Private Equity and Venture Capital in Europe_11 pot

The venture capitalist contributes a large amount of money to protect the target company’s market position and to support the management during the design of new growth plans.. A15.1.2 I

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growth) After commercial validation of the product or service offered by the target company, the venture capitalist intervenes and increases produc-tion and the selling and marketing capacity The company is still medium

or little, but the growth capacity of the business idea has improved It is important to emphasize that the ﬁ nancial resources invested are reduced because the company has already acquired a good part of the market, and selling guarantees the resources needed for the production process

2 Third stage ﬁ nancing — Figure 15.3 illustrates how third stage ﬁ nancing

sup-ports the consolidation of the development reached by the venture-backed company At this point, it has passed the initial development phase and wants to consolidate and enlarge its market position The venture capitalist contributes a large amount of money to protect the target company’s market position and to support the management during the design of new growth plans These types of plans involve the launch of new product, enlargement

or diversiﬁ cation of manufacturing and distribution activities, or the sition of a competitor Consequently, it becomes necessary to collect new funds dedicated to research and development, marketing, and production

acqui-3 Fourth stage or bridge ﬁ nancing — Figure 15.4 illustrates the maturity stage

of a company’s life cycle By this time the target company has grown siderably by enlarging the markets reached and the range of products or

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services offered Financing is geared toward going public or for a planned trade sale with venture capitalist support to facilitate the next steps The venture capital fi nancing can also bridge fi nancial diffi culties and the quo-tation of the company In this phase the level of risk is very low with occa-sional fi nancial operations that involve large amounts of money

Expansion deals involve not only equity capital but also debt ﬁ nancing when a leveraged buyout (LBO) is realized Expansion deals only provide minority par-ticipation in the equity of the target company, whereas an LBO requires a major-ity participation These deals change the property composition of the target company allowing for the differences in participation

Venture -backed companies with private equity ﬁ nanced company growth have several advantages:

1 Support in building business — Experienced venture capitalists assist the

target company in recruiting managers, developing relationships with tomers, and ﬁ xing business strategy

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2 Cash feed — Private equity investors provide the funds necessary to support key business activities

3 Higher overall return — The support of private equity ﬁ rms allows the

original shareholders to obtain a higher return from their investments in the target company, especially when exiting through an IPO

4 Sponsor in going public — Experienced venture capitalists are key assets

in reassuring IPO investors, so their involvement increases the possibility

of success in going public Usually, IPOs realized with private equity tors create higher returns

5 Spin-off support — Venture capitalists with a wide range of relationships

can help when the target company wants to sell its subsidiaries

6 Venture capitalists improve the target company’s ability to satisfy market

demands — Today markets change quickly due to customer needs or nological revolutions, so it is critical to a company’s success to be able to quickly exploit market opportunities

7 Venture capitalists support the target company upon entry into new

mar-kets or industries because they are able to share their management skills and business know-how

8 Private equity investment is a clear signal a business idea has potential On

the other hand, the lack of interest is a good indicator of an existing problem not easily recognized by the management team or the original shareholders

9 Original shareholders receive critical support from the private equity investor

— The bottom line of the balance sheet will be diligently watched and every possible action placed to maximize the potential return on the investment

To have a clear picture of how private equity investments impact the sion of a target company, a recurring group of potential disadvantages should be considered:

1 Culture changes — The target company’s managers and employees have

to work with a new partner who has a high-proﬁ t-oriented culture bined with an intense pressure to continue to develop the business

com-2 After investing in the target company, private equity ﬁ rms have greater

con-trol of the agendas and activities of the original shareholders and managers

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3 Timing of exit strategies may not be consistent with the plan of the

origi-nal shareholders and management Many conﬂ icts can arise while ing the right time to exit

4 Buy back options are usually limited This means that original shareholders

may not be allowed to re-purchase the participation from the venture italist if the deal was unsuccessful Private equity ﬁ rms are usually reluc-tant to include a buy back option, because it can affect the real potential

cap-of the investment return

5 Private equity investors require a high return from the investment This

means a high level of the value transfers from original to new ers The high return expectations include the value of the money invested

sharehold-as well sharehold-as the soft support consisting of invested time, networks, ence, and expertise The original shareholders, before closing the deal with equity investors, have to understand that if the value of their busi-ness will be higher after the deal, then this justiﬁ es the high percentage of value that they must give to the investor

6 Closing a transaction with private equity ﬁ rms is complex and

time-consuming, because this type of deal includes agreements on liabilities and obligations that can take up to a year to close

7 A typical private equity approach comes with fast decision making If

there are bureaucratic delays, due to the timetables and procedure of the previous shareholders, the investors can decide to abandon a partnership

8 The willingness of a private equity ﬁ rm to commit additional ﬁ nancial

resources in a speciﬁ c investment already part of its portfolio is limited by the continuous focus on its expected returns This situation can force origi-nal shareholders into adding new funds to the venture-backed company to avoid losing new business initiatives or opportunities due to lack of funds

15.5 CHARACTERISTICS OF GROWTH

Expansion ﬁ nancing deals work best with middle or small size ﬁ rms that want

to grow quickly Small medium fi rms have fl exible production systems that adapt quickly to demand changes Consequently, fi rms turn to expansion fi nanc-ing to reach another element for their success — dimension Increasing dimen-sion allows the small medium companies to exploit business opportunities that they otherwise would lose due to the lack or the low availability of effective and alternative tools for internationalization

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During this strategic process, soft support given by private equity investors

is critical Their ability to provide ﬁ nancial resources as well as a set of advisory services helps the small medium company to improve its competitive skills The extensive support provided to these types of companies is also demonstrated in the average duration of the holding period, which is around four years or more when compared with the holding period of buyout operations

The support given for the dimensional growth of the ﬁ rm can be classiﬁ ed in two ways: quantitative and qualitative Company performance can be quantita-tively compared in terms of revenue and improvement of the margin and num-bers of employees between venture-backed companies and companies that have never needed professional investors Research demonstrates the high impact of the private equity operation by analyzing the increase in the employment level and turnovers An expansion deal can lead to qualitative development facilitat-ing the collaboration and joint venture with foreign partners that can result in export business

1 Reinforcing the competitive advantages of the company to strengthen its

distinctive skills in the existing activities and businesses — Acquisitions usually involve ﬁ rms operating in the same markets with similar products and services

2 Expanding competitive advantages to improve and extend the company’s

distinctive skills to neighboring sectors — Companies targeted for tion usually offer products and services with technological and marketing elements

3 Exploring the competitive advantages of the company when entering a

new sector that requires new skills — This type of target ﬁ rm operates upstream or downstream or in sectors without any correlation

External growth refers to merger and acquisition (M & A) operations with several different objectives; some need a long period of time to be reached, while oth-ers are realizable more quickly Long-period objectives are classiﬁ ed in three dif-ferent clusters The ﬁ rst type desires to increase the company’s value and satisfy

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the interests of the different stakeholders The second type is connected with a manager who wants to reinforce his personal visibility, and the last type looks for opportunities to collect earnings in a capital account

The short-term objectives, also considered strategic motivations, refer to:

Researching and exploiting the scale and scope economies — These nies want to use their experience in marketing or production to improve production capacity through the skills and technologies of the acquired

compa-ﬁ rm

Managing interdependence with stakeholders by accelerating growth in the industry where the acquired ﬁ rm already successfully operates to improve their own skills

Improving the proposal system and markets served by acquiring a higher market share and entry into new markets by using the marketing skills of the acquired company and increasing the client base

Entering in new businesses to obtain critical resources from the acquired company or to reduce the risk related to the expansion in new industries Exploiting and optimizing ﬁ nancial resources through the leverage capacity

of the acquired company, stabilization of the cash ﬂ ow, or the acquisition of

an underestimated company that can be sold with a good economic return

Appendix 15.1

A business case: REM

A15.1.1 Target company

REM was founded in the 1930s and operates in the industrial machine sector It was ily controlled until 2003 when a venture capitalist acquired minority participation After this investment, the company developed a strategy of acquisitions and a partnership, becoming a global leader of life science and testing equipment REM operates in more than 50 countries and 70% its total revenues is made in exports REM’s markets are the electronic, automotive, aerospace, and defense sectors

A15.1.2 Investment structure

The operation, closed in 2003, was an expansion capital deal consisting of a minority sition of about 14% evaluated at €6 million with €40 million as the pre-money value of the target company Shareholders agreements provided an exit strategy of listing the company or the opportunity to realize a buy back by minority shareholders within a ﬁ xed period of time and with a predetermined method for price determination

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A15.1.3 Critical elements of the investment

The main reasons for the deal were the strong competitive market position and the tional exposure of REM, their operation within several markets, and their clear strategy of external growth in a high potential industry

A15.1.4 Management phase activity

Despite tough pressure on the operating margin provoked by the unfavorable exchange rate of the US dollar with the euro, between 2003 and 2007 REM, with the support of a venture capitalist, realized 6 acquisitions in and out of its domestic market, making it a global player REM has since started to reorganize its production cycle

A15.1.5 Exiting

The founder family terminated the deal in 2008 with re-acquisition of the minority participation owned by the venture capitalist

Appendix 15.2

A business case: MAP

MAP was founded in the 1950s starting with a wholesale food business Over the years the pany expanded toward oil production and fresh food trading Today, MAP is a wholesale and retail distributor of food and consumer goods including the manufacturing and packaging of food Its channel is a mix of hypermarket, large stores, and supermarkets with three different brands

The operation was realized at the end of 2003 with the acquisition of a minority stake by two venture capital ﬁ rms of €12,8 million and was a typical expansion capital transaction with an evaluated enterprise value of €106 million Agreements between the shareholders regarding exit options consisted of a buy back by the majority shareholders or the listing of MAP

This investment was realized because of MAP’s leadership in a speciﬁ c area of its market, its attractiveness to big foreign players, and high growth trend and good proﬁ t performances

A15.2.4 Management phase activity and exit

During the investment, the external growth strategy was unsuccessful so the venture capitalist exited from MAP with a buy back

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Appendix 15.3

A business case: FMM

The company was founded in the 1930s because a group of workers started providing ity services to a big transportation ﬁ rm FMM business consisted of specialized management services for buildings and equipment including maintenance of electrical and lighting services, refrigeration equipment, and catering and canteen services

The investment was realized by two venture capitalists for a total of €20 million, 12% of the equity capital of NewCo, which was built to realize an expansion capital transaction NewCo involved two business units: facility management and a cleaning and environmental services unit FMM has subscribed 75% of its equity capital; the remaining stakes were subscribed

by other minor private equity operators This deal structure allowed FMM to collect money

to sustain and maintain the strategic growth and control of the two main business units of NewCo There were two options included in the exit agreement between the shareholders: the listing of NewCo to be realized within a certain period of time or buy back by the minority shareholders

This deal was done because FMM was a leader in the domestic market with a wide range

of diversiﬁ ed services Venture capitalists were attracted by the high potential growth of the domestic market, the highly skilled management team, the attractive price, and the likelihood

of realizing an IPO considering the appeal of the facility management services sector to the

ﬁ nancial market

The contribution of the venture capitalist was important because it allowed the company to low and realize an intense growth strategy of expansion from the facility management industry

fol-to the global industrial services secfol-tor FMM has been focused on the integration of new ties as well as the acquisition of a business unit dedicated to healthcare services

A15.3.5 Exiting

Early in 2008 shareholders planned to list the company, but due to the negative situation of the

ﬁ nancial market, they decided instead to seek out venture capital They signed an agreement with a venture capitalist to sell 25% of their stake in the company

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Appendix 15.4

A business case: S & S

The company was founded in the 1960s as a typical ﬁ rm led by two families with equity ticipations equal to 60 and 40%, respectively The core business of S & S is the production and distribution of passive security products such as locks for wooden and aluminium frames, padlocks, security locks, and master key systems Within a few years, it became a leader in its domestic market S & S expanded its business into the access and safety control systems industry providing both single products and global services Their main distribution channels include wholesalers, dealers, ironmongers, retails chains, and industrial and banking groups The revenues are divided between domestic and European markets and the rest of the world

par-at 40, 50, and 10%, respectively

The deal, realized in 2004, consisted of an expansion capital transaction where the venture capitalist acquired a participation of 15% of €13 million and an S & S equity value of €84 million while the enterprise value was €106 million The exit agreement between the shareholders and venture capitalists was to list the target company within a certain period of time or a buy back by the minority shareholders with a predeﬁ ned method of price calculation

This company was targeted because of its strong and competitive market position S & S was the leader in the domestic security market with huge potential value creation realizable by changing from passive security to safety and security integrated systems This change created

a higher possibility of growth and better proﬁ ts The venture capitalist was interested in ing from the investment with an IPO Another interest was the newly started external growth process, initiated by the acquisition of a European company, which was a source of potential manufacturing and commercial synergies

The performance of S & S during 2004 and 2005 was lower than expected because of the down European and the domestic markets Another issue faced by S & S was the inability of management to handle the increasing raw material costs during the turnaround phase Support provided by the venture capital ﬁ rm was critical in redeﬁ ning and implementing the new strategy from S & S

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view wanted to keep the old strategic vision of focusing on the passive security industry Due to these problems, the venture capitalist exited from the deal through a buy back of S & S because

he did not agree with the spin-off operation decided on by the founder families

Appendix 15.5

A business case: RDC

This manufacturer of vegetable conserves was founded during the second half of the 1800s The control and property of RDC was acquired by different owners over the years In 2003 the controlling group of RDC was declared in default so the temporary receivership divided RDC into two businesses RDC was purchased by VC, an industrial company that manufactures vegetables, with the support of a venture capitalist, making RDC the leader in the domestic market of fruit juices and one of the most important companies in vegetable products and tomatoes

The deal, concluded at the end of 2004, was realized to support an expansion capital tion The venture capitalists involved in the investment subscribed 49% of the NewCo with an enterprise value of €113 million and €45 million as debt ﬁ nancing Even if the private equity

transac-ﬁ rms subscribed a minority participation, the agreement between the shareholders was very effective The exit strategy agreed upon was to list the target company within a certain period of time or a buy back by the minority shareholders with a predeﬁ ned method of price calculation

Venture capitalists invested in this company because of its well-known brands and market leadership, despite decreasing market shares due to the default Also attractive was the opportunity to improve RDC through product innovation strategies, extension of the brands, and the possibility of realizing an IPO at the end of the investment

During the holding period, RDC tried to reorganize the company through functional distribution and completed the strategic merger between RDC and VC

A15.5.5 Exiting

During the management period, problems arose due to a conﬂ ict of interests between the shareholders, so, early in 2006, the venture capitalists agreed with VC and placed a put call option on their RDC participation Luckily, after a few months, they sold their shares

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Appendix 15.6

A business case: MED

MED was founded in the 1990s as a publishing company realizing an average yearly growth

of 33% until 2004 Today, MED is involved in areas such as information technology, home entertainment, and video games It leads the market in home entertainment and information technology, while it is second in the video game industry

The deal was realized at the end of 2004 as an expansion capital transaction Venture ists subscribed a minority participation of MED equal to 22% with an enterprise value ﬁ xed at

capital-23 million The agreement between the shareholders was very effective; the exit strategy vided for the listing of the target company within a certain period of time or the possibility for the venture capitalist to put 100% of MED up for a trade sale

MED was targeted because of its terriﬁ c growth potential and leading position in the ment and technology industries as well as the appeal of the domestic publishing market and the opportunity to increase the ﬁ rm’s advertising revenues

The management phase of the MED deal had many milestones:

Launches of new magazines focused on the video game industry

Agreement with an international publishing company for the production and distribution in the MED domestic market of a foreign information technology magazine

Launch of DVD fi lm series with the fulfi llment of signifi cant fi nancial performances

A15.6.5 Exiting

Venture capitalists exited in 2007 by selling the owned participation to another private equity ﬁ rm

Appendix 15.7

A business case: FC

The company was founded in the 1980s and manufactured clothes for the fashion industry Over time it built a retail chain in its domestic market In 2005, FC launched an expansion strategy to increase the international arm of its business by opening shops in prominent European cities such as Berlin, Barcelona, and Paris FC operates through two different brands: one

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focused on women’s clothing generating 80% of the company’s revenues, and one consisting of unisex clothing The distribution channels are composed of retailers, ﬂ agship stores, and outlets

The deal was closed in 2007 by two private equity ﬁ rms that purchased a minority stake of 45% through the constitution of a NewCo, with the remaining shares still in the hands of the founder shareholders This was an expansion capital investment operation The agreement between the shareholders was good for the venture capitalists; the exit strategy, agreed upon by all shareholders, provided for listing of the target company within four years or the possibility of

a trade sale of 100% of FC with a specifi c covenant for the EBITDA realized by the company If the gap between the planned and actual EBITDA was above a predefi ned value, the two private equity fi rms can place a put option on 100% of the shares owned by the founder shareholders

This deal was realized because FC had what private equity ﬁ rms want in a target company:

Strong market position

Well-known and appreciated brands

High potential growth in international and domestic markets with the opening of new shops, launching of new brands, and new clothing lines

IPO opportunity

The management phase of FC began by reorganizing the commercial and production structure

to support the expansion of the two original brands in the international market FC successfully closed important and high strategic brand licensing agreements with other fashion houses

A15.7.5 Exiting

The investment is ongoing

Appendix 15.8

A business case: BALTD

BALTD is a world leader in the automotive and industrial supplier sector It is divided into three business segments: automotive pipes and cooling technologies, industrial pipes, and die cast assemblies Their expansion strategy was to enlarge market coverage by acquiring a foreign player, CANCO, to increase their range of products and improve and develop international growth

During 2008, BALTD founded a NewCo to realize the acquisition of CANCO and its equity capital was subscribed by a pool of private equity investors and a group of managers from both BALTD and CANCO The enterprise value of BALTD was ﬁ xed at €120 million for an equity value of €55 million

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