PRIVATE EQUITY: DEFINITION

Private equity includes all those financial transactions through which an investor acquires shares in a company defined as a target, both by acquiring existing shares from third parties and by subscribing to newly issued shares, bringing new capital with the aim of having a revaluation of the investment carried out over time.

Target companies can also be listed, but willing to abandon the stock exchange and in this case we speak of public private equity.

PRIVATE EQUITY: DIFFERENT KINDS OF CONSIDERED OPERATIONS

The financial transactions considered are distinguished on the basis of:

• Type of Target Company (Start up, Expanding company)
• Type of subjects (MBO, MBI, BIMBO) participating in the operation.

By creating these types of operations:

• Venture capital: investments in established companies, but with negative cash flows and great growth potential and cash needs to finance product launches or develop the market. These types of transactions are the most risky on the market
• Development capital: investments in established companies, with rapidly growing positive cash flows with cash needs linked to market development
• Management buyout (MBO): where the company's management assumes an entrepreneurial role by taking over (possibly with a private equity fund) the company
• Management buyin (MBI): where managers external to the company assume the role of entrepreneur by taking over (possibly with a private equity fund) the company
• Management buyin / out (BIMBO): where a mix of internal and external managers assumes the role of entrepreneur taking over (possibly with a private equity fund) control of the company
• Special situation: investments in companies that are in crisis.

PRIVATE EQUITY IN ITALY:

• As for the EP, Italy represents a medium-small quota in Europe, especially compared to the United Kingdom, France, Belgium, Holland, Luxembourg and Germany which are the leading ones. Europe represents the second world force of EP after the USA, but far from first place in terms of volume and turnover
• The Private Equity trend in Italy has recovered slightly in recent years. It suffered a major decline starting in 2012 and then recovering in 2017-18. However, a return to the values ​​prior to the decline is still a long way off; in fact, it followed the European trend, with the difference that in other European countries it has already went above the values ​​of 2010.
• As for the Sectors, the situation between Italy and Europe changes; in Italy the EP is still closely linked to the classic industrial sectors; in Europe there is an increasing focus on New Technologies, the Pharmaceutical and the Financial Sector; energy is an important sector, but it is not growing like those mentioned above. Real Estate, on the other hand, is in a slight decline.
• As regards the size of companies in Italy, the weight of small companies is more accentuated than the European average, while it being understood that small and medium companies represent the bulk of investments in private equity in Europe too.
• NB: In the USA, on the other hand, large companies weigh more.
• As regards the internal market, the number of Start-ups in PE is stationary, while growth is much more accentuated at European level. Both in Italy and in Europe there is a very low rate of companies that pass the start-up stage.
• As for the type of Investor, Italian and European Private Equity is strongly oriented towards the buyout, that is, the acquisition of the company by internal managers. Italy is also strongly oriented towards investment by SGRs or in any case by Italian lenders. Other European countries, on the other hand, are more oriented towards foreign lenders (intra-European or extra-European)
• The results of EP in Italy and in Europe are in both cases slightly increasing, in terms of average IRR. However, this evaluation changes negatively if we look at the number of companies that are forced to leave.

LIMITS OF EXCEL TECHNOLOGY FOR THE PRIVATE EQUITY:

Any Private Equity operation must always start from the evaluation of the target company in an average period considered that ranges from 5 to 10 years, using the values ​​obtained from the Business Plan which summarizes the Economic Financial Business model.

The Business Plan represents the picture of how the company will evolve based on the assumptions defined, considering the:

• Necessary investments and how they will be contributed (Equity, shareholder financing, Debt lines)
• Cost and Revenue Model with the related VAT rates, payment and collection days
• Tax policy
• Macroeconomic variables
• Dividend Policy
• Relative risks that will affect the various quantities defined in the BP in terms of probability and relative deviation in% or absolute value.

The reliability of the values ​​obtained will depend on how the Business Plan (BP) was drafted. This will allow the investor to decide in terms of what to invest, how and with what risks. Unfortunately, most BPs are made with Excel spreadsheets.

For the Start Up, we will have considered:

• The Business Idea
• CVs of the founders and partners of the company, as a guarantee for the business model
• The ability of the Business Idea to create the market, making assumptions in terms of cost to acquire a K € of turnover over time
• Obviously the Business Model in its generality

For Started Companies, we will have considered:

• The topicality of the Business Idea with a possible revision of the same
• The Management
• The Context in which it operates (Market, Customers, Suppliers, critical issues, risks, etc.)
• Obviously the Business Model overall

That said, a question arises for the investor.

Unfortunately, the answer is not positive, as the average reliability of any Business Plan, created with Excel sheet technology, regardless of the skill of the analyst who created it, is on average 15-20%

Let's look at the reasons in detail, discovering that, in addition to the lack of reliability, there is also a lack of opportunities and profitability for Business Plans made with Excel, which greatly limit the correct choices of an investor.

Let's go and examine them in detail.

LACK OF RELIABILITY:

The average reliability of a Business Plan created with Excel sheet technology, regardless of the competence of the analyst who processes it, was measured on a large number of BPs processed and was found on average to be 15-20%.

20% approximation, at best, means that each result obtained has a reliability of 20% or, in other words, has a margin of error equal to its complement, that is, 80%. This implies, for example, that a Cash Flow value of € 1,000,000, calculated in this way, fluctuates from a value of 1,000,000 +/- 800,000, that is, from € 200,000 to € 1,800,000.

This type of approximation highlights a problem of reliability of the expected value of the company, but even more of precariousness in referring to the Business model, to make business decisions that have an economic and financial impact on it.

Let's see the structural reasons for the inadequacy of the Excel sheet due to the limited opportunities it can offer in the management of the various "Private Equity" operations:

ANALYSIS ON AN ANNUAL BASIS:

of Business Plans, developed on average for a period varying between 5 and 10 years, is one of the most striking causes of unreliability, for these reasons:

A cash flow which is always positive on an annual basis can, in fact, be negative for most months, with the need to have coverage, using a bank line or a capital increase. The NPV values ​​obtained are therefore unreliable.

A cash flow on an annual basis prevents you from viewing the payment of taxes and dividends in specific months, preventing you from having evidence of liquidity criticalities, which become essential for obtaining preventive financial coverage.

LACK OF A SYSTEMIC APPROACH:

due to the inability of Excel sheet technology to take into account all the variables inherent in a given context such as, for example:

The VAT rates associated with each variable that enters the model.

The days of payment / collection.

The tax rates.

The risk variables, not taken into due consideration.

VAT MANAGEMENT PROBLEM:

it is managed incorrectly or insufficiently in most Business Plans, due to the inability of Excel technology to take it into account.

A striking case was that in which, in a BP relating to the acquisition of equity interests made by an investment fund, VAT was considered an accounting, but not a financial one. Obviously, the investor found himself in serious trouble.

In many cases of BP analysed we found only vertical compensation of VAT, but not horizontal, forcing Investors to take a long time to reimburse credit VAT, resulting in financial distress.

In many BPs the possibility of creating a financial line for VAT is not even used, lacking the control of Cash Flow.

WORKING CAPITAL PROBLEM (DUE TO THE DIFFERENCES BETWEEN PAYMENT AND COLLECTION DAYS):

in most cases the Business Model is ignored not for reasons of competence, but for the impossibility of managing it annually and not monthly.

On an examined BP, created by a renowned consulting firm, which certainly had knowledge of the currency, but that was unable to represent it on the Excel sheets on an annual basis. This generated a financial problem of € 700,000, on an investment of about 3 million euros, which would have completely disregarded the investor's financial expectations.

PROBLEM OF LACK OF CERTIFICATION OF THE ALGORITHMS USED:

due to the lack of reference to sources declaring its correctness, which is an important element that every investor should request. Certification of wine and oil is required but not of the BPs that decide on the analysis of investments of millions of euros.

An investor's Advisory Board was asked which algorithms were used and by whom they had been certified. It emerged that different algorithms were even used for the same function and, furthermore, when asked what the sources were, the answer was: the experience of the person who drafted the Business Plan. Obviously the Deal did not go ahead.

ERROR PROBLEM RELATED TO COMPLEXITY:

due to the fact that the more complete the BP model created using an Excel spreadsheet, the more the probability of error (formula, non-connected cell, calculation, etc.) increases, making the results unreliable.

Two well-known professors at MIT drafted the three-year plan of works to be carried out for a major government department. Unfortunately, a few months later, an MIT university student disavowed the BP / PEF after finding trival calculation error, such as to make the obtained calculations unreliable, furthermore with serious damage to the image of the Government and the two distinguished professors.

THEREFORE, THE "EXCEL SPREADSHEET" TO CREATE BUSINESS PLANS FOR "PRIVATE EQUITY" OPERATIONS IS THE FIRST RISK, ESTIMATED TO BE ON AVERAGE 80-85%.

LACK OF OPPORTUNITY:

The ability to flexibly manage the various cases that a Business Model can offer is very limited with a BP developed using Excel sheet technology, for the very fact that this technology does not allow the development of models that can exhaustively simulate the various aspects of financial economics of reality.

In fact, reproducing the different assumptions on an Excel sheet means recustomising the model each time with a consequent waste of time, effectively making operation impossible.

However, not managing them means not being able to translate the entrepreneur's ideas into reliable economic and financial data to find the best solution.

What does this limit mean for the investor? It means he will lose business opportunities that can range from a few thousand euros to millions of euros.

Let's see the structural reasons for the inadequacy of the Excel spreadsheet due to the limited opportunities it can offer in drafting a Business Plan:

DIFFICULTY / IMPOSSIBILITY IN BREAKING DOWN A BUSINESS MODEL INTO ITS BUSINESS UNITS

Due to the complexity that would be induced in the Excel model to manage them. In fact, the Business Unit represents the minimum unit of analysis with its investments, costs and operating revenues, useful for breaking down the corporate model into its operating divisions, in order to allow the investor to decide priorities in investments, on which business units focus attention and operate.

An MBO operation of about 12 million euros, processed using Excel spreadsheet technology, proved inadequate information on the divestment of some divisions of the company, due to the fact that the model was monolithic.

DIFFICULTY / IMPOSSIBILITY IN ANALYSING A BUSINESS MODEL IN ITS DIFFERENT SCENARIOS

Based on the different assumptions, having to deal with the formulas causing time-wasting and an increased possibility of errors.

We cite the case of a Venture Capital project, elaborated on a spreadsheet, in which the calculated scenarios did not correspond to the economic / financial reality that then emerged, with a serious problem for the investor.

DIFFICULTY IN EXAMINING COMPLEX OPERATIONS

Which with Excel spreadsheet technology, would become so approximate as to become unreliable.

It was not possible to carry out a complex MBO acquisition of the company on Excel by the group of reference executives, which involved breaking down the companies into its divisions, analysing investments, reducing costs, analysing revenues , debt restructuring and the analysis of three possible Business Plans, but it was possible to successfully examine it with “Finance Atena”.

DIFFICULTY IN DELEGATION

Due to the fact that in the BPs made with spreadsheets the data are wired with the formulas and therefore only those who created the spreadsheet can put their hands on the Financial Economic Plan, with all the imaginable limits and not being able to activate any delegation to other offices.

In the acquisition processes, time is of the essence and therefore having the possibility of delegating data loading in the analysis model becomes important.

LACK OF PROFITABILITY:

The Business Plan (BP) of a Private Equity financial transaction elaborated using a spreadsheet, as well as having a reliability of 15-20% and therefore not significant for seriously analysing a financial transaction of hundreds / millions of euros, of great impact on the investor, presents this recurring problem:

OVERESTIMATION OF SOURCES TO COVER INVESTMENTS (EQUITY, BANK LINES, SHAREHOLDER LOANS)

due to Excel technology, as it does not allow for financial optimization of cash flows instead allowed by the breakdown of the Corporate Model into Business Units, by the management of flows on a month basis and by the management of self-financing, that are all too complex to reproduce using Excel. This causes an investor to waste useful capital that he could use in other initiatives and also reduces the profitability of the project, decreasing the shareholder's NPV.

For this problem, an acquisition of a shareholding was overestimated by € 3 million, calculating an unreliable shareholder NPV.

SUSTAINABILITY IS ALWAYS CRITICAL

As it does not take into account all the financial variables involved. The reasons for these results are mainly due to the fact that a predictive financial economic analysis is a very complex analysis. It is inadequate to try to translate it on an Excel sheet, due to the structural limits thereof, due to the problem raised.

Sustainability on an annual basis in most cases is critical because it does not take into account cash flows on a month basis, creating unrealistic Reliability and, ignoring the necessary hedges, which leads to an underestimation of the debt.

UNEXPECTED PROFITABILITY:

due to Excel technology that easily leads to the calculation of NPV and IRR values, but the problem is not to obtain these values ​​which are obtained very simply using the Excel functions, the problem is upstream, where cash flows were obtained . Precisely for this reason the values ​​obtained never correspond to reality, constituting a problem for everyone, first of all for the investor.

Profitability is always overestimated compared to the reality of the facts, always disappointing the Investor's expectations who utters the fateful sentence at the end of the transaction: "I thought I would earn more, or, it don't add up, etc.”