Martin Milev - Private Equity Deal Structures [Entire Talk]

American University in Bulgaria now it's my great H and pleasure to introduce one of my speakers um Martin M um he's actually from the class of 2009 and he has been working with me um over the last few years as a guest speaker and also as a supporter ubg activities including my classes so I'm greatly appreciate he's coming again to talk about topic that is uh quite related to our class and what we do in this company evaluation class so the topic of presentation is really quite interesting the private Equity deal structures so I hope you can enjoy uh the next 150 minutes with my guest speaker thank you very much to be here I know how busy time is that okay thank you okay thanks um so Professor M said uh my name is Martin I am an alumni and um I've been working with this private Equity company for the last three years and uh it's great to be back uh again I guess I did good job last year like keeping keeping everybody awake so um so and than thank you again for coming so what uh what I'll be talking today uh is um deal structures in private equity and there are three main topics that I will cover why uh deal structures are important for the private equ Equity investment class um what are some of the common private Equity deal structures that are out there of course we won't be able to cover everything and the last one is uh what are the private what are the DU structures that we actually see in central eastern Europe because central eastern Europe is a little bit of special place in terms of of any type of investment okay now do you know and by the way I want to make it like a conversation because I'm kind of tired of talking to myself all day okay so if you have any questions or comments please feel free to jump in uh I won't penalize or something or anything like that okay so do you know what private Equity is okay so this came too too fast come on somebody I know that it was a alumni challenge weekend and you must be retired but let's let's let's give it a try okay well private Equity is basically holding ownership interests in a non-publicly traded private company and uh it is usually associated with having um control over your investment much higher uh much better and higher control over your investment now uh and do you know how private Equity so now you know what private Equity is so do you know how private Equity is different from the other investment class that are out there like stocks bonds Commodities Futures forwards Etc okay this is okay good this is number one risk well this is not usually the case uh this is usually the case but not in the recent years and it all depends okay so yes good different tax different different tax rate tax rate oh depends on the legal structure whether your fund is on the Kim or in Luxembourg so it all depends okay good so let's try to answer this question together okay and in order to to see what what the different the main differences are and uh to highlight one of them which is important for our topic today let's let's see what the invest what an investment process is okay so there are a couple of steps um and basically the goal of investing the goal of professional investing is to generate return at a given level of risk right if you don't agree good just let me know okay so and how how do you do that what what is the process I think there are basically four main steps probably and of course you can break it down even more but basically first is identifying an opportunity an investment opportunity whether it's a it's stock Bond private Equity investment commodities anything you identified you you identify an opportunity that is going to meet your goal and uh that is going to meet your return and risk goals okay so the next step is actually entering into a transaction to utilize that opportunity so this is the entry point now you then you have holding period Then you have exit so this is the typical life lifespan of a of any investment basically it may VAR like uh in terms of liquidity in terms of um how long you hold that real estates tend to be longer like Futures tend to be shorter any type of type of derivative is usually much shorter now and what I what I would claim here today is that private Equity is different uh from the other investment classes is that you have control over over this these over the over the last three three stages over the entry holding period and exit now and this is this is one of the differences of course there's as I said liquidity high risk um so any any type of difference but we are going to focus on this today and why why is it important that you have control and of course this control comes with higher risk and higher return um so it is important and it is it is a main differentiator between private equity and other investment classes for instance if you think if you think stocks okay you have your goal I'm going to achieve like 10% this year so you go out there identify the stocks that you think are going to achieve 10% a year you invest and that's it you make you you pick up the the phone tell your broker that okay I want IBM for next year and that's it and then you pick up the phone again at exit and you say Okay sell that stock and uh send me the returns that's it you don't have any control over there now and here comes the uh the difference in private Equity you have control at Exit holding period and uh um an entry okay and and what what this control means now in most of the Investments and most of the leads that we see both globally and here in my for instance in my company most of those leads are not meeting our our goals in terms of return and risk most of them don't the trick is that you have the you have at your disposal a number of levers you can use uh during during entry uh um holding period and exit that can adjust the profile of of that lead of that opportunity so it actually meets your risk return objectives okay so and this this is this actions these levers all of them or let's say most of them belong to the deal structuring that is why deal structuring is crucial for private equity and deal the deal structures are usually set before entry okay and they're usually based on negotiations with the selling party and the buying party when you're at exit so they're very unstructured there's very little regulation so if you if you are stock investor uh you cannot go to the seller and say okay this doesn't work for me so uh let's twist this and that in order to meet my objectives okay you cannot do that unless you're Warren Buffett and manage birkshire H away so so this this is the main difference that's why private Equity that's why in private Equity deal structures are crucial and that's why actually I'm quite excited about private Equity okay now um let's let's talk about what are what are some of the uh dual structures and features of the Dual structures that are that are out there and that can actually lead to to uh having an opportunity that is going to meet your goal and um shall I use this one here okay good so let's let's see three three of the four stages so this would be entry by the way uh I don't have a PowerPoint presentation on purpose because I know it makes students sleepy especially as I said especially after a lni challenge weekend but I have my chatet all right now can you tell me do you do you know any deal structures any types of deal structures anything okay acquisition is basically a transaction process when you when you enter into a deal with the selling party and you are the buyer so this this process is called acquisition merger is when you merge the two companies but what about the details how do you do acquisition for instance okay so this this is this is Again part of the process but what is it in the details like the devil is in the details what is it that you actually do okay this is this is important and uh yeah this is quite important but again this is not something that you do at at at the transaction closing what is it that you do when you close a transaction [Music] yes again this this is a goal rather than a goal okay and yeah actually a step back I let you think about that we'll come back to that but basically the goal of any deal is to first to have a transaction and to have a transaction that actually aligns the uh the objectives of both the seller and the buyer and this is this is not usually easy okay because like there are number of points where there are conflicts like who's going to control the company after the transaction this kind of stuff and what do you think is the main is the largest uh points of conf point of conflict that leads to deal breaking the price offer by okay so this would be the valuation Okay so what was this course quote again okay good so valuation yes this is usually when the two minds don't meet okay and I will give you specific examples in in my last part about my experience when people just don't know what the value of their businesses and they think that it's too much so yes basically the goal of the deal structure is to is to come up with a with a mechanism which is going to align the objectives of both the seller and the buyer and and uh one of one points of conflict that is usually like deal breaker is valuation so what you do what you do it at um at deal closing any better ideas okay what is what is the transaction what does the transaction looks like when you buy a company what do you buy how do you get into into becoming an owner of that [Music] company okay it could be it could be buyout okay you buy existing shares of that company so this is so this is my my little map here I'm going to be attributing the different features of the structures that I'll be talking about on that on this map here okay so we have buyout I think this is very straightforward buyout basically you go out there and you say Okay I want to buy your company I buy the existing shares okay any altern that you might think of ownership exchange example youate youry you get okay this this would be a merger okay it's valid what about Capital Ray have you heard of that what do you do what do Venture Capital Venture Capital funds do yes how does the transaction look like you get money for shes B exactly so actually you can put additional Capital let's say your company costs 100 units okay there're 100 shares now you can can either buy existing shares so you can buy 20 out of the 100 shares at the market price that you agree or you can you can put additional 100 units and then you are you're going to own like 50% of that company and the seller is going to own the the other uh the other 50% with his initial 100 units so this is this is this is what capital rise is and this is what growth uh growth and Venture Capital funds uh private equity funds usually do they go into the company put additional money into the business and expand the business okay this is yeah this is the wisdom behind the Venture Capital funds this capital risting okay what else what else can you think of so this is straightforward right what else is being what else is being traded at uh at dual closing besides Financial Financial um assets what else management rights yes management rights so this is something else that that you can control that you can control during during your negotiation okay you say that uh okay my company your company costs uh 2 million but this is only if I come in and I become the CEO and I control all the assets of the company you might say okay no but if you if you give me 3 million that is going to be the case so this is another liver that that you can use this is another uh another feature of the of the private Equity uh deal structures and this is the one that is based on negotiation of course okay shall we move to another to another section just to keep you interested okay now let's let's think about um actually let me give you an example okay okay we were dealing with this entrepreneur um which controls a company he says my company costs uh 4 million and we say okay listen the market valuation of your company is around 1.5 million and he says no and we say okay why not what is the extra value where do you see Extra Value in your company rather than the one that we have evaluated on your existing uh business on your iida last year where is the existing value and he says okay listen um I have uh put the grounds for development of a new product which hasn't yet generated revenue and this has hasn't yet generated ibida so what do you think is is there a mechanism you think about like bridging that bridging this huge gap between the two valuation expectations well of course there is otherwise I wouldn't be here uh one of them is called earnout okay and it could be both cash and stock okay and the earnout works in the following way okay youra last year was 300 and the multiple the market multiple that uh that we use and that it's on the market out there is like six so your Enterprise Value is like 300 * 6 1.8 right so and he says no uh my company costs 4 million and then we come we come again to the to the undeveloped potential of the company Etc so what we do is we say okay good there is a potential that is going to be de that is going to be utilized um and we are willing to pay for that but not now we're going to pay next year when that potential is realized okay so what we do and let me use this chart here so this this is going to be uh this is going to be the iida we have a multiple okay and okay and this is 1.8 right so this is a entry during next year during the holding period that multiple that EA increases by 200 and sorry for the wrong scale so that that the iida increases by 200 okay time 6 so this is the total is again 1.8 okay but we have 1.2 that is being earned out during the holding period okay is it clear yes okay and he says okay so you're going to give me 1.2 million more and we say well of course not because well first of all it's true that there is a potential that is that that was realized in order to achieve this Ebu growth but the thing is that we were part of that company already so we also contributed to that with management experience with uh the capital that was utilized Etc so we are basically going to split this in two so this is going to be initial entrepreneur and this is going to be the private Equity font so this is this is how it works now and there and of course it depends how much what is the what is the equity split um and which determines How This 1.2 xray is going to be is going to be separated now the entrepreneur might say okay so you're going to give me cash then uh we say okay it's Cas cash is one option but we can also give you stocks for that because we want you to keep your interest into the company and and so it is aligned with our interest so we can make the big buck bucks at exit so we're instead of giving you instead of giving you cash the amount that that that is um that goes to you is going to be um put into the capital structure of the company so there will be an adjustment of the equity split so at Exit you out of the 100 units that we sell the company for you're going to get higher share so this is how this is how this this stock C out works okay and he says okay okay it sounds reasonable okay there is a potential that is not realized again I think that that t would be delivered so I agree to that so this is this is a mechanism that is bridging that could Bridge uh the valuation Gap that uh that exists before before any types of dual structuring okay um what else what is what what return can be generated during the holding period for the owners [Music] operations selling will be here at ex again this is partial exit Okay what valuation models do you use for for this course okay what what else what about div dividend discount model okay yes so you can generate uh dividends can also bring you uh bring you positive cash flows for the from your investment okay now and this is this is my favorite one here now of course we're not going to discuss dividend because this is straightforward I mean you what usually happens is when you when you are preparing to enter for the deal you're are signing this memorandum of understanding that this is how we are going to manage the company from now on this is this is going to be the dividend distribution policy so basically you know how much dividend is going to be distributed during the holding period and under what conditions okay so let's not cover that what is what is more interesting I think is dividend recapitalization okay and this could be a tricky one if you a private Equity Fund can actually exit it um can receive exit cash flows from the business without going to exit without selling the equity so a trick that that could be used here is taking on a bank loan or any type of debt for facility and then Distributing uh the cash inflows from that facility uh to the equity holders so this is this is what dividend recapitalization is called now It's Tricky you have to be in bed with the banks your business has to be bankable and it has to be good year in terms of credit Supply okay but it works and actually we are right now we are considering s such a such a feature such a deal structure we have a business uh we're looking at this business which is um over capitalized meaning that its piers on the market have certain depth into the capital structure which is of course cheaper and which leads to higher returns for the equity holders okay but that company doesn't have that facility so what we are planning to do is go to the bank say okay we are going to cover all your covenants you know what Covenant Covenant is right okay so even even if you give us like2 million EUR in in working capital facility we still will be able to cover our covenants you'll be happy we will be happy and but we are going to distribute the cash as dividend to the owners and this is again this is again pre-agreed uh pre-agreed during the deal structuring negotiation um before before the entry so everything everything that that we're going to cover is either determined before the entry in the deal structuring process or conditions for imposing additional deal structures are discussed are discussed during the negotiation so in terms of so this this is exciting like this is that's why deal structure is important because everything happens in the end in the beginning and then it has implications all over the all over the investment period okay um another thing that is usually that that is used um by mainly by Venture Capital funds is this preferred preferred stocks which can be also convertible okay so what what this means is that the Venture Capital goes to the um goes to the entrepreneurs and say and says that okay I'm going to give you the money but I won't guarantee that I'm going to make two times my money so the money multiple you know of ir right you know what IR is okay good I told okay and then you know what money multiple is okay so then the private Equity Fund says okay I I'll give you the money only if I can only if you can guarantee me with certain with u like defined like or with high extent of certainty that I'm going to make two two times my money so what we have is preferred stock that that is valued two times at the at exit is valued two times the the value they were cost uh at entry so the value of money is basically doubled at exit and no common no common Equity holder can receive any proceeds from exit before the preferred stocks are being fully paid okay so this is this is another this is another trick uh all right uh um again additional Capital races are being discussed so what it means that let's say that we have this restaurant chain that and we're planning for currently it has like 20 20 shops and we're planning um our strategy at entry is envisioning 10 more shops but actually Market potential stipulates that there could be like 12 more shops but we need extra Capital that's that's why we need additional Capital raises by the private Equity Fund um during the holding period which is going to change the equity structure again this is straightforward however what has to be defined is how the valuation of the company would be made here during the holding when just before you raising the capital again because if you value at 100 with if you put extra 20 it would give you like one uh one six of equity but if you value it at 50 and if you put extra 20 it is going to give you 27th right so this is also important and it is also usually defined before entry not the price but the price me the pricing mechanism okay the valuation mechanism and this is where you guys come in with your uh company valuation course okay let's cover something at Exit as well um again here actually I like this one quite a lot waterfall structure and again I'm going to go back to my example with the guy who who was saying that U his business his business the value of his business is like 4 million if we were saying okay listen no it's 1.8 million so but he was he's very adamant about this 4 million number and when when actually I think I asked the question when I ask him okay why do you think so and he says well this is just this is just my price there is no justification behind that okay it is your price so let me let me jump a little bit to the examples so we're saying we're saying that your business cost 4 million okay so this is 4 mil okay and we are going to buy uh to buy out 50% of that business for 2 million right so this is going to be 50% okay in his mind his value of the value of his business is 4 million now however we're going to split this into 25% and 75% okay and we're going to pay you 1.5 million now and we are going to pay you the rest of the million at exit so let's see how the exit looks like again scaling could be different let's say this is X okay because we don't know what the sales price would be at that point okay again up to now the investment cash flows for the funds for the fund is 1.5 million okay now at Exit let's say that we are going to sell the company for X units okay the waterfall structure looks like this okay first 500,000 are going to go to the entrepreneur because this this is this is part of the purchase price he want guarantee guarantee on that okay and we have the reminder okay the reminder and let's just take a notional notional Capital here this is going going to be 12 million okay so we have 11.5 here now how is this 11.5 split what do you think he would have the initial 50% of then mhm so this 50 yes yes this this would be his desire but um again deal structuring is about aligning goals of both parties so we say no this is this is not going to happen because we don't know whether we are going to sell the business for 12 million because 12 million is calculated based on the ibida and the multiple multiple is something that we don't usually control at exit but um iida and iida is basically given we're going to take last year ibida and if the potential that you are saying is going to be realized does not realize we're not going to reach the 12 million and our fund is not going to reach the the goal of let's say 25 or 30% IR uh that it has so what we say is that from this amount here we're going to take this chunk of money okay which is again unknown however it can be defined okay again here we're not at at um entry we're not specifying what this amount would be here here but we're specifying the mechanism which is going to be used to calculate that amount so what we do is basically we take our investment 1.5 million at entry Okay then if if there are any additional Capital raises or dividends for that matter we account for them and we want to have such number here that our return is 25% IR okay is it clear and the and now we have another remainder here and then the remainder it is split 50/50 okay what this deal structure achieves is that basically and just imagine that um do you have a long stick or something okay no but anyways just imagine that that this is the valuation here again I was not the best at drawing in school but imagine that this is the valuation actually this is the valuation here okay so if it's if it's lower if it's lower this is going to go down so this has high highest priority then is this amount with the second highest priority and then whatever is remaining is split okay so what this deal achieves is that okay we're saying that your your value of the business is 4 million only only if we can achieve at Exit if if we have preferred uh proceeds at Exit which is going to guarantee our return okay so only then we're we're giving you the 4 million and if if we're giving you the 4 million then we are going to split the company 50/50 as if as if at entry were giving formul so whatever happens you have your return guaranteed so and [Music] then chance M well let's say let's say the dis amount here okay let's say the this amount here covers only the 50 the 50,000 and our our return then there is no split then what is what the cas is is that we have acquired the company which cost much much less so this notional cap this notional valuation of 4 million is gone okay he doesn't have any any other proceeds than the 50,000 so basically what we did is acquired the company for 2 million basically there was no potential that was realized so he basically guarantees with his other 50% that uh that there is such potential so if there's not there's no 50% okay and actually the worst case the worst case scenario for us as investors is if we sell the company for 500,000 or less then there would be this trench here and let's call it trench one trench two and Trench three so there will be there will be no cash for Tren two then we'll be we will have paid uh 1.5 million for nothing okay and this is this is the the highrisk profile of the private Equity Investments so and by the way this is a dual structure that we are going to propose next week so we'll see we'll see whether the guy is going to like it or not okay any questions I think you have a question no the [Music] same no actually um no it's not this is about um financial services company in the Czech Republic um which is dealing basically it's existing business is money transfers so basically they're a franchise of one of these um Western Union money ground type of uh big money transfer companies so they're the local franchise in the Czech Republic and uh what it has is basically partnership with the um partnership with the this big company Money Transfer Company on one side and it has distribution Partnerships with u 4 or 600 um local Partners in the small cities okay it's quite interesting by the way because like this type of money transfers not bank money transfers but this kind of uh money transfers are usually done from workers working abroad who are sending money home and they're usually sending money home to people which are not living in the cities and don't usually like to go in the bank okay and this is the existing business what we want to do is uh use that network of uh 600 players of 600 um distribution points and push another product through the through that Network and this would be probably micr crediting so what what the entrepreneur says is that okay I've prepared the stove for cooking this new product so I have the existing business processes for the micr crediting uh and what you just need to do is just put some cash and uh uh like distribute the cash um to the client and we say okay well listen it's not that easy and this this this potential hasn't yet generated Revenue so basically we don't know whether it's going to work or not so we need some kind of guarantee so and this is the type of structure that um that uh that we came up with that is going to align our goals and his goals okay um and I'll be talking about this guy a little bit more uh in the third part but let's just cover some other some other deal structure features here um at exit now what what we have seen quite often is we see very entrepreneur who very much trust in the in his business he has high trust in his business and uh and he says okay um I want to stay for long I want to stay for the next 15 years in this business and we are like a medium-term investment fund so uh we stay up to four or five years and he says okay well then there's no deal okay but no actually there is a structure that can that can also accommodate this kind of discrepancy between the the the holding period aspirations of the two parties and it uh it is called reverse buyback okay in the reverse buyback what we agree is that okay we're going to uh we are going to invest in in your company and instead of selling to a third party at exit sorry we're going to uh sell to you okay uh this is not my favorite one uh because even though it gives you guaranteed return so basically you know what is going to happen the guy tells you that we are going to Value the business at uh EV to ibida multiple of six which could be which could be good or bad depending on the market conditions but you know how much you're going to Value the business for and depending on the iida that is achieved uh you know how much is going to get how much you're going to get however this this creates different problem uh basically it is going to um it is not going to align the incentives of the uh of the fund to the incentives of the entrepreneur because what what he would try to do is basically uh hold back back hold back the development of the company and accommodate potential that he would be able to realize after we do this reverse buyback while what we want to do is maximize the value of maximize the value of the company at the point when we'll be selling back uh Equity to him so this is again this is this is an alternative I wouldn't say it's my favorite one question sure what the next point the entrepreneur is BR and cannot back M what do you do well usually you he's going to guarantee with his Equity okay so what would happen is let's say that we're going to enter 50/50 he he says that he's going to buy us back and if he doesn't we're going to take his uh 50 um 50 50% stake in the equity and then we will have the right to sell to a third party so he better have money if he wants to stay for 15 years in the business um okay what else I think yeah CPS condition precedence this this is something that that is valid for entry holding and exit Okay CP is basically we're going to do something if something else is achieved okay and let me let me um go back to this restaurant business from last year I don't know is there anybody who was here last year when I okay I wasn't that boring then you yes I knew that you going to remember the the minor things okay yes okay good so basically with with that guy we had CPS that basically you either put your all your assets on the balance sheet or we are not going to do the deal okay so this is something that you can see here okay here and it exit so you're you're doing a condition precedent um and let me try to think of an example yes I mean this is this is one thing we're going to buy your company only if something else is done like only if the assets are on the balance sheet okay or here we're going to pay you the earnout only if the iida is not only higher than the I that we already paid for but if it reaches the amount of money that you said that it's going to reach only then you you are going to get some money okay and the same at exit Okay so this this is this is fairly common and um the the lawyers are usually engaged with that okay um let me see whether I have anything else on my on my cheat sheet yeah I think I think these are the most common ones that uh that we've seen and we that we have considered now and let's now let's go to the third part of our talk basically what type of deals are happening and and are being considered in our region in central eastern Europe now as you know it is a special place because basically the investment culture is not as advanced as in Western Europe or or um in the states and in terms of private Equity also not as advanced as um in the Nory countries like I think Sweden is the country with the highest U share of private Equity investment store um against GDP okay so they're fairly Advanced but unfortunately we are not okay so and like these are these are these are relatively straightforward okay so one challenge that we that we are facing is that explaining this to an entrepreneur like the restaurant uh the restaurant owner who doesn't have the assets on on his balance sheet explain explain him the the preferred stock conversion policy for instance so this could be a challenge okay we just don't have the investment culture yet okay so one of the major one of the main goals uh when we are considering to propose some du structures here in both in Bulgaria in Hungary Czech Republic and Poland is whether it's simple enough to be understanded okay whether whether the guys will be able to understand it and whether it's executable okay because you don't you have no use of having a deal structure uh with number of CPS Etc if the guy says okay no sorry I cannot take that okay and actually I've been in a situation when I had to explain to this same guy with the restaurant business that we're going to give you this kind of type of Fout and this is going to imply valuation of seven seven time cbda versus the six time cbda that you want right now and versus the five times C that we want to give you right now and he say okay I don't understand so if he doesn't understand we don't have a deal if we don't have a deal we don't have return okay so our objective is not met so this is this is quite important so let me go back to this financial services business okay and one uh and actually this a very good example exle of this this person factor that we have to account for okay when we first met with this guy he says uh he said that okay and we ask okay what do you want actually every conversation starts with that okay what do you want and he says okay I want to have professional company like in UK um I don't want any money now I want everything at exit and say okay great you're our guy come in now what he want like four or five months from that point he wants to maximize his um his earning here he wants to see 4 million valuation and he wants to see the cash now and guarantee it either now or guaranteed at exit that that 500,000 so so this is this is an example of a typical entrepreneur who you you will have to deal with if you do U private Equity investments in our region okay and that's why we had to develop this uh waterfall um structure with the three trenches Etc and actually I'm afraid that he might not like it he might not be able to understand that but we'll see we'll see so this this is a risk so and let me let me give another example now this time we have a logistics company uh here in Bulgaria which is being owned by a foreign strategic investor so basically that that investor has a number of logistic compan companies all over the region and for some reason um it wants to dispose of the Assets in Bulgaria now what we do there is basically we said that okay your business uh the value of the business right now costs um 2.2 million if I'm not mistaken okay and they say okay you have to pump up that number if you if you want to if you want us to pick up the phone so and these are the guy the guys abroad so these are fairly sophisticated guys who do at least one or two m&a deals a year so what we do there is basically we're using this um this earnout structure that I talked about so basically they say that again why the conversation goes as follows why why do you think your company costs like a 3 million they say okay because we just signed a contract with uh with baa which is going to generate that that much revenue next year which is going to U translate into that much ebda that's why the business costs that much okay great that's great for the new owner us however we haven't seen that contract performing that's why we're we're going to propose this um this turnout structure now if they if they meet if they gen if the company generates that much revenue from a from the new contracts we're going to pay them the earn out so this would be a cash out now another another issue that we might have with that company is that it might go over our um transaction size limit okay and this this could happen fairly often often so for instance our fund we invest between two and5 million into into uh majority stakes in in in companies uh but sometimes the case might be that uh we don't we just have to pay more in order to acquire majority in that company or if you want to acquire the whole company so basically we want to give them 5.5 million but the problem is that uh our investors in the fund know that allow us to invest only 5 million so what we are also considering in this case is something called vendor financing okay so what vendor financing is is basically uh we are going to propose that okay we have this this gap of let's say half a million or one million Euros which and unless we basically reduce the size of our investment to that amount uh there will be no transaction and the thing is that they want to sell the company fairly quickly so we're kind of in a better bargaining position here now what so what we're going to propose is this vendor financing option okay so this means that we are going to ask the seller to lend us money at given uh interest rate in order to finance the transaction okay or what it means is that he's going to postpone the collection of the and of the purchase price and we're going to pay 8% let's say interest rate on that on that uh part that was postponed so this is vendor financing this is how this is how you can breach you can breach your uh dual deal limits uh with the value of the company even if you agree with the value of the company okay any questions yeah I have a question but by using this vendor financing don't you actually cheat your own investors who want to diversify the risk and they don't want you to put more than 5 million in one M uh no because we don't we don't we don't invest more than 5 million yeah but we still have to pay the Lo this is only if the company performs okay if we are able to sell the company so what the investors are looking for is maximum risk exposure okay what is the risk of them losing 5 million okay or what is the risk of us losing 5 million if if the company does not perform as the seller says at entry he's never going to see that this vendor financing there's no possibility that you lose more no so this is the maximum exposure that you get okay now any questions sure in all the discussions you mentioned that you as a font use only the multiples to have the business you want to acquire um my class waste most of them B Anis but well I would say that uh usually that is the case at least this gives you the rough idea of how much business is worth when you first see an opportunity it's it's very easy it happens within 2 minutes okay now of course there are drawbacks and I I I would rather say that this is specific for the private Equity industry okay because there is namely because there is this deal structure ing option and control that you have and mainly because you have you can negotiate okay so what what we do is we use this this um multipost as reference point uh we say okay your business is going to cost around uh5 million EUR based on based on your iida and on the multiple however the next stage is developing a very detailed financial model very very detailed um and we see okay if this multiple doesn't work for us we're going to propose lower multiple okay so this this is where the negotiation practice comes in and if he says okay I don't like this multiple at least using the financial model we know what tolerance we we as investors have in order to increase that multiple so that our um return goals are achieved okay so and of course like this is this is this relates mostly to uh private company valuation now what we had actually what we have now is a very specialized company which doesn't have many peers and actually there are just a couple of transactions so we have very few data points we have one EV to e multiple of nine and we have one e to multiple EV to iida multiple of four so what do you do then so what we did is we tried to find public companies and uh we looked into their financial reports we took the market cap added the the depth and then we saw what what they implied e to iida um ratio is and then of course for the public companies you have to add a markup on that on that ratio because basically if you're buying control there is a premium okay if there is if the the company is liquid there is also premium okay any other questions sure face lawsuits do you the compan face lawsuits we not yet no just kidding no actually we're like very few things that there is legal risk go out of of our boardroom discussion okay and usually there there is a in central eastern Europe actually this is very relevant in central eastern Europe there is usually uh some kind of legal preference or legal tolerance of protecting the entrepreneur okay um however we're we as as company are very care we are very careful and also our uh our peers are very careful with that I mean before any proposal goes out it goes it gets screened through our legal department and our external lawyers so sure can you give an example if the company actually lost money on investment mhm well actually I cannot give example from our experience uh because we don't have such an example and it's good um but what usually happens is it uh that investment is being write off written off or it is being sold at significant discount now with one of the companies that we're currently looking at we're going to enter the enter potentially enter the Company by buying the stake of another private Equity Fund that invested initially into the company at least this is what we are considering now this stake is discounted at uh 20% of its face value so it lost if they invested 1 million they lost 800,000 so but again they did quite quite good Returns on the other Investments and actually this this actually goes goes to the profiling of the private Equity Funds like Venture Capital funds do you know how they make their money in terms of portfolio strategy yes so basically one one one win makes you like 20 or 30 or 50 times your money and the other you're basically writing them off and actually this is this is one reason I think I personally think that it's very difficult to do private to do venture capital in Bulgaria because BAS you don't have you don't have stable flow of of U of projects which you can do 10 do do successfully one and then write off the other nine so because basically when you take your pipeline how how how what is the percentage you think that that of the leads that we see that actually happen uh turn into transactions let's say that we see 500 leads a year how many do you think that that actually what percentage of those do you think that actually happen as transaction two so you can do the math I mean if you want 10 10 companies in your portfolio and if this is um 2% of all the all the leads that you see so you need 500 leads a year okay and the problem uh with this business in Bulgaria is that there there is no entrepreneurship culture yet as I say that can generate 500 individual leads a year however I know that there are some initiatives like the Jeremy seed funds Etc uh I think they generated like 700 projects so this is very promising okay other questions please use me for anything leverage usually yes however with our strategy it would be difficult um because mainly because we are investing into services and um this and services so for a transaction between 2 and 5 million you can imagine that the revenue of that company is like 10 million it's usually it usually has very low fixed asset base and it's not bankable and that's why the owners of those businesses are ready to see us as a partner i' have to say an expensive partner rather than go to the bank so and that is why we cannot usually do this leverage buyout so this is a problem that there is limited credit Supply going to that particular sector and it's yeah it's usually typical for larger uh for larger companies High fixed asset companies um with stable cash flows and predictable predictable performance in the future like the types of the type typ of companies that you are going to do DCF model about like telecoms or Banks this is when you do L AOS okay anything else okay my PR class was um visiting my one class and he was talking about you know the um skills knowledge personality and all these kind of stuff that I need for young people like you to go two job interviews and get a good job um the the purpose here is not the same actually completely different but my question will be um how much his OB education help him to be good in that job or the job okay well basically uh when I when I got into this position I was definitely not prepared did not give me the preparation to do the job however it gave me the training that I used in order to develop the skills or that my colleagues used in order to develop the skills that are needed what I mean is that let's not fool fool ourselves we are and I were I were in that shair like three years ago okay let's not fool ourselves we don't have the skill the skill set to be to be accomplished Prof investment professional okay what we have is a potential to develop into such kind of person okay and I think LG was great for that it basically give you gave you the gave me the opportunity like it gave me the how how to structure that I know how to learn things as a result of the education here okay and actually I I've seen this in in a couple of other I had we had two interns last year and I've seen that uh they did not have the skill set that was required of course they didn't nobody had at their first kind of professional experience but they had the discipline and they had the training to develop certain skills and that that was great it was great so in terms of that it is very useful yes okay anything else uh how hard is toise capital ing very hard and it doesn't happen in Bulgaria capital for like additional Capital if you need ining period or uhhuh well let's let's structure it a little bit okay so the private Equity Fund already has committed capital and it invests into into invest companies okay and this capital is being cised from from somebody body else from other investors okay so you are asking about this Capital that is raised for the private Equity Fund right okay so our experience is that our investors are basically High net American High Network American individuals and we also have some Pension funds and it was extremely difficult to raise that fund it is 25 million fund $25 million fund and um we raised it we closed the fund in the end of 2009 just after the the turbulence of the of the crisis so it was it was extremely difficult now during like two years ago we started doing um second second um fundraising um however we were advised to wait until we first accomplish our first fund okay and it is difficult it goes through very very strict due diligence processes like eif ebrd are typical multi Nationals who are investing in this type of growth funds in our region um it is it is difficult but it is not impossible and if you're interested in the process we can do we can talk about that as well okay anything else by the way I'll be at your um presentations tonight whoever is presenting in this room yeah yeah okay you and me will be the oh great so and um I'll be around uh I'll be around so if you think of something else and if you if you want they have IPM class in 15 minutes or 30 minutes and they some of them maybe all them will present the IPM project so we are wellcome to to be at this class in the Next Room I have one last question we have an m&a simulation again we try to you know do some kind of simp and going to negotiate actually fail okay some some con the deal for 5 seconds but did they reach their goals uh someone try to you know spend half an hour to negotiate to beat up the price how important negotiation in your private business well this is this is the well who is involved in that process MH well as I said actually negotiation is like the 90% of the of the deal structuring and as I said deal structuring is like 90% of the success let's say so negotiation is quite important and that's why and it also it could be challenging here with our local entrepreneurs and um it usually involves different different parties like from both from our side and from their side usually there is legal councel uh when the negotiations are at the stage where they have to be formalized where like memorandum of understanding has to be signed um and of course our partners fly from Budapest for this kind of negotiations so it is really important I this is actually this is this is the essence of the of the of the Dual structuring negotiations okay I guess this is last question so thank you very much for the exciting um speech um and for the whole interesting even a lot of new things like waterfall structure stuff as well so guys I hope we can also benefit of not experience he graduated 2009 with four years of experience in in that business mostly I guess yes well I spent three six months in another company but it was also an investment fund so um you see how many different and new things we can learn and you may decide what should be your professional career um so hopefully um you know my classes and our guest speakers can can help you to make a choice where want to you know spend the next few years and what kind of business do you want to start and whether you want to work for a big bank or for a private Equity Firm or become a you know entrepreneur and do your own business um so it's a it's a difficult choice but it's quite interesting so thank you m to be here today thank you very much this program is brought to you by aubg talks for more please visit us at AU g.edu talks

Channel: AUBGTalks

Views: 76,386

Keywords: AUBG, Talks, AUBGTalks, American University in Bulgaria, Lecture, Speaker, Private Equity (Industry), Business, Private Equity Fund (Organization Legal Structure), Corporate Finance (Field Of Study), Success, Investing, Martin Milev, Miroslav Mateev, Oriens Ltd, Deal Structures, Ownership, Training, Education

Id: 5DmNgbaAShs

Length: 67min 36sec (4056 seconds)

Published: Tue Apr 01 2014