direct investing 101bvequity.com/files/bve_directinvesting101_feb2017.pdf · · 2017-09-12upon...

Direct Investing 101

Trends & Perspectives For 2017

Prepared by:

Ross E O’BrienFounder & CEO Bonaventure Equity, LLC

1© 2017 Bonaventure Equity, LLC. All rights reserved

Outline

I. Overview of Direct Investing

II. The Direct Investing Landscape

III. Role of the Private Investor

IV. The Direct Investing Process

V. Conclusions


I. Overview of Direct InvestingDirect Investing 101

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¤ “Direct Investing” is a term that is front and center for investors today. What is the attraction and what do we mean by calling an investment “Direct”?

¤ We define direct investing as acquiring a financial and operational interest in illiquid assets such as privately held companies or real estate, and that the future asset owner is making the decision to take part in a specific investment.

¤ In this report direct investing refers to an overall approach that includes originating, analyzing, processing and structuring of private equity and real estate investments.

¤ Many private investors are looking at direct investments as a focal part of their alternative asset allocations in 2017 and beyond.



¤ The overall process for sourcing, vetting, structuring and closing a direct investment is virtually indistinguishable from an institutional private equity process. Success is reliant upon exceptional deal origination, a defined investment thesis, sophisticated due diligence and analysis, specific terms, and structural best practices.

¤ The nuance to direct investing is that investors are funding investments from their internal sources of capital they directly control.

¤ Direct investing is a high risk investment strategy and since it is not suitable for most investors, remains primarily the domain of family offices, ultra high net worth individuals and other private investors.


II. The Direct Investing LandscapeDirect Investing 101

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¤ Many investors view direct investments as assets within their alternative allocations that offer more control, alignment of returns, and a counter cyclical long-term investment. The majority of direct investments map back to the institutional private equity and real estate market.

¤ When investors controlling the investment decision, and take risks through their internal sources of capital this often leads to an alternative and customized process.

¤ Many direct investors will look for specialized oversight methods and may have more flexibility with respect to timeframes compared to formal funds where investors are allocating to a blind pool of investments.

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© 2017 Bonaventure Equity, LLC. All rights reserved


¤ There are many types of direct deals that typically map to the boarder investment markets that institutional funds and investment groups focus on:¤ Private Equity (operating business and real estate)¤ Venture Capital¤ Club Deals/Pledge Funds¤ Debt and Equity Financings

¤ In each of these sectors there are institutional quality investors with long standing industry specific expertise and track records whose sole purpose is to find the most attractive deals with the highest probability of generating extraordinary returns.


¤ Therefore it is relevant to evaluate the broader private equity markets as it relates to:¤ Sector focus – where are the investments going?¤ Transaction types – where is the capital flowing?¤ Risk/IRR – what types of investments present the

highest/lowest risk and return profiles?

¤ Our analysis indicates that 2017 will continue to be a strong year for buyouts and valuations will continue to be strong as private equity funds have record levels of capital to deploy.

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¤ 2015 was another record year for private equity buyouts exceeding $450 billion.*

¤ 2015 was the 5th consecutive year that distributions outpaced capital calls.

¤ This record flow of capital has resulted in steady fundraising by PE funds that now have an all time record amount of capital available for investment (“Dry Powder”) while continuing to increase topping $1.2 trillion globally.

¤ Deals remain scarce, driving up valuations.

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*Source: Bain & Company, Inc. Global Private Equity Report 2016



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¤ 2015 was a record year for exits, while fundraising and investments held steady*


Global Private Equity Report 2016 | Bain & Company, Inc.

Page 1

I. The private equity market in 2015: What happenedWith its complex interplay of fund-raising, investments, exits and returns carried out on a global scale against kaleidoscopic shifts in the business cycle, credit conditions and regulatory environment, a year in private equity (PE) is a lifetime in most other industries. As the global economic expansion showed signs of strain amid continued record-low interest rates, feverish competition that had investment multiples skirting record highs and increased volatility in public equity markets, 2015 presented many challenges. Yet, PE turned in another surprisingly solid year.

PE’s vital signs remained healthy in 2015, although the aggregate figures retreated somewhat from the highs in 2013 and 2014 (see Figure 1.1). Exits in 2015 rode a tsunami of corporate merger and acquisition (M&A) activity as cash-rich strategic acquirers set out to buy growth. PE returns once again began to widen their performance edge over the public markets, reinforcing investor confidence. The eagerness of limited partners (LPs) to recycle a flood of cash distribu-tions back into their best-performing asset class enabled PE firms of just about all sizes, areas of focus and performance track records to hit or exceed their targets. New investments by PE funds remained robust despite sky-high asset valuations and growing uncertainty in the debt markets as general partners (GPs) discovered new ways to deploy capital.

As we will see in Section 2 of this report, the disciplines and resourcefulness that served PE so well last year will be even more important in the year ahead as the competitive intensity for deals reaches new highs, recession risks mount and the maturing PE industry wrestles with generational change. Leading PE firms are arming themselves for future turbulence by probing deeply to understand the unique sources of their past successes, investing in skills that will enable them to create value across their portfolios and learning how to anticipate—

Figure 1.1: 2015 was another strong year for private equity

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$500B

Global buyout deal value

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$500B

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0

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$500B

Global buyout capital raised

2011 12 13 14 15 2011 12 13 14 15 2011 12 13 14 15

Exits Fund-raising Investments

Sources: Preqin; Dealogic


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¤ Global Private Equity Dry Powder is at an all time high


Global Private Equity Report 2016 | Bain & Company, Inc.

Page 2

and invest behind—the new macro forces that will disrupt industries and reshape economies. There are lessons in these novel approaches that no PE firm or LP can afford to ignore, because if there is one constant amid the PE industry’s kaleidoscope of challenges it is the need to embrace change.

Fund-raising: Bigger, better, faster

GPs setting out to raise new funds in 2015 encountered some of the best conditions they had seen in years. With cash distributions from exits continuing to run well ahead of calls on previous commitments LPs had made for a fifth consecutive year, abundant fresh capital enabled most GPs to hit or exceed their fund-raising targets. Funds are also raising capital more quickly, on average, than in any year since the height of the last PE cycle nearly a decade ago.

Indeed, with memories of the global financial crisis still fresh in the minds of GPs and LPs alike, it is remarkable how far fund-raising has rebounded. With all exit channels blocked in the period immediately following the crisis as GPs gradually nursed their troubled holdings back to health—and because LPs were overweighted in PE as the value of non-PE assets tumbled—most shelved new fund-raising plans, and many looked as if they might never be able to raise another fund. As economies and markets around the world slowly recovered, PE fund-raising began to climb out of its trough. (For Bain’s analysis on how surprisingly well PE industry fund-raising weath-ered that last downturn, see “The shakeout that didn’t happen” on page 3.) Fund-raising in 2015 built on recent years’ strengths as cresting cash distributions lifted across-the-board demand from LPs. The strength was not evident in the year’s headline numbers. As recently as mid-December, total capital raised globally in 2015, at $527 billion, was slightly less than the $555 billion raised in 2014 (see Figure 1.2). Most fund categories dipped be-low the previous year’s level, with growth funds slipping 30%, infrastructure funds off by 16% and buyout funds

Figure 1.2: PE capital raised globally in 2015 came in less than the previous year’s high

Real estate

Venture

Infrastructure

Growth

Buyout

Total value

CAGR CAGR(10–15) (14–15)

Global PE capital raised (by fund type)

0

200

400

600

$800B

2003

93

04

207

05

349

06

538

07

666

08

681

09

318

10

299

11

352

12

405

13

547

14

555

15

527

Distressed PE

Nat. resources

Fund of funds

Mezzanine

Secondaries

Other

12%

1%

13%

17%

−2%

16%

2%

26%

5%

21%

11%

18%

−30%

−16%

−5%

−2%

−2%

−11%

118%

14%

44%

−5%

−32%

70%

Notes: Includes funds with final close and represents year funds held their final close; distressed PE includes distressed debt, special situation and turnaround funds; other includes PIPE and hybrid fundsSource: Preqin


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*Source: Dealogic

¤ The following sectors continue to attract the most investment from PE funds by sector, value and volume of transactions (not including real estate)

11Regaining equilibrium: Global private equity watch 2014 |

Sector watchLast year saw the return of the consumer sector. An improvement in economic confidence in the US and Europe, moves by China toward a consumption-led economy, and the continued rise of the middle class in other emerging markets creating investment opportunity all led to the consumer sector attracting more PE attention globally.

In Asia-Pacific, the energy, mining and minerals sector has been knocked off the top spot for attracting PE investor interest over 2014; it had held this position for two years. Nearly three-quarters of Asia-Pacific PE market participants expect the consumer sector to be the most popular area for PE investment, versus just 53% citing energy, mining and minerals.

Technology was the other big story in 2013 (the Dell deal is excluded from the results and the chart below, given its size). Low interest rates, wide availability of credit and opportunities in the financial technology, cloud, big data, and software and services spaces (including companies weakened by disruptive technologies) were among the key drivers fueling activity. Moreover, the opportunity for roll-ups in the tech space is growing, as corporations become more active acquirers.

Meanwhile, health care took more of a back seat, in part because of uncertainties in the US around the Affordable Health Care Act.

30%

40%

50%

Figure 11: Add-on transactions as a percentage of global buyout, deals 2004-2013

Source: Pitchbook‘04 ‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11 ‘12 ‘13

Oil and gasMaterials IndustrialsConsumer goods

Health careConsumer services

TelecomUtilitiesFinancialsTechnology Retail

Figure 12: PE investment by sector by value and volume

0%

10%

15%

5%

0%

10%

15%

20%

25%

5%

20%

2012 value2013 value 2012 volume 2013 volume

Source: Dealogic



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*Source: Preqin Ltd. Quarterly Private Equity Update 2015

¤ The Risk/Return profile comparisons of different private equity strategies

The Preqin Quarterly Update: Private Equity, Q1 2015

Download the data pack at:www.preqin.com/quarterlyupdate

13© 2015 Preqin Ltd. / www.preqin.com

Fund Performance and Dry Powder

Fig. 1 shows the level of dry powder, or uncalled capital commitments, within the private equity industry. The graph reveals that dry powder fi gures have risen every year since 2012 and currently stand at a peak of $1.24tn. This is a 13% increase on December 2014, just three months earlier. The largest proportion of dry powder (37%) is held in buyout funds, followed by real estate funds (17%) and venture capital funds (11%). Growth and real estate funds have seen the largest percentage increase in dry powder levels between December 2014 and March 2015, growing by 23% and 19% respectively.

The PrEQIn Private Equity Quarterly Index in Fig. 2 shows that venture capital funds are continuing to edge closer towards the

base value of 100 following 14 consecutive years of relative underperformance. Distressed private equity and buyout funds have seen upward movement in their indices since 2012 but are now showing signs of levelling off during Q3 2014. The real estate index has fallen slightly behind the industry as a whole for the same quarter.

Fig. 3 shows the risk-return profi le of different private equity strategies. Mezzanine funds have the lowest level of risk, with a standard deviation of 5.4% and a median net IRR of 8.6%. Secondaries funds are shown to have the highest median net IRR at 15.0%, with a standard deviation of 12.8%.

Fig. 2: PrEQIn Private Equity Quarterly Index by Fund Type

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PrEQIn All PrivateEquity IndexPrEQIn BuyoutIndexPrEQIn DistressedPrivate Equity IndexPrEQIn Fund ofFunds IndexPrEQIn Real EstateIndexPrEQIn VentureCapital IndexS&P 500 TR Index

Source: Preqin Performance Analyst

Ind

ex

Retu

rns

(Re

ba

sed

to 1

00 a

s o

f 31-

De

c-0

0)

Fig. 1: Private Equity Dry Powder by Fund Type, December 2003 - March 2015

0

200

400

600

800

1,000

1,200

1,400

De

c-0

3D

ec

-04

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Ma

r-15

Other

Venture Capital

Real Estate

Mezzanine

Growth

Distressed Private Equity

Buyout


Dry

Po

wd

er (

$bn)

Fig. 3: Risk and Return by Strategy (Vintage 2002-2012 Funds)

0%

5%

10%

15%

20%

25%

0% 5% 10% 15% 20%

Buyout

DistressedPrivate EquityFund of Funds

Growth

Infrastructure

Mezzanine

NaturalResourcesReal Estate

Secondaries

VentureCapital

Source: Preqin

Return - Median Net IRR (%)

Risk

- St

and

ard

De

via

tion

of N

et I

RR (

%)

Fig. 4: All Private Equity: Median Net IRRs and Quartile Boundaries by Vintage Year

0%

5%

10%

15%

20%

25%

30%

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Top Quartile IRRBoundary

Median Net IRR

Bottom QuartileIRR Boundary


Vintage Year

Ne

t IRR

sin

ce

Inc

ep

tion



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*Source: Preqin Ltd. Quarterly Private Equity Update 2015

¤ Conclusions:¤ Institutional investors are likely to continue to focus on larger

investments in strong later stage companies¤ These transactions continue to be competitive for investors, driving

strong valuations¤ M&A will continue to be strong in 2017 and the primary exit

strategy for direct investments¤ IPOs however are likely to reemerge at the top end of the market¤ Many opportunities will continue to exist in the smaller private

investment market whereby investors can find unique opportunities that offer compelling value creation


III. Role of the Private InvestorDirect Investing 101

16


¤ Allocations to alternative assets by family offices has continually increased and is expected to continue to increase serving as a good benchmark for private investors.*

¤ Many family offices are drawn to the direct deal marketplace for a variety of reasons including:¤ Wealth was originated through company ownership and they understand the

extraordinary value that can be created through privately held enterprises.¤ Limited partner interests in funds as a blind pool may not achieve

performance expectations while top quartile performance funds are closed to new investors.

¤ The investible capital controlled by family offices is growing significantly, therefore family offices can compete with institutional private equity funds for deals.

¤ Investors want direct engagement with a portfolio company.¤ Investors are scrutinizing the fee structure of traditional funds.¤ Motivated by deep sector expertise and provide significant value.

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*Source: The World Economic Forum, Direct Investing by Institutional Investors



¤ Returns & a Tailored Portfolio – direct investments can provide a counter cyclical asset class to a customized portfolio designed to achieve unique and specific returns and long-term performance.

¤ Control – investors have more control over when to sell an asset, and investing directly removes layers of intermediaries and asset managers.

¤ Value & Alignment – many investors can build out sophisticated direct investment capabilities at a similar cost basis to external fund managers with closer alignment to an office specific strategy.



¤ There are three main pathways to making direct investments:¤ Solo – has the most discretion but is also the most

demanding requiring significant infrastructure, rigor and resources.

¤ Partnering (co-investing with other family offices) – aligning with other asset owners to share risks and responsibilities.

¤ Fund Co-investing – investing alongside a fund leveraging their process, due diligence and ongoing oversight.

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Modes for Direct Investing



¤ Many critical risk factors and considerations exist with any direct investing strategy:¤ Direct company/asset ownership presents many

operational, governance, oversight and control issues.Operating businesses require “care and feeding” and achieving returns is predicated on exceptional operational execution.

¤ The discipline to NOT move forward with an investment is critical to avoiding future losses but also requires a high level of deal scrutiny and process rigor.

¤ Investors may find themselves involved in transactions as co-investors as friends and personal contacts draw them into transactions that are not suitable.

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Risks



¤ There are many instances of unsuccessful investments in the direct marketplace for a variety of reasons:¤ Generating desired returns (defined) is reliant on a business operating

and executing at the highest possible levels. The ongoing oversight, monitoring and operational participation is extremely high.

¤ Company level – operational risks (internal)¤ Market level – competition and sector risks (external)¤ Product or Service level – e.g. technology obsolescence (unseen)¤ Investor level – continued requirements for additional capital

(unplanned)¤ Investor was fee driven, cut transaction costs, and underestimated what

was required to process and oversee the investment which reduces the return expectations below that of a traditional fund.*

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Risks

*According to research by the World Economic Forum, very few institutions say their direct investing programs are principally a cost-avoidance tactic.



¤ There are many types of private investors that participate in the direct investment marketplace, with different objectives, capabilities and characteristics.

¤ Family offices are unique in the private equity investment market primarily because they operate without a specific mandate allowing for more flexibility in terms and time horizon/exit strategies.

¤ General types¤ Sophisticated and experienced – has strong capabilities as an investment

office and views direct investing as an economic engine for continued multi-generational wealth creation (focused staff and infrastructure)

¤ Opportunistic – will look at deals as they come along but generally more focused on wealth preservation (outsourced capabilities and not the focus of overall investment structure)

¤ Unplanned – brought into deals through friends or family (has small portfolio and high concentration of risk with only one or two investments)

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Types of Investors


IV. The Direct Investing ProcessDirect Investing 101

23

IV. The Direct Investing Process

¤ Sourcing

¤ Vetting

¤ Negotiating

¤ Due Diligence

¤ Post Closing Monitoring

¤ Operational Oversight & Board Participation

¤ Exit Strategies

24

Direct investors will likely have gone through, a customized and disciplined rigorous process specific to its direct investing activities.

Many times additional resources, both internal and external, are required.


IV. The Direct Investing Process: Sourcing

¤ The first step to identifying suitable opportunities is to have a defined investment thesis that will serve as a screen to evaluate opportunities:¤ What are you looking for and why? Growth equity? Venture Capital?¤ What sectors are suitable (and why)?¤ What are the value added capabilities or advantage the investor has in

this particular transaction compared to other investors?¤ What is the desired outcome(s)?

¤ Sourcing opportunities that fit a defined investment thesis requires a concerted and sustained effort that leverages the investor's ecosystem:¤ Attorneys, accountants, investment bankers, lenders, rolodex…etc. ¤ Each investor has a unique ecosystem that should be considered when

defining an investment thesis


IV. The Direct Investing Process: Vetting

¤ Once an opportunity passes the first level of evaluation and warrants a closer look typically a formal vetting process takes place.¤ Preliminary information request¤ Multiple meetings with management¤ Defined & organized investment committee¤ Vetting memorandum

¤ Investment committee established and makes a go vs. no-go decision


IV. The Direct Investing Process: Negotiating

¤ Once an investor desires to move forward with a specific opportunity they typically submit a term sheet before entering into due diligence.

¤ General transaction terms should be proposed and negotiated so all parties know that if the due diligence process is positive, all parties have agreed to a structure up front and can move forward.

¤ Negotiating with Management (seller)¤ Valuation analysis¤ Aligned objectives¤ Investor value add/advantage


IV. The Direct Investing Process: Due Diligence

¤ It is critical to run a detailed and intensive due diligence process with a “quarterback” for the family office responsible for driving the activities and analysis.

¤ Industry experts may be hired as consultants and advisors.

¤ Focus areas:¤ Legal¤ Accounting¤ Operations¤ Management¤ Business Plan¤ Risk assessments¤ Industry and regulatory


IV. The Direct Investing Process: Post Closing & Oversight

¤ The most overlooked question in the direct investing marketplace is; “what do you do after you write the check”?

¤ Governance established in closing documents.

¤ There should be a clear alignment between investors and operating teams as to the business plan and objectives.

¤ With an alignment of the business plan, the appropriate interactions, involvement, and communication types and frequency can be implemented.


IV. The Direct Investing Process: Exit Strategies

¤ Typical private equity exit strategy is 10x (cash on cash multiple) return within 5 years.

¤ Is this right for a private investor?

¤ Considerations:¤ Buy and sell – build value quickly, growth oriented and then sell

to strategic or financial buyer¤ Buy and hold – looking for dividend return of capital over

extended period of time¤ Family member participation – succession planning¤ Legal Trust as an investor – wealth transfer strategy and tax

considerations


V. Conclusions

¤ Direct investing is not just a passing fad and is predicted to continue to increase.

¤ Success will be driven through a dedicated or refocused investment thesis, processes, rigor and resources.

¤ Investors must distinguish between ownership and control.

¤ A direct investing strategy should not be undertaken solely as a cost reduction activity.

¤ There are multiple pathways to the market with co-investing being the most prevalent.

¤ The investor who is interested in direct investing, should honestly answer the question “does direct investing play to our strengths?”


Bonaventure Equity, LLCwww.bvequity.com

32

Ross E O’BrienFounder & CEO

[email protected]: 646-554-5058


Disclaimer

This presentation is confidential and is being supplied to you solely for yourinformation and is not for distribution. Although reasonable care has beentaken to ensure that the facts stated in this presentation are accurate andthat they opinions expressed are fair and reasonable, no presentation orwarranty, express or implied, is made as to the fairness, accuracy,completeness or correctness of the information and opinions contained inthis presentation, and no reliance should be placed on such information oropinions. Further, the information in this presentation is not complete andmay be changed at any time. No liability whatsoever for any losshowsoever arising from any use of such information or opinions or otherwisearising in connection with the presentation is accepted by any person.

33© 2017 Ross E O’Brien. All rights reserved

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