Columbia Business School Course B7399-099

Private Equity: the Asset Class, its Investments & its Markets

Fall 2008 Instructor: J. Christopher Kojima email: chris.kojima@gs.com

Telephone: 212-855-0478 Class times and office hours: see below Teaching Assistant: Geoffroy Berbesson Contact: gberbesson09@gsb.columbia.edu

Course Overview: This course is intended to provide a survey of the private equity asset class. Over the past 30 years, private equity has evolved into a global industry approaching $2 trillion of capital commitments. There are now hundreds of well-established private equity firms with differentiated strategies, producing meaningful returns for a wide range of investors around the world. We will explore the evolution of the private equity market and its participants, focusing on its players as well as the characteristics that have contributed to its sustainability. A unique characteristic of this asset class is the relationship between general partners and limited partners; we will study the perspectives and motivations of both sides. Through case analysis, class discussion and role playing, students will develop a comprehensive understanding of each perspective. The building blocks of a private equity firm will be evaluated in detail:

• Investments (deals) – understanding a company’s fundamentals, conducting due diligence, developing an investment thesis, creating a capital structure, assessing and securing leverage, forming a valuation, negotiating, executing on the investment plan and exiting.

• Investors (capital) – developing a track record, raising capital, aligning interests, reporting and communications, managing conflicts and regulatory issues, creating an ongoing relationship/brand.

• Managing the business (people) – creating competitive advantages (team, strategy, deal sourcing), designing economic incentives that are sustainable, managing human capital (deal professionals, operating partners, portfolio company management teams), creating franchise value.

The course broadly will be comprised of three parts as follows:

• Overview of the private equity industry, including the history, terminology, categories within the asset class, participants, anatomy of funds and partnership agreements, key terms, economics, GP and LP perspectives and negotiations (approximately 3 classes).

• The fundamentals of private equity investments, including an overview of diligence and valuation basics (approximately 3 classes, including a mid-term exam).

• Understanding and evaluating private equity firms, including the building blocks of a firm, the selection of top-quartile funds, portfolio constructions, and managing LP liquidity options. This section will also include class presentations, as well as a discussion of current topics in the field, including the emerging markets and publicly-traded private equity vehicles (approximately 4 classes).

Prerequisites: A general understanding of finance, the capital markets and accounting is expected. It is recommended that students considering this course have completed B7023, B7301 and B7801. Please note that this course will not focus on building financial models and is not recommended for students who have worked in sectors that have had meaningful exposure to private equity firms or their portfolio companies (e.g. financial sponsor coverage, leveraged finance, consulting or advisory services). Course Requirements: This course will comprise lectures and class discussion. Course materials will be a combination of selected text materials, cases, private equity firm source material (fund offering documents, partnership agreements and investment material) and articles. Texts will be available in the bookstore and library. There will be a case packet as well as material posted on the course web site. Class participation is essential. Students will be expected to attend classes and to come prepared. Preparation includes reading materials, specific session cases and questions, role playing exercises and team projects. There will be a mid-term exam focused on confirming a sound understanding of key industry fundamentals. Students will also organize themselves into teams, which will be reviewed and approved by the instructor, and each will prepare a presentation to be delivered to the class. Grading will be based on the mid-term exam (25%), class participation, including team presentation, and team member ratings, (40%; 10% will be team member ratings), and final paper (35%). Class participation will be determined by a combination of instructor and team member reviews.

Columbia Business School Course B7399-099

Private Equity: the Asset Class, its Investments & its Markets _____________________________________________________________________________________________ PART I: THE INDUSTRY An Overview of the Strategies, the Players and the Dynamics Session #1: Industry Overview – The Terminology, the Strategies, the Participants Class: Thursday, September 11, 2008 (6:30pm)

Introductions, course overview and expectations of class participants Overview of the terminology History of the industry, developments and today’s landscape Overview of private equity strategies Discussion of the current economic, investing, and regulatory landscape Introduction to the key documents, and the “anatomy” of these materials

Required Readings: • Jensen, “Eclipse of the Public Corporation,” Harvard Business Review (1989). • Lerner, Hardymon, Leamon, “Private Equity Today and Tomorrow,” in Venture Capital & Private

Equity (4th ed) (2009): 1-12 (Chapter 1). • Meyer & Mathonet, “Private Equity Market,” in Beyond the J-curve: Managing a Portfolio of

Venture Capital and Private Equity Funds (2006): 9-26 (Chapter 2). • Private Equity Council, “Public Value: A Primary on Private Equity” (2007): 1-15. • Goldman Sachs 2007 Private Equity Diagnostic (February 2008): 1-17.

Session #2: The Investors’ Perspective -- What Is Important to the LP? Class: Thursday, September 25, 2008 (6:30pm)

Overview of the limited partner (LP) universe Portfolio management approaches and asset allocation Introduction to performance assessment and benchmarking (continued in Session #7) Introduction to fund selection (continued in Session #7) Means of access, diversification, and implementation challenges Alignment of incentives and the Limited Partnership Agreement (LPA) Negotiating the LPA, from the perspective of the LP Liquidity and the secondary market for private equity

Required Readings: • Kojima, The Secondary Market for Private Equity, Journal of Alternative Investments (2003). • Lerner, Hardymon, Leamon, “Yale University Investments office: August 2006,” in Venture Capital

& Private Equity (4th ed) (2009): 34-58 (Chapter 3). • Meyer & Mathonet, “Private Equity Fund Structure,” in Beyond the J-curve: Managing a Portfolio of

Venture Capital and Private Equity Funds (2006): 27-40 (Chapter 3).

Session #3: The General Partners’ Perspective – What Is Important to the GP? Class: Friday, September 26, 2008 (12:35pm to 3:20pm) Office Hours: Friday, September 26, 2008 (3:30pm to 6:00pm)

Overview of the general partner (GP) universe The components of the firm, and structural variations between firms Introduction to firms’ competitive advantage and sources of alpha (continued in Session #7) Introduction to capital raising (continued in Session #8) Negotiating the LPA, from the perspective of the GP The regulatory, political and media environment Publicly-traded private equity -- permanent capital vehicles and public management companies

Required Readings: • Lerner, Hardymon, Leamon, “Note on Private Equity Partnership Agreements,” in Venture Capital &

Private Equity (4th ed) (2009): 72-82 (Chapter 5). • Meyer & Mathonet, “Portfolio Design,” in Beyond the J-curve: Managing a Portfolio of Venture

Capital and Private Equity Funds (2006): 81-94 (Chapter 8). • Bear Stearns Merchant Banking Partners III (private placement memorandum).

PART II: TRANSACTION FUNDAMENTALS An Overview of Due Diligence, Capital Structure and Company Valuation Session #4: Conducting Due Diligence, Analyzing the Company and Considering the Capital Structure Class: Thursday, October 9, 2008 (6:30pm) Office Hours: Thursday, October 9, 2008 (5:00pm to 6:30pm)

Overview of the deal process and the participants Assessing the business and management, and conducting due diligence at the company level Overview of forecasting and the financial model – identifying key variables and value drivers Analyzing comparables Components of the capital structure and introduction to leveraged finance Introduction to valuation approaches

Required Readings: • Tuck School Case Study #5-0004 (Note on Leveraged Buyouts) (2003). • Lerner, Hardymon, Leamon, “Tad O’Malley: June 2005,” in Venture Capital & Private Equity (4th

ed) (2009): 165-182 (Chapter 10). • Additional materials forthcoming.

Session #5: Leveraged Finance, Valuation and Negotiation – Pulling It All Together Class: Thursday, October 23, 2008 (6:30pm) Office Hours: Thursday, October 23, 2008 (4:30pm to 6:30pm)

Discussion of valuation approaches Identifying components of strategic plan and operating improvements Financing commitments, the commitment process and execution risks Discussion and assignment of presentations for Part III

Required Readings: • Standard & Poor’s, “The Leveraging Of America: LBOs – The Good, The Bad, And the Ugly”

(2007): 1-22. • Additional materials forthcoming.

Session #6: Midterm Examination / Executing the Plan, Monitoring and Managing the Exit Class: Thursday, November 6, 2008 (6:30pm) Office Hours: Thursday, November 6, 2008 (5:00pm to 6:30pm)

Mid-term examination (for half of the class) Monitoring the investment and board composition Implementing strategy and the role of operating partners Assessing the exit strategy

Required Readings: • Kaplan, Klebanov, Sorensen, “Which CEO Characteristics and Abilities Matter?”, Working Paper

(July 2008) (overview reading). • Additional materials forthcoming.

PART III: THE PRIVATE EQUITY FIRM Identifying Top Tier Performance, Raising Capital, Managing the Firm and Evolving the Business Model Session #7: The Search for Alpha – Evaluating Private Equity Firms Class: Friday, November 7, 2008 (8:45am) Office Hours: Friday, November 7, 2008 (11:45am to 1:30pm)

Exploring the sources of alpha within a leveraged buyout fund Evaluating the fund’s investment strategy and competitive advantage Analyzing track record – assessing the realized and unrealized performance Assessing the depth and breadth of the investment team Examining the alignment of incentives

Required Readings: • Lerner, “Francisco Partners” HBS Case 9-200-063 (2000). • Meyer & Mathonet, “Fund Manager Selection Process,” in Beyond the J-curve: Managing a

Portfolio of Venture Capital and Private Equity Funds (2006): 193-218 (Chapter 14). • Kaplan & Schoar, “Private Equity Performance: Returns, Persistence, and Capital Flows”, The

Journal of Finance Vol. LX, No.4 (August 2005): 1791-1823 (overview reading). • Lerner, Schoar, Wongsunwai, “Smart Institutions, Foolish Choices: The Limited Partner

Performance Puzzle,” The Journal of Finance Vol. LXII, No. 2 (April 2007) (overview reading). Session #8: Raising Capital and Managing the Business Class: Thursday, November 20, 2008 (6:30pm) Office Hours: Thursday, November 20, 2008 (5:00pm to 6:30pm)

Designing the financing “pitch” and optimizing the investor base Structuring a fund – traditional models and “permanent capital” extensions Human capital management and structuring economic incentives Governance models and succession planning Reporting, monitoring and the management of investor relations

Required Readings: • Lerner, Hardymon, Leamon, “Tad O’Malley: December 2004,” in Venture Capital & Private Equity

(4th ed) (2009): 13-28 (Chapter 2). • Lerner, Hardymon, Leamon, “A Note on Private Equity Fund-Raising,” in Venture Capital & Private

Equity (4th ed) (2009): 112-118 (Chapter 7). • El-Hage, Ruback, Pierson, “ABRY Fund V” HBS Case 9-208-027 (2008).

Session #9: Team Presentations Presentations: Friday, November 21, 2008 (12:00pm)

Comments: • Presentations to Investment Committee members • Debrief and discussion of team presentation questions

Session #10: Current Topics – Convergence, Public Markets, and the Emerging Markets Class: Thursday, December 4, 2008 (6:30pm) Office Hours: Thursday, December 4, 2008 (5:00pm to 6:30pm) Office Hours: Friday, December 5, 2008 (4:00pm to 6:00pm)

Liquidity and the secondary market for private equity Publicly-traded private equity and permanent capital vehicles Convergence between private equity and hedge funds Emerging markets and sovereign wealth funds

Required Readings: • Kojima, Liquidity Solutions for Portfolios of Direct Investments, Routes to Liquidity (2004). • Assignment of final papers • Meyer & Mathonet, “Secondary Transactions,” in Beyond the J-curve: Managing a Portfolio of

Venture Capital and Private Equity Funds (2006): 297-310 (Chapter 14). • Additional readings forthcoming.