Chap 20 Private Equity Assets

Question 1

Three major forms of private debt

Answer 1

1. mezzanine debt
2. distressed debt
3. leveraged loans

Question 2

Difference between venture capital vs buyouts

Answer 2

VC - target nascent, start-up companies
Buyout - target more stablished and mature companies

VC - capital necessary to get a prototype product/service out the door
Buyout - capital necessary to take the company private to concentrate on maximizing operating efficiencies

VC - rely on new tech/innovation
Buyout - see if can add operating efficiencies or expand product distribution

VC - acquire substantial but minority position, control is not absolute
Buyout - acquire all equity, control is absolute

VC - target IRR is higher - more risk in funding new companies
Buyout - target IRR is high but lower than VC as funding mature companies with regular and predictable cash flows

Question 3

Three methods of executing an exit from VC

Answer 3

1. conduct IPO of company’s securities
2. sale to acquiring firms
3. leveraged recapitalization (proceeds from debt paid to VC)

Question 4

Difference between angel investing stage and seed stage of VC financing

Answer 4

Angel investing - earliest stage in VC, often family/friends, funding an idea, no formal business plan, no team, no product, no market analysis - 50 - 500K

Seed stage - first stage where institutional investors commit capital into a startup, prior to having established the viability of the product. Business plan completed, some form of management team, performed market analysis - 1 - 5 million

Question 5

What is compound option and its relation to VC

Answer 5

An option on an option, allows its owner the right but not the obligation to pay additional money at some point in the future to obtain an option. In VC, this means the owner of the option can delay further capital until new information has arrived or reaching milestones

Question 6

Define springing board remedy

Answer 6

Occurs when the investor designates a majority of the defaulting issuer’s board of directors

Question 7

Difference between management buy-in LBO and management buyout LBO

Answer 7

Buy-in - led by target firms current management, replace all or most top management

Buyout - led by outside management team, retains all or most top management

Question 8

Evolution of buyout market

Answer 8

70s - KKR founded with 3 mil

80s - financing the buyouts using bonds with low credit ratings led to growth in buyout. Peak when KKR bought food conglomerate RJR for 31 billion

90s - decline in buyout due to 1) recession of 90-91 pushed credit spreads to high levels which lowered the attractiveness of junk bond financing for buyouts 2) 98, Russian government defaulted on its sovereign bonds, credit spreads shot up

00s - started quietly for the buyout market before availability of credit created a boom from 03 - 07 before falling off after the liquidity bubble burst in 07.

10s - resume growth, yet reached pre-crisis levels in 06-07

Question 9

Two conflicts of interest that emanate from the potentially lucrative compensation schemes offered to exiting management teams in a management buy-in

Answer 9

• Incumbent management has strong incentive to resist any buyout attempt that displaces them as managers if there’s no great compensation although it’s great for shareholders
• and encourage buyouts with great compensated even if it’s not good for shareholders

Question 10

Five general categories of LBOs designed to create value

Answer 10

efficiency buyouts
entrepreneurship stimulators 
overstuffed corporation
buy and build strategies
turnaround strategies