Private Equity is the term used for investing in companies that are not listed on a stock exchange. It is commonly used to refer to firms that are taken over by other companies and become limited partnerships, as well as simple-to-define investments. The main goal of private equity is to extract maximum value from the target company. According to experts, the private sector will only grow and evolve in the next 3 years, and so to get a better understanding of private equity and the investment industry, in this article you will learn more about the structure of such deals.

Getting Started – Discovery and Teasers

The initial phase involves the discovery and evaluation of investment opportunities. A private equity deal is made through a variety of methods, some of which are networking, equity research, and internal analysis. A teaser is a multi-page document that outlines basic information about a company for sale or private equity investment opportunity. It includes only a description of the company’s services or products and basic financials, without naming the seller.

Signing the NDA

If a private equity firm has expressed interest in the company’s teaser, it must sign an NDA in order for the deal to move forward. Once it is signed, the financial intermediary must also provide investors with a confidential information memorandum. The target company will then be ready to provide confidential information about itself.

Conducting Due Diligence

Initial due diligence is necessary to better understand the target company. During this process, experts gather information about the company and its industry and evaluate its return on investment, determining the organization’s future projections. Often, investment banks are approached during this operation to obtain their opinion of the company.

Investment proposal

At this stage, the investment team draws up an investment proposal and submits it to its committee. The investment committee holds a first-round meeting, during which it may simply update the deal or begin the formal approval process. During this process, the investment team is allowed to spend some amount on consulting and other expenses.

A non-binding letter of intent

The investment team delivers a non-binding letter of intent to the target company. Its content may include the following criteria:

  • A purchase price range
  • After-acquisition capital structure
  • Necessary time to provide a binding offer
  • Experience and expertise of the PE firm
  • Value creation strategy
  • Compatibility with the pitching firm’s management

Further due diligence

This due diligence is more in-depth because the target company provides investors with more confidential documents. This information includes legal data, board reports, financial documents, intellectual property, employee information, and more.

Creating an internal operating model

The operating model is the key distinction between revenues and expenses. It includes key target business factors, which may include:

  • Cost of raw materials
  • Volume
  • Price
  • Number of customers
  • Renewal rates
  • Fixed and variable cost structure

This helps in evaluating the financial performance of the target firm and gives a better idea of the factors that affect the company’s profits.

Preliminary Investment Memorandum

A PIM is a very lengthy document that can be about 40 pages long. It consolidates investment options for the investment committee. The PIM consists of sections such as:

  • A summary of all theses, backgrounds, team recommendations, and transaction
  • Company overview
  • Market and industry overview
  • Financial overview
  • Risks and key aspects
  • Exit details
  • Proposed project plan

Final Investment Committee Approval

At this stage, the investment committee creates the FIM – that is, the final investment memorandum. The FIM reviews the due diligence results from the beginning of the PIM, and is sure to discuss the key issues highlighted by the investment committee.

This is followed by the final two steps – sending the final binding application and signing the contract.

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