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Current Trends in Private Equity & Family Offices

Presentation to the Houston CFA Society

May 2019

Cole Parker, Kirkland & Ellis Mickey McFarlin, Stephens Inc.

Alex Rose, Kirkland & Ellis Cole Naylor, Stephens Inc.

Agenda

M&A Activity Overview

Dry Powder in the Private Equity Market

Continued Investment in Private Equity is Strong

Industry Trends and Sectors

“Shadow Capital” Accounting for an Increasing Slice of the Market

Family Office Trends

Advantages and Potential Drawbacks of Family Office Buyers/Investors

Benefits and Challenges of Direct Investing for the Family Office and Components to Success

Family Office Direct Investing Platform Processes

Looking Within - Family Office Structures

1

2

4

5

6

3

7

8

9

10

M&A Activity Overview

Private Equity’s net asset value has grown by over 7X since 2002, twice as fast as global public equities

Private Equity Market growing not only in terms of deal value, but also in total AUM

Source: Thompson Reuters; Dealogic

Global M&A Activity Since 2000 (in US$T)

$1.6$1.3 $1.4

$2.0

$2.8

$3.7$4.3

$2.9

$2.2

$2.6 $2.6 $2.5 $2.6

$3.5

$4.2

$3.7$3.4

$4.0

5%

11%12%

15%

12%

20%

17%

7%6%

9% 9% 9%11%

8% 8% 9% 8%10%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Global M&A Value (US$t) PE as a Percentage of Total M&A Value

1

Dry Powder in the Private Equity Market

Global dry powder is at an all-time high and has more than doubled since the beginning of 2016, to $1.21 trillion

Private Equity industry grew 8.1% over the first half of 2018

Source: Preqin, through Sept 30, 2018

Global Private Equity Dry Powder by Region (in US$B)

North America$714 Billion

Europe$303 Billion

Asia and RoW$193 Billion

2

Continued Investment in Private Equity is Strong

Large institutional investors remain interested in private equity as an asset class

In a recent survey by Preqin, 46% of LPs said they intended to increase their allocations to private equity over the longer term, with only 5% looking to decrease their allocations

Debt and infrastructure are similarly popular, while hedge funds and natural resource funds saw the highest percentage of LPs intending to reduce their allocations

Source: Preqin LP survey

Results of Preqin LP Survey – Attitudes Towards Various Asset Classes

Private Equity

Hedge Funds

Real Estate

Infrastructure

Private Debt

Resources

Reduce Allocation Increase Allocation

46%

35%

29%

52%

51%

28%

5%

26%

16%

9%

9%

23%

3

Industry Trends and Sectors

Information Technology sector is the largest destination for private equity capital, but has been decreasing in size in recent years

Industrials and Healthcare sectors have been steadily growing

Telecoms, Media & Communications saw a sizeable increase in 2018, largely due to $17 billion acquisition of Refinitiv (Thompson Reuters subsidiary) by Blackstone Group LP

Source: Triago Quarterly, January 2019

4

Sector-by-Sector Breakdown of Private Equity-Backed Buyout Deals (in US$B)

“Shadow Capital” Accounting for an Increasing Slice of the Market

Private equity firms are also looking at increasing their co-investment activity, direct investments, and commitments to separate accounts as ways to further reduce fees paid to private equity managers

Source: Triago Quarterly, January 2019

Private Equity “Shadow Capital” – Co-Investments, Direct Investments and Separate Accounts (in US$B)

$63

$161$173 $179

$189

2009 to 2014Average

2015 2016 2017 2018

5

Family Office Trends

$4.0 TRN$3.2 TRN$2.5 TRN

Family Offices Hedge Funds Private Equity

6

Projected Growth Trends of Family Offices

65%of family offices invest

directly in private companies and real

estateGlobal Survey by J.P. Morgan and

the World Economic Forum

Average global family office portfolio allocates

approximately

29%to direct investments in

private equity, venture capital and real estate and 7% to

private equity funds

UBS/Campden Wealth Global Family Office Report 2016

AUM Globally as of 12/31/2016

U.S. estimated to have3,000

family offices with more than$1.2 trillionin assets and

10,000family offices globally

WSJ, March 10, 2017

Globally, family offices hold assets of more than

$4 trillionapproaching the combined $5.7 trillion of private-equity

firms and hedge funds.

“At least 20 founders or top executives of prominent U.S. hedge funds and private-equity firms have set up family offices or similar private investing ventures.” WSJ, March 10, 2017

Family offices are an increasing part of the private equity markets generally.

Family Office Trends (continued)

The transactions listed below are just a few examples of prominent family office transactions over the past 12-18 months

6

Jacob Holding’s $2.6 billion acquisition of

Cognita from Bregal & KKR

Koch Equity Development’s $500 million minority

investment in Getty Images

JAB Holding Company’s $2 billion acquisition of Pret a

Manger

CC Industries’ partnership with KSL Capital Partners in the $2.4 billion acquisition of the Intrawest, Mammoth and

Squaw ski resorts

Declaration Capital along with The Donaldson Group and DRA Advisors in the

$86.75 million acquisition of Silver Spring residential

community

PPC Partners in its acquisition of Plaskolite

MSD Capital in its acquisition of a significant portion of the high-profile

Knox district, a best-in-class, mixed-use neighborhood in

Dallas

Elysium Management in the acquisition of restaurant

chain Huddle House from Sentinel Capital

Knox District Mixed-use Property

Note: Stephens Inc. did not serve in an advisory capacity for the transactions listed above.

Family Office Trends (continued)6

Market perception of family capital is still evolving

− Informal, fickle, flakey

− Ill-equipped, or too inexperienced or too slow to compete in a process

− However, sellers are intrigued by the attributes versus PE (more on that later)

We are all aware that families are increasingly allocating more capital to direct private investments

− Declining risk adjusted net returns in institutional PE

− Preference for deal by deal decision making

− More visible roadmap of success

Availability of strong, experienced execution teams with PE background

Many families are creating formal direct investing platforms staffed with investing professionals

− Defined strategies and criteria

− Credible in a process

But, some are still more comfortable with an ad hoc approach

In any case, the deal market is very competitive, and partnership / resource sharing is the key thematic takeaway

Advantages and Potential Drawbacks of Family Office Buyers/Investors7

Advantages

– Long-term, patient capital– Less likely to rely on debt financing– Often have deep sector knowledge and “peer networks”– More flexible than institutional investors

Potential Drawbacks

– Longer deal timelines (e.g., slower diligence process)– Due to long hold, must structure for liquidity events to incentivize management– Capital constraints for long term growth/further investment into the business

Institutional Sponsors Family Offices

Objective Internal Rate of Return Let Profits Run

Economics Earning a Carry No Carry (paying a carry in some cases)

Exit Driver Shorter Term Gains Multiple of Investment

Hold Period 3 – 7 Years Often Indefinite

Reinvestment Risk Embrace Avoid

Control Often Required Upfront Not Always Required / Path to Control

Likelihood to Transact Paid to do Deals More Reasons to Say “No”

Visibility of Investment Criteria Highly Defined Varies by Group; Can Fluctuate

Benefits and Challenges of Direct Investing for the Family Office and Components to Success

8

Benefits

– Greater control of investments

– Reduces management fees and carried interest expenses

– Potential for increased returns

Challenges

– Increasingly competitive landscape, especially vis-a-vis private equity firms

– Accessing deal flow

– Sourcing and diligence process can be expensive and time-consuming for smaller teams

– Capital constraints

– Incentivizing deal professionals

Build a professional team

Develop an industry focus and check size “sweet spot”

Find other like-minded investors as potential partners

Consider complete ownership vs control vs co-invest

Find opportunities where you bring intellectual and

investment capital to the table

Develop an investment thesis – knowing when to buy

and when to sell

Define how to participate in a process

Utilization of leverage

Key Components of a Successful Direct

Investing Platform

Family Office Direct Investing Platform Processes9

• Firm financial, operational and thesis criteria– Return thresholds

– Operating ratios vs. benchmarks

– Market opportunity analysis

• A standard approach to analysis

• Leverage existing portfolio for expertise and management bench strength

• Cast the “net” as wide as possible– Intermediaries

– Other families

– Cold calling

– Thesis driven

• Frequent, clear and broad communication of investing statement to minimize incoming noise

• Greater context and sense of market when weighing potential investments

• Lean on investment thesis / approach as a screening tool – must fit to be evaluated

• Active or passive management preference will inform screening / selection– If passive, existing

management team due diligence is especially important

– If active, matching bench strength with opportunity set is key

• Standardized reporting across portfolio

• Idea / best practice sharing summits

• Criteria / triggers for exit

• Standardize and replicate to minimize frictional costs, delays and blind spots

• Develop a “deal team” of repeat providers to increase buying power

• Standard areas:– Accounting / Q of E

– Legal

– Risk

– HR

– Environmental

– Management personality evaluation

SelectionScreening ManagementDiligence

Looking Within - Family Office Structures10

Management Company

Individuals, Trusts, and Related Entities

Expenses

Mgmt Team, Individuals, Trusts and

Related Entities

Profits Interests [X]% [Z]%

Venture Capital Investment Entity

Private EquityInvestment Entity

[Y]%

Hedge FundInvestment Entity

Issue: Tax Cuts and Jobs Act eliminated deductibility of management fee expenses

Kirkland Solution: Establish profits interest family office structure to recapture economics of lost deductions

Benefits of Structure: Investors no longer incur non-

deductible management fees, instead allocating profits to the management company

Management company expenses deductible as “trade or business” expenses

Potential for significant tax savings for family office and owners of investment entities

Example of Kirkland Model Family Office: Profits Interest Structure

Increasing number of family office formations

Structures, size, and investment philosophies vary widely among family offices

Certain internal structures can create significant administrative and tax efficiencies, helping family offices compete in themarketplace

Looking Within - Family Office Structures (continued)

Assumptions: Family pre-tax, pre-expense earnings = $100M/year Tax rate on earnings = 40% 3rd party management fee rate = 1% Overhead = $1M/year Profits interest of family office management company in profits interest structure = 2%

10

“De Facto” Family Office Structure

Even family offices that do not have large teams or portfolios can benefit from implementing a profits interest structure.

Earnings $100MProfits Interest N/ATax Base $100MTax Liability ($ 40M)Mgt Fees ($ 1M)Overhead ($ 1M)

Net Pre-Tax Income $ 98MNet After-Tax Income $ 58M

Fee StructureProfits Interest Structure“De Facto” Family Office (limited staff or overhead)

Earnings $ 100MProfits Interest ($ 2M)Tax Base $ 98MTax Liability ($39.2M)Mgt Fees N/AOverhead N/A

Net Pre-Tax Income $ 98MNet After-Tax Income $ 58.8M

Looking Within - Family Office Structures (continued)10

Family offices may also take on capital from outside investors, sometimes resembling their private equity peers in structure, but retain control and other benefits of a family office.

Kirkland recently published an article on this topic that can be viewed on the Kirkland website: The Evolution of Alternative Family Capital

New Fund

Family Office

Investment I

Other Partners

Co-invest

GP capital or special LP capital

Alternative Family Capital Structures

Investment II

Benefits

– Eliminates or can address some of the challenges faced by family office investors• Capital constraints / deployment

• Attracting/maintaining strong deal team

• Increase competitiveness

– Broaden investment mandate and scope• Move upstream in market

• Capture opportunity

• Improve deal flow

– “Relevel the playing field”

Challenges

– Regulatory considerations

– Sensitivity around opening up family office to third party investors

– Loss of control

– Increased costs to compensate deal team and back office expenses (costs increase due to regulation, reporting, etc.)

Speakers

Cole Parker, Partner | Kirkland & Ellis | +1 312-862-2963 | cole.parker@kirkland.com

Cole Parker is a corporate partner in the Chicago office of Kirkland & Ellis. His practice concentrates on negotiating and structuring complex business transactions, including leveraged buyouts for private equity funds and family offices, domestic and cross-border mergers and acquisitions and general corporate representations for publicly and privately held/family owned companies and private equity funds and their portfolio companies, and family office structuring.

Alex Rose, Partner | Kirkland & Ellis | +1 214-972-1667 | alex.rose@kirkland.com

Alex Rose is a corporate partner in the Dallas office of Kirkland & Ellis. His practice concentrates on the representation of both public and private companies and private equity funds in connection with complex transactions such as mergers, acquisitions, leveraged buyouts, going private transactions, joint ventures, tender offers, divestitures, private financings, recapitalizations, debt and equity security investments, fund formation and other general corporate matters. Alex has broad experience counseling clients in a variety of industries, including manufacturing, consumer products, retail, energy, healthcare, real estate, transportation, technology, financial services and telecommunications.

Speakers

Cole Naylor, Vice President | Stephens Inc. | +1 214-258-2792 | cole.naylor@stephens.com

Cole Naylor joined Stephens in February 2018 as Vice President and is a member of the Private Company Advisory team. Prior to joining Stephens, Mr. Naylor was a Vice President at BlackhillPartners and has a diversified background of transaction and operational experience serving publicly-traded, sponsor-owned and privately-held companies across a variety of industries. Mr. Naylor received his Bachelors and Masters of Accountancy from the Rawls College of Business at Texas Tech University and holds the Certified Public Accountant (CPA) designation.

Mickey McFarlin, Managing Director | Stephens Inc. | +1 501-377-8040 | mmcfarlin@stephens.com

Mickey McFarlin is a Managing Director and the Head of Family Advisory Services at Stephens Inc. In this capacity, he is responsible for providing family businesses and family offices with a comprehensive set of solutions to fulfill the needs unique to families including Investment Banking, Wealth Management, Risk Management and other services. Mr. McFarlin began his career at Stephens in 1999 as part of the Mergers and Acquisitions advisory group. During his career, Mr. McFarlin has advised on dozens of transactions with a combined value of greater than $10 billion across a wide range of industries and transaction structures. In recent years, Mr. McFarlin has concentrated on transactions involving family owned businesses and family offices. Mr. McFarlin graduated cum laude from Hendrix College with a BA in economics and business, and an MA in accounting.

The foregoing material was prepared for informative purposes only and is not an offer to buy or sell any securities. The foregoing material is not intended to recommend the purchase or sale of any securities or to provide information on which an investment decision to purchase or sell any securities could be based. Information contained in the material was obtained orderived from sources considered reliable, but has not been independently confirmed or verified. The foregoing material does notpurport to contain all of the information that may be required to evaluate all of the factors that would be relevant to any person considering entering into a transaction, and no representation is made that the information is accurate or complete. Any personconsidering entering into a transaction should conduct its own investigation and analysis and should consult such person’s own professional advisors. Stephens and its directors, officers, employees, affiliates and representatives expressly disclaim any and all liability based, in whole or in part, on any such information, errors therein or omissions therefrom. Stephens is not a legal advisor, accounting advisor or tax advisor. Nothing in the foregoing material is intended, or should be construed, as legal,accounting, regulatory or tax advice. Any discussion of tax attributes is provided for informational purposes only, and each recipient should consult such recipient’s own tax advisors regarding any and all tax implications or tax consequences of any investment or any other transaction or course of action. Stephens in a member of the NYSE and SIPC.