&A) Disputes .............................................. 12
6.2 Securities Litigation ................................................................................... 12
6.3 Employment and Labor Law Cases ........................................................... 12
6.4 Bankruptcy and Restructuring Cases ......................................................... 13
7. CURRENT TRENDS AND FUTURE OUTLOOK ................................................... 14
7.1 Market Trends ............................................................................................ 14
7.2 Challenges in Private Equity ..................................................................... 14
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1. INTRODUCTION TO PRIVATE EQUITY
1.1 Overview of Private Equity
Definition and Scope: Private equity (PE) refers to investments in companies that are not listed
on public stock exchanges. These investments are made by private equity firms, venture
capitalists, or angel investors. The primary goal is to acquire significant equity stakes in
companies with the intention of increasing their value over time through various strategies such
as operational improvements, financial restructuring, or strategic management.
Importance and Impact: Private equity plays a critical role in the economy by providing
capital to businesses that may not have access to public markets. It supports innovation, growth,
and turnaround of struggling companies. Private equity investments can lead to job creation,
improved company performance, and increased competitiveness in various industries.
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2. KEY CONCEPTS IN PRIVATE EQUITY
Private Equity Funds: Private equity funds are pools of capital collected from institutional
investors (like pension funds, endowments, and insurance companies) and high-net-worth
individuals. These funds are managed by private equity firms (General Partners or GPs) who
invest the capital in private companies. The investors in these funds are known as Limited
Partners (LPs).
Leveraged Buyouts (LBOs): An LBO is a transaction where a company is acquired using a
significant amount of borrowed money (leverage) to meet the cost of acquisition. The assets of
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the company being acquired are often used as collateral for the loans. The aim is to improve
the company's financial health and performance to generate returns that exceed the cost of debt.
Venture Capital (VC): Venture capital is a subset of private equity focused on early-stage,
high-potential growth companies. Venture capitalists invest in startups and small businesses
with innovative ideas but high risk. The investment provides these companies with the
necessary capital to grow and scale their operations.
Growth Capital: Growth capital is provided to mature companies that require funding for
expansion or restructuring operations, entering new markets, or financing significant
acquisitions. Unlike venture capital, these companies are usually profitable and have a stable
business model.
Distressed Investments: Distressed investments involve buying the debt or equity of
companies that are in financial distress or bankruptcy. The goal is to turn around these
companies by restructuring their operations and finances, ultimately selling them at a profit
once they are stabilized.
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3. IMPORTANT DEFINITIONS
• Basis Point (“bp”): One one-hundredth (1/100) of a percentage unit. For example, 50
basis points equals one half of one percent.
• Beta: A measure of volatility of a public stock relative to an index or composite of all
stocks in a market or geographical region.
• Blockchain: A distributed ledger using advanced cryptography to create a “chain” of
“blocks” of information that are unalterable and verifiable.
• Board of Directors: A group of individuals, typically composed of managers,
investors, and experts, who have a fiduciary responsibility for the well-being and proper
guidance of a corporation.
• Bootstrapping: The actions of a startup to minimize expenses and build cash flow,
thereby reducing or eliminating the need for outside investors.
• Bridge Financing: Temporary funding that will eventually be replaced by permanent
capital from equity investors or debt lenders.
• Broad-Based Weighted Average Anti-Dilution: An anti-dilution method that adjusts
the price per share of the preferred stock using all common stock outstanding on a fully
diluted basis.
• Burn Rate: The rate at which a startup uses available cash to cover expenses in excess
of revenue, usually expressed on a monthly or weekly basis.
• Business Development Company (BDC): A publicly traded company that invests in
private companies and is required by law to provide meaningful support and assistance
to its portfolio companies.
• Business Plan: A document describing a new concept for a business opportunity,
including sections like executive summary, market need, solution, technology,
competition, marketing, management, operations, exit strategy, and financials.
• Buyout: A sector of the private equity industry; also, the purchase of a controlling
interest of a company by an outside investor using substantial debt (leveraged buyout)
or a management team (management buyout).
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• Buy-Sell Agreement: A contract that sets forth the conditions under which a
shareholder must first offer his or her shares for sale to the other shareholders before
being allowed to sell to entities outside the company.
• C Corporation: An ownership structure that allows any number of individuals or
companies to own shares and offers protection to its owners, managers, and investors
from liability resulting from its actions.
• Vesting: A schedule by which employees gain ownership over time of a previously
agreed upon amount of retirement funding or stock options.
• Vintage: The year that a private equity fund begins making investments. Venture funds
are generally benchmarked to funds of the same vintage year.
• Voting Rights: The rights of holders of preferred and common stock in a company to
vote on certain acts affecting the company, such as payment of dividends, issuance of
new stock, mergers, or liquidation.
• Warrant: A security which gives the holder the right to purchase shares in a company
at a pre-determined price. Warrants are usually issued concurrently with preferred
stocks or bonds to increase their appeal to investors.
• Washout Round: A financing round whereby previous investors, founders, and
management suffer significant dilution, often resulting in the new investor gaining
majority ownership and control of the company.
• Weighted Average Anti-Dilution: An anti-dilution protection mechanism that adjusts
the conversion rate of preferred stock to reduce an investor’s loss due to an increase in
the number of shares in a company.
• Weighted Average Cost of Capital (WACC): The average of the cost of equity and
the after-tax cost of debt, determined using weight factors based on the ratio of equity
to debt plus equity and the ratio of debt to debt plus equity.
• Write-Down: A decrease in the reported value of an asset or a company.
• Write-Off: A decrease in the reported value of an asset or a company to zero.
• Write-Up: An increase in the reported value of an asset or a company.
• Zombie: A company that has received capital from investors but has only generated
sufficient revenues and cash flow to maintain its operations without significant growth.
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4. THE PRIVATE EQUITY LIFECYCLE
Fundraising
Investment
Process
Managing
Investments
Exiting
Investments
4.1 Fundraising
Structure of Private Equity Funds: Private equity funds are typically structured as limited
partnerships. The private equity firm (GP) serves as the general partner and is responsible for
managing the fund, making investment decisions, and operating the portfolio companies.
Investors, such as institutional investors and high-net-worth individuals, are the limited
partners (LPs) who provide the capital but have limited liability and no role in day-to-day
management.
Fundraising Process: Fundraising for private equity involves creating a fund's investment
thesis and strategy, preparing marketing materials, and meeting with potential investors. The
process is often assisted by placement agents who help GPs connect with LPs. The fundraising
process can take several months to years, depending on market conditions and the reputation
of the GP.
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Investor Commitments: Investors commit to providing a certain amount of capital to the fund,
which is then called over time as investments are made. These commitments are typically for
a period of 10-12 years, during which the GP manages and eventually exits the investments to
return capital and profits to the LPs.
4.2 Investment Process
Sourcing Deals: Sourcing deals involves identifying potential investment opportunities. This
can be done through industry networks, intermediaries like investment bankers, or by directly
approaching target companies. A robust deal flow is essential for a successful private equity
firm.
Due Diligence: Due diligence is the comprehensive appraisal of a business by a prospective
buyer, particularly to establish its assets and liabilities and evaluate its commercial potential.
This includes financial due diligence, legal due diligence, operational due diligence, and
sometimes environmental and social due diligence.
Valuation Methods: Valuation of target companies is critical and involves several methods:
• Discounted Cash Flow (DCF): Projects future cash flows and discounts them to
present value.
• Comparable Company Analysis: Values the company based on the valuations of
similar companies.
• Precedent Transactions: Uses valuations from similar past transactions to determine
the value.
Deal Structuring: This involves negotiating the terms of the investment, including the
purchase price, the percentage of equity to be acquired, governance rights, exit provisions, and
the type of financing (equity vs. debt). The goal is to structure the deal to maximize returns and
protect the interests of the investors.
4.3 Managing Investments
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Value Creation Strategies: Post-investment, private equity firms focus on value creation
strategies which can include:
• Improving operational efficiency
• Expanding into new markets
• Introducing new products or services
• Implementing better governance and management practices
Monitoring and Oversight: Regular monitoring of portfolio companies is crucial. This
includes financial reporting, performance tracking, and strategic oversight. The GP often works
closely with the company’s management team to ensure alignment with the value creation plan.
Add-On Acquisitions: These are additional acquisitions made by a portfolio company to
complement its existing business. They can help achieve economies of scale, expand product
offerings, or enter new geographic markets.
4.4 Exiting Investments
Initial Public Offering (IPO): An IPO involves taking a private company public by listing its
shares on a stock exchange. This can provide a significant return on investment if the
company’s public valuation exceeds its private valuation.
Secondary Buyouts: In a secondary buyout, the company is sold to another private equity
firm. This provides liquidity to the selling firm and a new opportunity for the buying firm to
create additional value.
Strategic Sale: Selling the company to a strategic buyer, often a competitor or a company in a
related industry, can be an effective exit strategy. Strategic buyers may pay a premium for
synergies or strategic fit.
Recapitalization: This involves restructuring the company’s debt and equity mixture, often to
return capital to shareholders or to optimize the capital structure for future growth.
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5. LEGAL AND REGULATORY FRAMEWORK
5.1 Key Regulations
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Securities Laws: Private equity transactions must comply with securities laws, especially
during fundraising and IPOs. This includes regulations set by the Securities and Exchange
Commission (SEC) in the U.S. or equivalent bodies in other jurisdictions.
Antitrust Laws: Acquisitions must comply with antitrust laws to prevent the creation of
monopolies or anti-competitive practices. This involves filing with regulatory bodies like the
Federal Trade Commission (FTC) or the European Commission for approval.
Taxation: Understanding the tax implications of private equity transactions is crucial. This
includes taxes on capital gains, carried interest, and the tax treatment of debt and equity
structures.
Employment Laws: Private equity firms must navigate labor laws, especially during
restructuring or layoffs. This involves compliance with employment contracts, labor unions,
and local labor laws.
5.2 Jurisdictional Variations
United States Regulations: The U.S. has a comprehensive regulatory framework including
the SEC, FTC, and various state laws. Compliance with the Dodd-Frank Act, particularly the
Volcker Rule, which restricts proprietary trading, is also essential.
European Regulations: In Europe, private equity firms must comply with EU regulations and
individual country laws. The Alternative Investment Fund Managers Directive (AIFMD) is
particularly important, setting standards for marketing, risk management, and transparency.
Asian Regulations: Asia presents a diverse regulatory environment with varying requirements
in different countries. Understanding local regulations, especially in key markets like China,
India, and Japan, is critical for compliance and successful operations.
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6. TYPES OF CASE LAWS IN PRIVATE EQUITY PRACTICE
6.1 Mergers and Acquisitions (M&A) Disputes
Breach of Contract: Cases involving allegations that one party failed to meet the terms of the
acquisition agreement. This can include disputes over earnouts, indemnities, and
representations and warranties.
Fiduciary Duties: Disputes where directors or officers of the company are alleged to have
failed in their fiduciary duties to act in the best interests of the shareholders.
Valuation Disputes: Conflicts arising from differing opinions on the valuation of the target
company. This can lead to litigation over the final purchase price.
6.2 Securities Litigation
Misrepresentation and Fraud: Cases involving allegations that the private equity firm or the
company’s management misrepresented or omitted material information during fundraising or
in financial statements.
Insider Trading: Litigation involving accusations of trading based on non-public, material
information.
Compliance with Disclosure Obligations: Disputes over whether all necessary information
was disclosed to investors or regulators, particularly during an IPO or other public offering.
6.3 Employment and Labor Law Cases
Executive Compensation Disputes: Litigation over the terms of executive compensation
packages, including bonuses, stock options, and severance agreements.
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Non-Compete Agreements: Cases involving the enforcement of non-compete clauses in
employment contracts, particularly when executives or key employees leave to join
competitors.
Labor Union Issues: Disputes involving labor unions, especially during restructuring or
layoffs initiated by private equity firms.
6.4 Bankruptcy and Restructuring Cases
Creditor Rights: Litigation over the rights of creditors in bankruptcy proceedings, particularly
in distressed investments.
Debtor Protections: Cases involving the protections afforded to debtors under bankruptcy
law, such as automatic stay provisions.
Plan Confirmations: Disputes over the approval of bankruptcy reorganization plans,
including objections by creditors or other stakeholders.
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7. CURRENT TRENDS AND FUTURE OUTLOOK
7.1 Market Trends
Increasing Dry Powder: The term "dry powder" refers to the amount of committed but
uninvested capital available to private equity firms. There has been a significant increase in dry
powder, indicating a strong potential for future investments.
Distressed and Restructuring Deals: With economic fluctuations, there is a growing focus
on distressed and restructuring deals. Private equity firms are increasingly looking at
opportunities to turn around struggling companies.
Environmental, Social, and Governance (ESG) Considerations: ESG factors are becoming
more integral to investment decisions. Firms are focusing on sustainable investments and
considering the long-term impact of their actions on the environment and society.
Technology and Innovation in Private Equity: The use of technology in private equity is on
the rise, from using big data for due diligence to deploying AI for operational improvements
in portfolio companies.
7.2 Challenges in Private Equity
Valuation Discrepancies: Bridging valuation gaps between buyers and sellers remains a
significant challenge. This is particularly pronounced in volatile market conditions.
Regulatory Scrutiny: Increasing regulatory scrutiny, particularly around anti-competitive
practices, securities laws, and tax treatment, poses challenges for private equity firms.
Economic Uncertainty: Economic fluctuations and geopolitical risks add layers of complexity
to private equity investments, requiring firms to be more strategic and cautious in their
approaches.
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