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Financing Change - PSIK

Financing ChangePRIVATE EQUITYDEMYSTIFIED An explanatory guideSecond editionJohn Gilligan and Mike WrightFinancing ChangeAn initiative from the ICAEW Corporate Finance FacultyThe first edition of private equity Demystified An Explanatory Guidewas published inAugust 2008, as the first report to be issued under Financing Change , the thoughtleadership programme of the ICAEW Corporate Finance Faculty. The faculty is the world slargest network of professionals involved in corporate finance and counts accountants,lawyers, bankers, other practitioners and people in business among its Changeaims to advance the economic and social contribution of corporatefinance activity by promoting better understanding and the publication of the first edition of private equity Demystifiedthe major economieshave moved from growth to recession, the global banking community has experiencedunprecedented turmoil and distress and we have all come to be familiar with the term credit crunch.

Financing Change An initiative from the ICAEW Corporate Finance Faculty The first edition of Private Equity Demystified –An Explanatory Guidewas published in August 2008, as the first report to be issued under Financing Change, the thought leadership programme of the ICAEW Corporate Finance Faculty.

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1 Financing ChangePRIVATE EQUITYDEMYSTIFIED An explanatory guideSecond editionJohn Gilligan and Mike WrightFinancing ChangeAn initiative from the ICAEW Corporate Finance FacultyThe first edition of private equity Demystified An Explanatory Guidewas published inAugust 2008, as the first report to be issued under Financing Change , the thoughtleadership programme of the ICAEW Corporate Finance Faculty. The faculty is the world slargest network of professionals involved in corporate finance and counts accountants,lawyers, bankers, other practitioners and people in business among its Changeaims to advance the economic and social contribution of corporatefinance activity by promoting better understanding and the publication of the first edition of private equity Demystifiedthe major economieshave moved from growth to recession, the global banking community has experiencedunprecedented turmoil and distress and we have all come to be familiar with the term credit crunch.

2 We have also seen the publication, in April 2009, of the European Commission sproposed Alternative Investment Fund Managers directive which would cover privateequity second edition builds on the work of the first edition to reflect this recent turmoiland examines the way in which the banking market has changed its approach to privateequity investments. It also includes more discussion of both mid-market buy-outs and thedynamics of the restructuring remains the case that media coverage of private equity and some public commentaryhave frequently displayed a poor understanding of how private equity operates, yet thesesources are frequently relied upon as fact. This guide provides an objective explanation ofprivate equity , recognising that for public scrutiny to be effective it must be conductedon an informed publication is unlikely to result in a reduction in the scrutiny of private equity .

3 Its value will be measured in better-informed debate, in private equity s effectiveengagement with wider stakeholders and in well thought out public policies. We welcome views and other comments on this work and related themes. For further information on the Financing Changeprogramme please or telephone +44 (0)20 7920 information on the ICAEW s work in funding academic research please contact Gillian Knight, Research Manager on +44 (0)20 7920 report, which includes a summary of academic studies and references, is alsoavailable to download from 2010 John Gilligan and Mike Wright 2010 All rights of the contents of this report is encouraged. Please give fullacknowledgement of the source when reproducing extracts in other published responsibility for any person acting or refraining to act as a result of any material inthis document can be accepted by the authors or the 978-1-84152-830-4 private EQUITYDEMYSTIFIED An explanatory guideSecond editionJohn Gilligan and Mike WrightContents iiiContentsPagePreface to the second editionviAcknowledgementsviiiAbout the authorsixList of figures, tables and findingsxExecutive Summary11.

4 The private equity An introduction to the private equity What is private equity ? A brief history of private equity in the How big is the private equity market? How significant are larger deals in the private equity market? What have been the biggest UK deals? What have been the biggest deals in the world? What are the largest private equity funds in the world? How significant are public to private transactions in the private equity market? What is the rationale for a public to private transaction? To what extent do private equity deals involve buy-outs of distressed firms?242 Who are the participants in a private equity transaction? Who s who? The private equity What is a private equity fund? How are private equity funds structured?

5 What do private equity fund managers do? How does a private equity fund differ from a quoted equity fund? How does a private equity fund differ from a group of companies? What are hedge funds and how do they differ from private equity funds? Emerging and converging alternative asset Where do private equity fund managers operate? Why are European private equity funds based predominantly in the UK? How are UK private equity fund managers rewarded? Management/advisory Carried Other Broad principles of UK fund Taxation of carried What was taper relief and how did it affect the incentives of private equity fund managers? Non-UK domiciled Competition for funds by private equity Can a private equity fund or a private equity manager fail?

6 Investors in private equity Who are the investors in private equity funds? Are institutions long-term investors in private equity funds? What are the average returns of the private equity market for investors? Why do private equity funds value unrealised investments? How do private equity funds value unrealised investments? Understanding private equity portfolio valuation Valuation of limited partner holdings: the J What is the range of returns for investors? How can individual investors invest in private equity funds? What role do banks play in private equity ? What is leveraged lending? How did the banking market Change ? Why did the banking market Change ? What are the risks of leveraged lending? What are collateralised debt obligations, collateralised loan obligationsand structured investment vehicles?

7 What went wrong? How much leveraged lending have banks undertaken? Advisers and other service Who are the advisers and service providers in the private equity market? Employees and other What is the impact of private equity transaction on wider stakeholders? What is TUPE and when is it applied? The wider impact of leverage on UK tax Refinancing and Types of What has been the pattern of exits from private equity deals? Secondary Leveraged How did the private equity industry respond to the public interest shown in it? What are the Walker Guidelines? Which companies do they apply to? How many companies and investors are covered by the guidelines? What do portfolio companies have to do to comply with the guidelines?

8 What do private equity investors have to do to comply with the guidelines? 693 Evaluating, structuring and restructuring a private equity Value and What is value ? The difference between enterprise value and equity value What is financial engineering ? How do you design and built financial instruments? What is a Newco ? How do you decide whether to buy shares or assets? Pricing a A financeable Senior debt and What is debt? What is senior debt, junior debt and subordinated debt? How much debt? How much debt? Cash flow How much debt? Security and cost of How did banks increase the levels of borrowings in buy-outs? Capital holidays and bullet How did banks increase the levels of borrowings in buy-outs?

9 Payment in kind Why did banks increase the amount of debt? What is mezzanine? Can Newco repay the borrowings? What security will the banks have? What are the potential sources of cash flow to repay borrowings? Increasing post-tax Reducing working Fixed assets: to own or lease? What are proco/opco structures? A special Asset stripping and financial assistance86iv What protection exists for publicly quoted companies? The risks of leverage: financial covenants and events of Incurrence covenants and maintenance One-to-one cash cover Net assets Interest cover An event of default and corporate How can the risks of leverage be mitigated? Institutional and management How much institutional equity ? Internal rates of return and short Debt: equity Are the largest leveraged buy-outs failing during the recession?

10 How much equity do management get in a buy-out? What is a ratchet? Distress and What are the types of company distress? What are the early signs of financial distress? What is equity cure? What is financial restructuring? When is financial restructuring possible? What is a hair cut and who bears it? What powers does a securred lender have? What tools are available to restructure a balance sheet? What are the differences in restructuring publicly traded debt? The paradox of Why is there a growing use of distressed debt funds? What are credit default swaps? A perverse new set of equity investors: the impact of equity investors: what are the options? Change the Change the finance What is the position of management in a restructuring?


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