Private Equity: Opportunities and ChallengesPresentation to: CFA Society of Pittsburgh

November 16, 2011

Eric L. Thunem

Managing Director

Portfolio Advisors, LLC

Alternative Investments

Hedge Funds Leveraged Buyouts

S i l Sit ti

Infrastructure

R l E

g y

Venture Capital

Special Situations

Distressed DebtReal Estate

Managed Futures

Secondaries

MezzanineNatural ResourcesSecondaries

Co-InvestmentsPrivate Equity Funds

Timber O h

1

Timber Other

Private Equity

• Provides capital to companies not quoted on a public stock exchange

• Multiple uses:• Multiple uses:

• Develop new products and technologies• Expand working capital

F ili h• Facilitate company growth• Strengthen a company’s balance sheet• Resolve ownership and management issues

• Domestic and International Strategies include:

• Buyouts: Large, Middle Market, Small-Cap• Venture Capital: Seed/Early-stage, Late-stage, Multi-stage• Special Situations: Distressed Debt, Mezzanine,

Multi-Strategy/Opportunistic

2

gy pp

Where Private Equity Fits

Company Growth Cycle

Early Stage; Entrepreneurial; Established; Mature;

Venture Capital

Development High Growth Level Growth Cyclical

Buyouts, Sub Debt

Restructuring

Special Situations

rofi

tR

even

ue/

Pr

PrivateMostly Public

R

Time

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Avenues for Investing in Private Equity

• Start your own Business• Control, Management, Focus• Concentrated Risk

• Invest in a Privately Held Company• Influence, Shared Ownershipp• Single-Company Risk

• Participate as a Limited Partner in a PE Fund• Passive Ownership, Diversified Holdingsp, g• Single-Manager Risk, Limited Vintages

• Invest in a Private Equity Fund-of-Funds• Broader Diversification – Industry, Manager, Geography, Vintageo de ve s c o dus y, ge , Geog p y, ge• Diversified Risk, Fees may Lower Overall Returns

4

Perspectives

• Entrepreneurs and Business Owners• Active Partners, Value Add, Liquidity• Ownership, Control

• Limited Partner Investors and their Advisors• Returns, Diversification, Long-Term Horizon• Illiquidity, Perceived Risk, Lack of Information, Fees

• General Partner Investors / Sponsors• Returns, Active Strategies, Timing, g , g• Deal Flow, Fund-Raising, Exit Environment

• Other Constituencies• Other Constituencies• Banks, Regulators, Politicians, Media

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Entrepreneurs / Business Owners

• Private Equity Opportunities• PE managers can add value to enterprises• Potential source of expansion financing• Additional expertise in specific industries• Governance and corporate best practices

Li idi f i l f• Liquidity for generational transfer

• Private Equity Challenges• Ownership changes• Control may shift• Leverage can become a growth driver

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New Companies/Small Businesses

* Headd, B. Redefining Business Success: Distinguishing Between Closure and Failure, 2002# Shane, S. Startup Failure Rates – The Real Numbers, 2008^ Phillips & Kirchhoff. Small Business: Critical Perspectives 1989 * Source: smallbusinessplanned.com

Two years: 7 out of 10Five years: 5 out of 10

Survival rates for new employer firms(U.S. Department of Commerce statistics, March 2010)

7

ve ye s: 5 ou o 0Ten years: one third

15 years: one quarter

New Companies/Small Businesses

8

Source: State of Washington, Department of Revenue, excise tax data 2002 through 2005

Global Buyout Annual Investments

7 000$200Amount Invested ($billions) Number of Deals

6,000

7,000

$160

$180

$200

4,000

5,000

$100

$120

$140

2,000

3,000

$40

$60

$80

0

1,000

$0

$20

$

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 3Q11Source: Thomson Reuters Venture Economics, October 27, 2011

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Global Venture Capital Annual Investments

18 000$160Amount Invested ($billions) Number of Deals

14,000

16,000

18,000

$120

$140

$160

8 000

10,000

12,000

$80

$100

$120

4,000

6,000

8,000

$40

$60

0

2,000

$0

$20

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 3Q11Source: Thomson Reuters Venture Economics, October 27, 2011

Q

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Limited Partners and their Advisors

• Opportunities• Perceived out-sized return potential• Diversification• Long-term appreciation is possible• Programs may become self-funding

• Challenges• Information is not readily available• Investments are illiquid• Risks can be concentrated• Measuring risk can be a challenge• J-Curve: returns may be negative in early years• Minimum investment levels may be high; access is limited• Minimum investment levels may be high; access is limited

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Basic Mechanics: Hypothetical Cash Flow

$400

• $1 million commitment

$200

$300

$100

$200

-$100

$0

-$300

-$200

1 2 3 4 5 6 7 8 9 10

Annual Drawdown Annual Return of Capital

Years

Basic Mechanics: Hypothetical Net Invested

• $1 million commitment

$600

$800

$1,000Cumulative Return ($)

$200

$400

$600

-$200

$0

65% 80%

$800

-$600

-$400 65% to 80% Net Invested

-$8001 2 3 4 5 6 7 8 9 10

Years

Private Equity Performance: Time Horizons

30%

24.2%

20%

25%

9 4%

17.0%

10.3%11.9%

15%

IRR

%

4.3%

9.4%

2.2%

6.2% 6.5%

5%

10%

0%3 Months 6 Months 9 Months 1 Year 3 Years 5 Years 10 Years 15 Years 20 YearsSource: Thomson Reuters Venture Economics, November 10, 2011. Data as of 6/30/2011

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Private Equity Performance: Stages

20%

13.4%

15.4%

12.8% 12 4%

15.1% 14.9%16.0%

12 0%

15%12.4%

11.7%

9.4% 9.9%

12.0%

10%

IRR

%

5%

0%All Venture

CapitalSeed/Early

StageLater Stage Balanced

StageAll Buyouts Small

BuyoutsMedium Buyouts

Large Buyouts

Mega Buyouts

Generalist All Private Equity

S Th R V E i N b 10 2011 D f 6/30/2011

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Source: Thomson Reuters Venture Economics, November 10, 2011. Data as of 6/30/2011

Private Equity Performance: Vintage Years

21.5%

25%

16.1%

19.3%

17.5%

19.4%

15%

20%

RR

%

12.3%11.6%

8.0%10%

15%IR

6.1%

4.6%

6.7%

5.2%

1.8%

5.4%

5%

0.3%

0%1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: Thomson Reuters Venture Economics, November 10, 2011. Data as of 6/30/2011

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Importance of Manager Selection

10 Year Returns: Upper Quartile vs. Lower Quartile Managers

20%

25%19.5%

15%9.7% 9.4%

5%

10%

2.9%

0%Private Equity Large Cap Equity International

EquityCore Fixed

Income

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Source: Clearbrook Perspectives, 2010 (eVestment Alliance and Cambridge Associates)

Performance Persistence

100%

24% 28%

10% 10%22%

31%

70%

80%

90%

100%

27%29%

28%

33%50%

60%

70%

Q4 Successor Fund

Q3 Successor Fund

Q2 Successor Fund

39%33%

24%

26%

24%20%

30%

40% Q1 Successor Fund

24%12%

0%

10%

Q1 Predecessor Fund Q2 Predecessor Fund Q3 Predecessor Fund Q4 Predecessor Fund

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2011 Preqin Private Equity Fund of Funds Review

Private Equity Investment Options

Investing through fund-of-funds can provide greater diversification

3

Investor

Fund of FundsFund of Funds

• # f PC 250 t 400

1

2

Private EquityPrivate Equity

Direct Investment

A Private Equity Fund

• # of PCs: 15 to 20

• “Single manager” risk

• # of PCs: 250 to 400

• Lowest risk

Private Equity Fund

Private Equity Fund

• # of Portfolio Companies (PC): 1

• Single company, highest risk

PC1 PC1 PC2 PC3PC1 PC2 PC3 PC20. . . . . . . .PC20

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Global Fund-of-Funds Annual Fundraising

0

Amount Raised ($billions) Number of Funds

200

250

$50

$60

$70

100

150

$30

$40

$50

50

100

$10

$20

0$01998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 3Q11

Source: Preqin, November 8, 2011

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General Partners / Sponsors

• Opportunities• Recurring management fees are possible• Long-term significant capital gains are possible• Investment strategies may involve active roles• Historically lower level of public scrutiny

M h l i i i• Managers may have some control over exit timing

• Challenges• Regulatory oversight is increasing• Deal flow may not be truly proprietary• Traditional exit routes may exhibit volatility• Big payday may happen only after LPs get returns• Fund raising• Fund-raising• Competition

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Global Buyout Annual Fundraising

400$350

Amount Raised ($billions) Number of Funds

300

350

$250

$300

200

250

$150

$200

50

100

150

$50

$100

0$01998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 3Q11

Source: Thomson Reuters Venture Economics, October 27, 2011

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Global Venture Capital Annual Fundraising

1,600$180

Amount Raised ($billions) Number of Funds

1,200

1,400

$120

$140

$160

600

800

1,000

$80

$100

$120

200

400

600

$20

$40

$60

Source: Thomson Reuters Venture Economics, October 27, 2011

0$01998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 3Q11

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Source: Thomson Reuters Venture Economics, October 27, 2011

Other Impacts/Influences on LPs and GPs

• Overall economic climateP bli it k t• Public equity markets

• Banks and other debt providersF d l d l• Federal and state regulators

• Media outlets; broad and industry-specificP li i• Politics

• Perceptions

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Regulatory Environment

• SEC, CFTC, FSA• FASB ASC 820 (formerly known as FAS 157)• Dodd-Frank Act

• Registration if assets >$150 million• Extraterritoriality (non-US firms marketing in US)

• Volcker Rule• No more private equity for banks (?)

• Alternative Investment Fund Managers Directive• European Securities and Markets Authority• US firms with EU investments (?)

• IRS – carried interest no longer treated as capital gains (?)g p g ( )• Private Company Flexibility and Growth Act (proposed)• FINRA rules – ban on “spinning” hot IPO shares• Second Market scrutiny by SEC and FINRA

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y y• Pay-to-Play rules restricting intermediaries in fund-raising

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THANK YOU

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