Private Equity and Venture Capital Assessment

Question 1 [70 marks]

As one of the General Partners (GP) at Plaisio Capital, a private equity firm, you are in charge of three (3) LBO funds Shroeder Opportunity I, Shroeder Opportunity II, and Shroeder Opportunity III.

Parts A, B, and C immediately below are independent but related to the context of

Plaisio Capital.

Part A

You have identified Barnaby Technology, a publicly traded software as a service (SaaS) company as a potential investment for Shroeder Opportunity III (the Fund). The Fund would take Barnaby Technology private, improve its operations, reduce any redundancies, then exit after three years. Barnaby Technology has no debt currently.

An analyst developed the following forecasts regarding this investment:

The Fund wishes to pay $800 million for Barnaby Technology consisting of $250 equity and

$550 million 10?bt. The $250 million equity investment is contributed as follows:

• $170 million in the form of 5% PIK preferred equity from the Fund
• $72 million as common shares from the Fund
• $8 million as sweet equity common shares from the management of Barnaby Technology

The Fund will use all free cash flows generated by Barnaby Technology to service the debt. The Fund estimates that it will be able to sell the company in 3 years for $1.00 billion.

CONTINUED

Tasks

1. [Total 20 marks] Required:

Calculate the MoM and the IRR for the Fund and for the management of Barnaby Technology. Show your workings.

Part B

Shroeder Opportunity I, with a committed capital of $650 million, is well into its divestment stage. Over the last seven years, it has made the following investments and exits (investments made in Years 1, 2 3, and 4 were exited in Years 4, 5, 6, and 7, respectively).

The management fee is 2%, applied to committed capital the first three years, and to invested capital after that. The carried interest is 20%, using a deal-by-deal waterfall approach.

2. [Total 20 marks] Required:

Calculate the net IRR for Shroeder Opportunity I. Show your workings.

TURN OVER

Part C

3. [Total 30 marks] Required:

In the context of a leveraged buyout deal, briefly explain how a private equity team goes about structuring the deal, namely deciding on leverage (how much debt versus equity), equity components (preferred versus common), and the breakdown of the debt components between the different types of debt.

END OF QUESTION ONE

CONTINUED

Question 2 [60 marks]

Cloud Nine Technologies is a startup cloud technology company in need of financing. Starting with a cash balance of $0, the company projects the following cash balances:

Based on its own projections, the company recognized that it needed to raise a total of $4.6 million. It also thought that it was more prudent to leave itself with some safety cushion, so it decided to raise a total of $5 million. As they do not need the entire amount immediately, the founders of Cloud Nine Technologies will seek to raise $3 million now, and another $2 million in two years.

The founders expect their company to be sold in four years for $25 million.

Following networking with other entrepreneurs in the same space, they have identified two venture capital firms who would be interested in investing: Ashcroft Ventures for the first round ($3 million), and Kingston Partners for the second round ($2 million). This fact is known from the onset by all three parties concerned (Cloud Nine Technologies, Ashcroft Ventures, and Kingston Partners).

The risk aversion of both VC firms implies an annual risk-adjusted discount rate of 20 percent. Suppose both VC firms believe that Cloud Nine Technologies might falter (with no value left), and that the probability of that event happening is 20 percent each year.

The entrepreneurs also decided that whatever valuation they would get, they wanted to own 1 million shares of Cloud Nine Technologies after their first round of financing.

TURN OVER

Tasks

1. [Total 10 marks] Required:

Calculate the percentage of shares in Cloud Nine Technologies that Kingston Partners will acquire upon the second round of financing in two years. Show your workings and carry percentage ownership to two decimals places.

2. [Total 11 marks] Required:

In relation to the first round of financing:

• Calculate percentage ownership of Cloud Nine Technologies by Ashcroft Ventures upon investing the $3 Show your workings and carry percentage ownership to two decimals places.
• Calculate the total number of shares Show your workings
• Calculate the price of one share. Show your workings

3. [Total 10 marks] Required:

In relation to the second round of financing:

• Calculate number of new shares issued. Show your
• Calculate the price of one share. Show your workings

CONTINUED

4. [Total 9 marks] Required:

Calculate the wealth (dollar value of stake) of each of Cloud Nine Technologies founders, Ashcroft Ventures, and Kingston Partners at exit in four years. Show your workings.

Task 5 below is independent from Tasks 1 through 4 immediately above.

5. [Total 20 marks]

Context:

Consider a startup company that has raised seed capital from a VC fund a couple years ago that is now trying to raise ‘Series A’ down round financing.from another VC fund.

Required:

Briefly explain a down round in this context and critically discuss the impact that such a financing situation would have on all parties involved

END OF QUESTION TWO

TURN OVER

Question 3 [70 marks]

As an analyst at Bianca Management, a private equity real estate fund, you were tasked with valuing a 12-year old industrial property as potential investment.

The appraiser feels that it has an effective age of 15 years based on its current condition. For example, there are cracks in the foundation that are not feasible to repair. In other words, it would cost more to try to repair these problems than the value that would be created in the property. The appraiser believes that it has a 60-year remaining economic life.

The building was constructed using a greater ceiling height than users require in the current market.

It would cost $27 million to reproduce the building with the same ceiling height but $25 million to construct a replacement property with the same utility but a normal ceiling height.

The higher ceiling results in increased heating and air conditioning costs of $50,000 per year. A cap rate that would be used to value the property would be 10 percent.

The building was designed to include a cafeteria that is no longer functional. This area can be converted to usable space at a conversion cost of $25,000, and it is believed that the value of the property would increase by at least this amount.

The roof needs to be replaced at a cost of $250,000, and other necessary repairs amount to

$50,000. The costs of these repairs will increase the value of the building by at least their

$300,000 cost.

The road providing access to the property is a two-lane road, whereas newer industrial properties are accessible by four-lane roads. This has a negative impact on rents (locational obsolescence), which is estimated to reduce NOI by $100,000 per year.

CONTINUED

Tasks

1. [Total 40 marks] Required:

Using the cost approach, estimate the value of this property. Show your workings.

Task 2 below is independent from Task 1 immediately above.

2. [Total 30 marks] Required:

Briefly but clearly explain the DCF method of valuing private real estate property and highlight four assumptions that need to be made in conducting a DCF analysis in that context.

END OF QUESTION THREE

END OF PAPER

Section C: Module Learning Outcomes covered in this Assessment

This assignment contributes towards the achievement of the following stated module Learning Outcomes as below:

1. Understand how LBO and VC funds are structured and operate.
2. Calculate the fees (management fee and carried interest) for PE funds.
3. Value target companies using different approaches.
4.  Compute the return of investments under different leverage structures for LBOs.
5. Comprehend fundraising considerations for entrepreneurs. Arrive at equity stakes over different rounds of financing.
6. Gage returns and net returns of investments.
7. Identify the different types of distribution
8. Know the alternative PE strategies.
9. Recognize the different exit
10. Visualize the IPO process and its alternatives
11. Categorize various types of real estate investments.
12. 13. Separate the various valuing approaches to private real estate.
13. Tell the different types of risks faced by PE

Section D: Assessment criteria

Within each section of this coursework you may be assessed on the following aspects, as applicable and appropriate to this particular assessment, and should thus consider these aspects when fulfilling the requirements of each section:

• The accuracy of any calculations;
• The strengths and quality of your overall analysis and evaluation;
• Appropriate use of relevant theoretical models, concepts and frameworks;
• The rationale and evidence that you provide in support of your arguments;
• The credibility and viability of the evidenced conclusions/recommendations/plans of action you put forward;
• Structure and coherence of your considerations and reports;
• As and where required, relevant and appropriate, any references should use either the Harvard OR Vancouver referencing system (see References, Citations and Avoiding Plagiarism)
• Academic judgement regarding the blend of scope, thrust and communication of ideas, contentions, evidence, knowledge, arguments,
• Each part has requirements with allocated marks, maximum word count limits/page limits and where applicable, templates that are required to be used.

Section E: Groupwork Instructions

Not applicable as this is an individual assessment

Section F: Additional information from module leader(s)

This is identified as an INDIVIDUAL assignment. That means that you complete ALL aspects of this work entirely on your own, with absolutely no communication, coordination, or even ‘brainstorming’ about approaches and/or answers