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This report seeks to contribute to the debate about the private equity industry by bringing clarity to how the industry works and by providing a summary of the findings of approximately 100 peer-reviewed academic papers which have examined aspects of the private equity industry over the past 25 years.

The public debate about private equity has focused on several areas: taxation, the impact of buy-outs on employment, and risks in the banking system related to money lent for buy-outs. In the case of the large buy-out market, questions have also arisen about the accountability, performance and mode of operation of private equity fund managers.

Private equity is risk capital provided in a wide variety of situations, ranging from finance provided to business start-ups to the purchase of large, mature quoted companies, and everything in between. Buy-outs are examples of private equity investments in which investors and a management team pool their own money, usually together with borrowed money (in which case they are called ‘leveraged’ buy-outs or LBOs), to buy the shares in a business from its current owners.

Contents
About the authors
Acknowledgements
List of figures, tables and findings
Overview

1. The private equity market
1.1 An introduction to the private equity market
1.2 What is private equity?
1.3 How big is the private equity market?
1.4 How significant are larger deals in the private equity market?
1.5 What have been the biggest UK deals?
1.6 How significant are public to private transactions in the private equity market?
1.7 What is the rationale for a public to private transaction?

2 Who are the participants in a private equity transaction?

2.1 Introduction
2.1.1 Who’s who?

2.2 The private equity fund

2.2.1 What is a private equity fund?
2.2.2 How are private equity funds structured?
2.2.3 What do private equity fund managers do?
2.2.4 How does a private equity fund differ from a quoted equity fund?
2.2.5 How does a private equity fund differ from a group of companies?
2.2.6 What are hedge funds and how do they differ from private equity funds?
2.2.7 Emerging and converging alternative asset investors
2.2.8 Where do private equity fund managers operate?
2.2.9 Why are European private equity funds based predominantly in the UK?
2.2.10 How are UK private equity fund managers rewarded?
2.2.11 Management/advisory fee
2.2.12 Carried interest
2.2.13 Other fees
2.2.14 Broad principles of UK fund taxation
2.2.15 Taxation of carried interest
2.2.16 What was taper relief and how did it affect the incentives of private equity fund managers?
2.2.17 Non-UK domiciled persons
2.2.18 Competition for funds by private equity managers
2.2.19 Can a private equity fund or a private equity manager fail

2.3 Investors in private equity funds

2.3.1 Who are the investors in private equity funds?
2.3.2 Are institutions long-term investors in private equity funds?
2.3.3 What are the average returns of the private equity market for investors?
2.3.4 What is the range of returns for investors?
2.3.5 How can individual investors invest in private equity funds?

2.4 Banks

2.4.1 What role do banks play in private equity?
2.4.2 How has the banking market changed?
2.4.3 How much leveraged lending have banks undertaken?
2.4.4 What are collateralised debt obligations, collateralised loan obligations and structured investment vehicles?

2.5 Advisers

2.5.1 Who are the advisers in the private equity market?

2.6 Employees and other stakeholders

2.6.1 What is the impact of private equity transactions on wider stakeholders?
2.6.2 What is TUPE and when is it applied?

2.7 Taxation

2.7.1 The wider impact of leverage on UK tax revenues

2.8 Refinancing and exits

2.8.1 Types of exit
2.8.2 What has been the pattern of exits from private equity deals?
2.8.3 Secondary buy-outs
2.8.4 Leveraged recapitalisation

3 Evaluating and structuring a private equity investment

3.1 Value and pricing
3.1.1 What is ‘value’? The difference between enterprise value and equity value
3.1.2 What is ‘financial engineering’?
3.1.3 What is a ‘Newco’?
3.1.4 How do you decide whether to buy shares or assets?
3.1.5 Pricing a transaction
3.1.6 A financeable offer

3.2 Senior debt and mezzanine

3.2.1 How much debt?
3.2.2 What is payment in kind debt?
3.2.3 Can Newco repay the borrowings?
3.2.4 What security will the banks have?
3.2.5 What are the potential sources of cash flow to repay borrowings?
3.2.6 Increasing post tax profits
3.2.7 Reducing working capital
3.2.8 Fixed assets: to own or lease?
3.2.9 Asset stripping and financial assistance
3.2.10 What protections exist for publicly quoted companies?
3.2.11 The risks of leverage: financial covenants and events of default
3.2.12 One-to-one cash covenant
3.2.13 Net assets covenant
3.2.14 Interest cover covenant
3.2.15 An event of default and corporate failure
3.2.16 How can the risks of leverage be mitigated?
3.2.17 What is mezzanine?

3.3 Institutional and management equity

3.3.1 How much institutional equity?
3.3.2 Internal rates of return
3.3.3 Debt: equity ratio
3.3.4 How much equity do management get in a buy-out?
3.3.5 What is a ratchet?

4 A detailed worked example of a leveraged buy-out

4.1 Illustrative operating projections
4.2 Funding requirement
4.3 Funding structure
4.4 The impact of leverage on profits and cash
4.5 Taxation: how much tax is paid by private equity-backed companies?
4.6 Summary of corporation tax impact
4.7 Due diligence and sensitivity analysis
4.8 Exits and returns

Appendix: Summaries of studies of buy-outs and private equity
References
Glossary

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