Adjusted Present Value Model
This model is similar to the Enterprise DCF model, with the difference that
the Adjusted Present Value model separates the value of the company into two
components: the value of the company’s operations at the cost of capital
as if the company had no debt, plus an additional element reflecting the impact
on this value of the tax savings related to leverage.
See Enterprise DCF model.
Anti-dilution [full ratchet]
Anti-dilution provisions in which the price at which the anti-dilution instruments
are converted is the lowest price at which ordinary shares have been sold.
For example: in a prior round of financing which raised capital at €2.00
per share, investors received full ratchet anti-dilution protection. A subsequent
round of financing was consummated at €1.00 per share, and the early round
investors therefore had the right to convert their anti-dilution instruments
at the lowest [ie €1.00] price.
See anti-dilution provisions, anti-dilution [weighted average].
Anti-dilution [weighted average]
Anti-dilution provisions in which the price at which the anti-dilution instruments
are converted is calculated by a weighted average formula.
For example: in a prior round of financing which raised €1 million of capital
at €2.00 per share, investors received weighted average anti-dilution protection.
A subsequent round of financing was consummated for another €1 million
at €1.00 per share, and the early round investors therefore had the right
to convert their anti-dilution instruments at a weighted average adjusted price
of €1.50 per share.
See anti-dilution provisions, anti-dilution [full ratchet].
Anti-dilution provisions
Provisions in a company’s charter and by-laws designed to discourage undesired
take-over bids. These take the form of options or institutional equity instruments
[e.g. convertible preference shares], which can be converted to ordinary shares
on any issue of new stock in a subsequent round of investment financing or in
a take-over bid. The price at which this conversion takes place is determined
by the type of anti-dilution provision.
See anti-dilution [full ratchet], anti-dilution [weighted average].
Arrearage
Unpaid dividends due to holders of preferred stock.
See Cumulative preferred stock.
BIMBO
Buyin-management-buyout. A combination of a management buyin [MBI] and a management
buyout [MBO]. In a BIMBO, an entrepreneurial manager or group of external managers
financed by venture capitalists buys into a company and teams up with members
of the target management team to run it as an independent business.
Bonds redeemable into shares
Financial debt in the form of bonds, the redemption of which principal will
be into share of capital under conditions set out at the issuance of the bonds
Burn rate
The rate at which an investee company consumes investment capital.
Business plan
A document which describes a company’s management, business concept and
goals. It is a vital tool for any company seeking any type of investment funding,
but is also of great value in clarifying the underlying position and realities
for the management/owners themselves.
Buy-and-build strategy
Active, organic growth of portfolio companies through add-on acquisitions.
Buyout
A transaction in which a business, business unit or company is acquired from
the current shareholders [the vendor].
Financing of this nature generally takes the form of a LBO, MBO or MBI.
See management buyout [MBO], management buy in [MBI], institutional buy out
[IBO], leveraged buy out [LBO].
Buyout Fund
Funds whose strategy is to acquire other businesses; this may also include mezzanine
debt funds which provide [generally subordinated] debt to facilitate financing
buyouts, frequently alongside a right to some of the equity upside.
Call option [or call]
The right to purchase a specified number of securities at a fixed price at or
during a specified time.
Compare put option.
Carried interest
A bonus entitlement accruing to an investment fund’s management company
or individual members of the fund management team. Carried interest [typically
up to 20% of the profits of the fund] becomes payable once the investors have
achieved repayment of their original investment in the fund plus a defined hurdle
rate.
Corporate venturing
There is no single definition of corporate venturing that seems to satisfy all
parties, so we distinguish indirect corporate venturing – in which a corporate
invests directly in a fund managed by an independent venture capitalist –
from a direct corporate venturing program, in which a corporate invests directly
by buying a minority stake in a smaller, unquoted company.
Covenants
An agreement by a company to perform or to abstain from certain activities during
a certain time period. Covenants usually remain in force for the full duration
of the time a private equity investor holds a stated amount of securities and
may terminate on the occurrence of a certain event such as a public offering.
Affirmative covenants define acts which a company must perform and may include
payment of taxes, insurance, maintenance of corporate existence, etc. Negative
covenants define acts which the company must not perform and can include the
prohibition of mergers, sale or purchase of assets, issuing of securities, etc.
Cumulative dividend
A dividend which accumulates if not paid in the period when due and must be
paid in full before other dividends are paid on the company’s ordinary
shares.
See Arrearage.
Cumulative preferred stock
A form of preference shares which provide that, if one or more dividends is
omitted, those dividends accumulate and must be paid in full before other dividends
may be paid on the company’s ordinary shares.
See Arrearage.
Debt financing
Financing by selling bonds, notes or other debt instruments.
Debt/equity ratio
A measure of a company’s leverage, calculated by dividing long-term debt
by ordinary shareholders’ equity.
Development capital
See expansion capital.
Dilution
Dilution occurs when an investor’s percentage in a company is reduced
by the issue of new securities. It may also refer to the effect on earnings
per share and book value per share if convertible securities are converted or
stock options are exercised.
See anti-dilution provisions.
Discounted cash flow [DCF]
A method of assessing the value of an investment based on predicted cash flows
discounted to take account of the fact that a euro tomorrow is worth less than
a euro today.
Drag-along rights
If the venture capitalist sells his shareholding, he can require other shareholders
to sell their shares to the same purchaser. These usually take the form of call
options over the shares of the other shareholders. They allow delivering 100%
of the company thereby capturing a control premium in the sale price.
Compare Tag-along rights.
Due diligence
For private equity professionals, due diligence can apply either narrowly to
the process of verifying the data presented in a business plan/sales memorandum,
or broadly to complete the investigation and analytical process that precedes
a commitment to invest. The purpose is to determine the attractiveness, risks
and issues regarding a transaction with a potential investee company. Due diligence
should enable fund managers to realise an effective decision process and optimise
the deal terms.
Early stage
Seed and start-up stages of a business.
See seed, start-up. Compare later stage.
Earn-out
An arrangement whereby the sellers of a business may receive additional future
payments for the business, conditional to the performance of the business following
the deal.
EBIT
Earnings before interest and taxes – a financial measurement often used
in valuing a company [price paid expressed as a multiple of EBIT].
EBITDA
Earnings before interest, taxes, depreciation and amortisation – a financial
measurement often used in valuing a company [price paid expressed as a multiple
of EBITDA].
Enterprise DCF model
Variant of the DCF model, which looks at the company’s operations and
calculates the present value of future free cash flows by discounting them with
the weighted average cost of capital.
See Free cash flow, Weighted Average Cost of Capital, Adjusted Present Value
Model.
Envy ratio
The ratio between the effective price paid by management and that paid by the
investing institution for their respective holdings in the NewCo in an MBO or
MBI.
Envy ratio = [MC/M%]:[IC/I %], where:
See Sweat Equity or Sweet Equity.
Equity
Ownership interest in a company, represented by shares issued to investor.
The shareholders bear the full risk of the business failing: if the company
goes into liquidation its shareholders generally lose all of their investment.
If the company is successful, however, the shareholders control all of the profit.
Exit
Liquidation of holdings by a private equity fund. Among the various methods
of exiting an investment are: trade sale; sale by public offering [including
IPO]; write-offs; repayment of preference shares/loans; sale to another venture
capitalist; sale to a financial institution.
Expansion capital
Financing for the growth and expansion phase of a company which has reached
breakeven or is making a profit [increasing production capacity, stepping up
marketing efforts, enhancing product development, or boosting working capital];
financing during the IPO period; or financing aimed at turning around a company
that has experienced commercial difficulties.
Follow-on investment
Second or third capital injection by an investor that participated in the company's
previous funding round.
Free cash flow
Free cash flow is defined as the after-tax operating earnings of the company,
plus non-cash charges [e.g. depreciation], less investment in working capital,
property, plant and equipment, and other assets.
Hurdle rate
The IRR that private equity fund managers must return to their investors before
they can receive carried interest.
See IRR.
Independent director
Independent or non-executive directors, although part-timers, still share all
the legal responsibilities of their executive colleagues on the board of a company.
Today, non-executive directors include some of the best operators in the business
world. Their status means they can take a strategic, long-term view of a business
[whether a listed or unlisted company], whereas the executive team may be too
close to the action. The modern view is that independent directors also play
a vital role in protecting the interests of shareholders.
Institutional buyout [IBO]
Outside financial investors [e.g. private equity houses] buy the business from
the vendor. The existing management may be involved from the start and purchase
a small stake. Alternatively, the investor may install its own management.
See Buyout.
Internal rate of return [IRR]
Performance benchmark for private equity investments. In a private equity fund,
the net return earned by investors from the fund’s activity from inception
to a stated date. The IRR is calculated as an annualised effective compounded
rate of return, using monthly cash flows and annual valuations.
Investment
Financial interest in a company, which may be a minority or a majority stake.
IPO [Initial Public Offering]
The sale or distribution of a company’s shares to the public for the first
time, sometimes accompanied by a capital increase. An IPO of the investee company’s
shares is one of the ways in which a private equity fund can exit from an investment.
See Exit.
Later stage
Expansion, replacement capital and buyout stages of investment.
Compare Early stage.
LBO [leveraged buyout]
A buyout in which the NewCo’s capital structure incorporates a particularly
high level of debt, much of which is normally secured against the company’s
assets.
Lead investor
The organisation heading up an investment operation, but working with other
financial partners who share the risks by forming a banking or investment syndicate.
Letter of Intent
A letter from the venture capitalist to the investee company indicating a general
willingness or intention to engage in some type of transaction. It often precedes
negotiation of a complete agreement, and is typically structured so that it
is not legally binding on either party.
See Term Sheet.
Leveraged build-up [LBU]
Consolidation of a company's financial and business performance by acquiring
and integrating other companies in the same sector [equity contribution and
large proportion of debt financing].
Leveraged buy-out [LBO]
Acquisition of shares in a company largely financed by debt, which leverages
the company's return on equity. The financial investors set up a holding company
[“NewCo”], which takes on debt to pay for the acquisition. The acquisition
debt is repaid via dividends paid to the parent company.
Leveraged recapitalisation
Transaction in which a company borrows a large sum of money and distributes
it to its shareholders.
Management Buy In [MBI]
A buyout in which external managers take over the company. Financing is provided
to enable a manager or group of managers from outside the target company to
buy into the company with the support of private equity investors.
Management Buy Out [MBO]
A buyout in which the target’s management team acquires an existing product
line or business from the vendor with the support of private equity investors.
Mezzanine finance [Mezzanine debt]
Loan finance that is halfway between equity and secured debt, either unsecured
or with junior access to security. Typically, some of the return on the instrument
is deferred in the form of rolled-up payment-in-kind [PIK] interest and/or an
equity kicker, and generally takes the form of subordinated bonds with share
warrants, issued by the recipient company. A mezzanine fund is a fund focusing
on mezzanine financing.
NewCo
A generic term for a new company incorporated for the purpose of acquiring the
target business, unit or company from the vendor in a buyout transaction.
Owner Management Buyout [OBO]
A buyout in which the existing family owned companies or “owner-managers”
sells the company to private equity investors.
Offer
The offer [or bid] made for the target company by the Newco offeror established
by the private equity provider and the participating directors of the target
company [those directors who are part of the management buyout team].
Offer document
The document by which the offeror makes the formal legal offer to target shareholders.
Offer period
The period from announcement of an offer or potential offer until the closing
date for the offer or the date when the offer becomes or is declared unconditional
as to acceptances [that is, the acceptance condition, which requires a certain
percentage of shareholders to accept, has been satisfied] or the offer lapses.
Ordinary shares [or common shares/stock]
In a public company, the stock which is traded between investors on various
exchanges. Owners of ordinary shares are typically entitled to vote on the selection
of directors and other important issues. They may also receive dividends on
their holdings, but ordinary shares do not guarantee a return on the investment.
If a company is liquidated, the owners of bonds and preferred stock are paid
before the holders of ordinary shares.
Pari-passu
Pari-passu is a latin term that means "of equal step" or "without
partiality". Pari-passu is often seen in venture capital term sheets, indicating
that one series of equity will have the same rights and privileges as another
series of equity.
Portfolio company [or investee company]
The company or entity into which a private equity fund invests directly.
Post-money valuation
The valuation made of a company immediately after the most recent round of financing.
See pre-money valuation.
Pre-emption rights
Rights of existing shareholders to have the first opportunity to purchase shares
from a departing shareholder [pre-emption on transfer], or to subscribe for
new shares issued by the company [pre-emption on issue].
Preference shares [or preferred stock]
Shares which have preference over ordinary shares, including priority in receipt
of dividends and upon liquidation. In some cases these shares also have redemption
rights, preferential voting rights, and rights of conversion into ordinary shares.
Venture capitalists generally make investments in the form of convertible preference
shares.
See cumulative preferred stock.
Pre-money valuation
The valuation made of a company prior to a new round of financing.
Compare post-money valuation.
Present Value
Present value is found by dividing the future payoff by a discount factor which
incorporates the interest forgone for not receiving this payoff at the present
time.
Private equity
Private equity provides equity capital to enterprises not quoted on a stock
market. Private equity can be used to develop new products and technologies,
to expand working capital, to make acquisitions, or to strengthen a company’s
balance sheet. It can also resolve ownership and management issues. A succession
in family-owned companies, or the buyout and buyin of a business by experienced
managers may be achieved using private equity funding. Venture capital is, strictly
speaking, a subset of private equity and refers to equity investments made for
the launch, early development, or expansion of a business.
See Venture capital.
Put option
The right of an investor to demand repurchase by the company or by another investor
of a certain number of its shares at a fixed price within a specified time period
or at a specified point in time.
See call option.
Quasi-equity
Quasi equity encompasses such instruments as convertible shareholder loans,
loan notes, preference shares. These instruments are unsecured and convertible
on exit.
Ratchet
Full ratchet is an investor protection provision, which specifies that options
and convertible securities may be exercised relative to the lowest price at
which securities were issued since the issuance of the option or convertible
security. The full ratchet guarantee prevents dilution, since the proportionate
ownership would stay the same as when the investment was initially made.
Ratchet/sliding scale is a bonus where capital can be reclaimed by managers
of investee companies, depending on the achievement of corporate goals.
Recapitalisation
Change in a company’s capital structure. For example, a company may want
to issue bonds to replace its preferred stock in order to save on taxes. Re-capitalisation
can be an alternative exit strategy for venture capitalists and leveraged buyout
sponsors.
Redeemable cumulative preference share
A form of preference shares which provide that, if one or more dividends are
omitted, these dividends accumulate and must be paid in full before other dividends
can be paid on the company’s ordinary shares. Redeemable cumulative preference
shares can be refinanced by mezzanine providers, banks and other institutional
equity providers, thus allowing the initial investors to recover their investment.
Redemption
Repurchase by a company of its securities from an investor. Often required for
preferred stock in private equity financing.
Refinancing bank debt
Financing to reduce a company’s level of gearing.
Replacement capital [secondary purchase]
Purchase of existing shares in a company from another private equity investment
organisation or from another shareholder or shareholders.
Right of first refusal
Traditional clause of shareholders’ agreements, whereby first, any shareholder
wishing to sell some of his shares must previously inform the other shareholders
of the terms proposed for the envisaged transaction, and then the other shareholders
benefit from a period of time during which they can buy such shares
Secondary sale
The sale of private or restricted holdings in a portfolio company to other investors.
Secured debt
Loans secured against a company’s assets.
Secured obligation
A debt obligation, which is secured by the pledge of assets.
Seed money / Seed money fund/ Seed stage
Financing provided to research, assess and develop an initial concept before
a business has reached the start-up phase. Seed money funds are intended to
assist entrepreneurs at this stage of development, downstream of, or alongside,
business angels.
Senior debt
A debt instrument, which specifically has a higher priority for repayment than
that of general unsecured creditors. Typically used for long-term financing
for low-risk companies or for later-stage financing.
Compare subordinated debt.
Shareholders' agreement
Agreement governing dealings between different groups of shareholders in a company
beyond the bye-laws of the company, generally in relation to the implementation
of expansion strategies, the relationship between directors and shareholders,
dividend policy, exit opportunities etc.
Spin-off
Creating a subsidiary or selling off part of a company to make it an independent
company; often in the context of an LBO, MBO or MBI by management and/or financial
investors. Typically, private equity investors will provide the necessary capital
to allow the division to “spin out” on its own; the parent company
may retain a minority stake.
Start-up
Financing provided to companies for product development and initial marketing.
Companies may be in the process of being set up or may have been in business
for a short time, but have not sold their product commercially.
See early stage.
Stock option
An individual’s right to purchase shares at a fixed price. Stock options
are a widely used form of employee incentive and compensation. The employee
is given an option to purchase its shares at a certain price [at or below the
market price at the time the option is granted] for a specified period of years.
Stock option is an essential tool for attracting talent to young companies.
Subordinated debt
Debt that ranks lower than other loans and will be paid last in case of liquidation.
Compare senior debt.
Sweat Equity or Sweet Equity
Incentive scheme put together by private equity investors for the benefit of
the management team during an LBO transaction and based, amongst other things,
upon the degree of achievement of the business plan
See Envy ratio.
Tag-along Rights
If another shareholder sells his shareholding, the venture capitalist can insist
that his shares are sold on the same terms to the same purchaser. These usually
take the form of put options in the hands of minority shareholders. If a large
shareholding in the company is proposed to be sold the ‘tag along’
rights allow the minority shareholders to put their shares with the selling
shareholder so that they can participate in the selling opportunity on the same
terms.
Compare Drag-along rights.
Term Sheet
A short document summarising the principal financial and other terms of a proposed
investment. It is usually non-binding, but may impose some legal obligations
on the investor and the company.
Compare Letter of Intent.
Trade sale
The sale of company shares to industrial investors.
Trade secret
Information, such as a formula, pattern, device, or process, that is not known
to the public and which gives the person possessing the information a competitive
advantage. May sometimes include customer lists, marketing and/or business plans,
and suppliers.
Unsecured debt
Loans not secured against a company’s assets.
Valuation
The process of estimating the value -- e.g., market value, investment value
-- of a company, based on its earnings potential, assets and liabilities. The
valuation report set forth the appraiser's opinion of a company's value as of
a specified date, and include a presentation of the valuation methodology and
analysis of relevant data.
Valuation methods
The policy guidelines a management team uses to value the holdings in the fund’s
portfolio. More generally, valuation is an estimate of the price of an item
at a given time, based on a model and comparison with the value of similar items.
Methods used to put a value on privately-held companies include Adjusted Book
Value, Asset Valuation, Capitalization of Income Valuation, Capitalized Earning
Approach, Cash Flow Method, Cost to Create Approach, Debt Assumption Method,
Discounted Cash Flow, Excess Earning Method, Multiple of Earnings, Multiplier
or Market Valuation, Owner Benefit Valuation, Rule of Thumb Methods, Tangible
Assets [Balance Sheet] Method, Value of Specific Intangible Assets.
Venture capital
Professional equity co-invested with the entrepreneur to fund an early stage
[seed and start-up stage or in their first few years of existence for product
development or initial marketing purposes, or to begin commercial production
and sale at the end of the product development stage] or expansion venture.
Offsetting the high risk the investor takes is the expectation of higher than
average return on the investment.
See private equity
Vesting
The process by which an employee is granted full ownership of conferred rights
such as stock options and warrants [which then become vested rights]. Rights
which have not yet been vested [unvested rights] may not be sold or traded and
can be forfeited.
Warrants
Type of security usually issued together with a loan, a bond or preferred stock.
Warrants are also known as stock-purchase warrants or subscription warrants,
and allow an investor to buy ordinary shares at a pre-determined price.
Warranty
Statements, usually contained in a share subscription or purchase agreement,
as to the existing condition of the company which, if not true, support a legal
action for compensation by way of money damages.
Weighted Average Cost of Capital [WACC]
Weighted average cost of capital is a discount rate used in valuation model
reflecting the opportunity cost of all capital providers, weighted by their
relative contribution to the company’s total capital.
© Balmoral Ventures