WHAT
KIND OF SITUATIONS DO PRIVATE EQUITY FUNDS INVEST IN ? Private equity funds intervene at every stage in a company's development, providing solutions to a range of different needs:
Venture CapitalStartup or very young companies with considerable development potential (ITC, biotech, etc.)
Development CapitalCompanies needing capital for the next phase of their development (new production unit, international development, diversification, etc.).
Transmission Capital or LBOMature companies of all sizes where all or some of the shareholders wish to sell their shareholdings.
An LBO is an opportunity for managers to acquire a stake in the company's capital: existing management
(MBO), new management (MBI) or even a mixture of the two (BIMBO).
Turnaround CapitalCompanies in difficulties.
WHAT
IS A LEVERAGED BUY-OUT? ?An LBO is the acquisition of a company financed partially by debt. A holding company is set up to receive funds from the purchasing investment fund and from management and to raise bank debt in order to purchase what is known as the target company. The leverage effect operates in two ways :
bank leverage : supplementing
the financing provided by shareholders. fiscal leverage : interest paid
on bank debt is deductible from corporation tax (thanks to fiscal
integrationof the holding company and target company) as long as the holding company owns at least 95% of the
target company.
In
a classic LBO, what is the breakdown between debt, mezzanine and equity
financing ?The structure depends on the level of cash flow (after investment) generated by the target company. It will therefore vary significantly from one LBO to another. A simple order of magnitude would be as follows: equity might represent 35% of the financing of the LBO, mezzanine debt 15% and bank debt 50%.
WHAT IS MEZZANINE FINANCING AND WHAT ARE ITS
ADVANTAGES ?In LBO deals, mezzanine financing is an intermediate form of financing between debt and equity. Mezzanine debt is subordinate to bank debt but senior to equity, is unlisted and generally subscribed by specialist funds. It is generally backed by bonds with share warrants.
Mezzanine funding offers three advantages: :
Optimising
managers' stake in the company's equity :predetermine the dilution resulting from the warrants in advance and thus eliminating the risk of an
unexpected strong dilution (unlike convertible bonds frequently subscribed by investors and convertible
into equity depending on its performance). The percentage of equity to which share warrant holders
are entitled is determined at the outset and not dependent in any way on the company's performance.
The
mezzanine component, by virtue of its nature and maturity, is
considered as equity :the capital repayable is subordinate to repayment of the senior bank debt,
and impacts only
marginally on operating cash flow and hence on the company's
development capacity :repayment at maturity of the principal and the bulk of the interest.
Is mezzanine financing a form of cheap
equity or expensive debt ?At first sight, mezzanine financing could be considered as an expensive form of debt, since it attracts interest and its expected yield is higher than that of senior debt.
In reality, however, mezzanine financing is a substitute for equity :
it is wholly
repayable on maturity (9 to 10 years on average) unlike the usual bank
debt, much of which is generally amortisable.
it is considered
by lending banks as a financial resource equivalent to equity and can
therefore increase the company's borrowing capacity.
What is the expected rate of return on
mezzanine financing ?The expected rate of return on mezzanine financing depends on the company's risk profile and the structure envisaged (breakdown of financing between equity, mezzanine and senior debt).
Theoretically, however, assuming that the minimum average expected annual rate of return on equity is 25%, the expected annual rate of return on mezzanine financing would be 15%.
In reality, its cost to the shareholder is less than 15% since the bond component of its remuneration is deductible from the profits of the target company.
It compares favourably to equity financing since it may cost around 12 to 13% after tax when the expected rate of return on private equity is 25%.
How does the remuneration of mezzanine
financing breakdown ?Mezzanine financing is remunerated in three ways :
cash interest
paid quarterly or half-yearly –Euribor for the period + a
margin) capitalised
interest paid on final repayment of the mezzanine debt share warrants
giving access to a proportion of the target company's equity. For the manager, what is the difference between convertible bonds and
mezzanine financing ?For managers, mezzanine funding optimises their equity stake when the LBO is unwound: the dilution associated with the mezzanine's share warrants is defined in advance and much less than the dilution associated with the conversion of convertible bonds.
WHAT IS THE DIFFERENCE BETWEEN SENIOR AND JUNIOR MEZZANINE DEBT ?Junior mezzanine debt is subordinate to senior mezzanine debt. It therefore carries a higher risk and so its expected rate of return is also higher. Senior mezzanine debt expects a return of 15% (assuming an IRR of 25% on equity), whereas junior mezzanine debt expects around 17 to 19%.
Remuneration of junior mezzanine debt is made up of capitalised interest and share warrants: unlike the remuneration on senior mezzanine debt, there is no cash interest component.
What are the criteria that make a company
eligible for an LBO ?Each company has its own specific characteristics, but candidate companies for LBO nonetheless generally share the following qualities :
regular historic
growth solid
positioning on their market quality
management recurrent cash
flow development
prospects Does the company still have the resources
it needs to develop (hiring, investment) when carrying such a high
level of debt ?Senior debt is split into two tranches: one amortisable, the other repayable on maturity. This second tranche has no impact on the company's cash flow. The amount of debt amortisable annually is calculated in accordance with the business plan produced by management. The business plan includes the projected hiring and investment necessary for growth. Debt maturity dates are chosen to allow a safety margin. Often the company is provided with a line of bank financing to cover external growth and acquisitions. Finally, the investment fund may inject more capital during the lifetime of the LBO to meet a specific need.
Does Capzanine run the companies in which
it invests? How far is it involved ?Capzanine plays no part in the operational management of the company.
Capzanine plays its part as a shareholder through its role on the Supervisory Board of the company. Its role is to support and assist managers in their strategic decisions, to make available its expertise in financial management and the introduction of reporting tools and, where necessary, its knowhow in the field of external growth. In addition, the team provides support by sharing their contacts with the companies present in the portfolio.
What prompted the concept of Capzanine, the
first hybrid equity/mezzanine fund created in France ? A maturing
market with a need for equity resources on attractive pre-tax terms
(IRR of 17 to 18%). Access to
mezzanine funding for companies with Entreprise Value of between
€15M and €50 M. Enhancing market
reactivity by offering all-in-one mezzanine and equity financing in the
€15-50 M Entreprise Value range.
What role does Capzanine play with regard to
its partners (company managers or private equity
funds) ?Capzanine is a mezzanine provider with an investment and entrepreneurial culture closely attuned to that of the senior executives and investment fund managers who constitute its partners.
Do the culture and working methods of the Capzanine team differ from
those of other mezanine funds ?Capzanine is not a mezzanine provider but a long term financing partner : working proactively with its partners and contributing to debate and discussion at Board meetings without overstepping its role.
The result is a flow of ideas, growth targets, introductions between parties and the development of synergies and business flows between its shareholdings.
WHAT MAKES Capzanine indepedent? What are
the advantages and disadvantages ?Capzanine is run by its three Managing Partners who take decisions jointly and are advised by an Advisory Board. There is no possible conflict of interest, since the fund has no sponsor. The senior team's long experience (20 years) on the private equity market and the presence of major groups (AXA, AGF, MMA, Finama etc.) amongst its shareholders, however, give it institutional weight.
