Lecutre 2 Flashcards
How is the connection between a PE firm, PE fund and underlying business?
A PE firm serves as the general partner to a PE fund that invest its money in underlying business enterprises.
What two roles do PE firms play in a partnership and how do carried interest and management fees line up with those two roles?
Which Public U.S. Pensions held more than 15 billion $ in private quity in 2020?
What are the top sovereign wealth funds investing in pe?
Private Equity Funds: What are the primary funcions of PE funds (5)
- Pooling investors’ capital for investing in private companies
- Screening, evaluating, and selecting potential companies with expected high return opportunities
- Financing companies to develop new products and technologies, foster their growth and development, make aquisitions, or allow for a buyout or a buyin experienced managers
- Controlling, coaching, and monitoring portfolio companies
- Sourcing exit opportunities for portfolio companies
Why is direct investment problematic for institutional investors?
Institutions often cannot offer performance-related pay to attract and retain top employees, and unlimited carried interest doesn’t align with traditional compensation schemes.
Why do private equity investments require significant effort from institutional investors?
Evaluating proposals and structuring transactions demand very hard work over long periods, which is challenging without incentives for risk-taking and value creation.
Life Cycle of a Venture Capital Fund: What are the five stages?
- the fundraising stage
- sourcing investments
- investing stage
- operations and management
- windup and liquidation
Life Cycle of a venture capital fund: the fundrasing stage
- capital is committed, not collected
- investors sign a legal agreement
- committed but not yet drawn
- 6m - 1 year
- is to make investments or to pay costs, expenses or management fees
Life Cycle of a venture capital fund: sourcing investments
- process of locating possible investments, reading business plans, performing intense due diligence on start-up companies and determining the attractiveness of each start-up company
- 3-5 years
- no profits are generated by the VC fund -> losses are generated, due to fees
Life Cycle of a venture capital fund: investing stage
- VC fund manager determines how much capital to commit to each start-up company, at what level of financing and in what form of investment (convertible preferred shares, convertible debentures, etc.)
- capital calls to the investors in the fund to draw the commited capital
- no cash inflow yet
- still deficit
- vintage year; operations commences
- 3-5 years, only the existing portfolio companies with the highest potential are furter supported
Life Cycle of a venture capital fund: Operations and Management
- operation and management
- everything is invested
- manager works with the portfolio companies
- manager may improve each portfolio company’s management team, establish distribution channels for the new products, refine the prototype product to generate the greatest sales, and generally position the start-up company for an eventual public offering or sale to a strategic buyer
- profit
- profit offset the previously collected management fees and other expenses
Life Cycle of a venture capital fund: Windup and liquidation
- all committed capital has been invested
- harvesting stage
three possible outcomes:
1. being sold to a strategic or financial buyer
2. being brought to the public markets in an IPO
3. being liquidated through a bankruptcy liquidation process
- profits are distributed to the LPs, and the general partner/fund manager now collects the incentive/profit-share fees.
Life cycle of a venture capital fund: J-Curve
What are the 4 substantial risks of private equity?
- Market risks
- liquidity risks
- commitment or funding risks
- realization risks
How does the life cycle model GP-LP Relationship look like?
How is the investment strategy, performance, size, economies of scale and management team in following fund charasteristics:
- entry and establish
- build and harvest
- decline or exit
What fees can generalpartners earn?
- director fees
- buyout fees
- financing fees
- divestment fees
- and so on
What is the hurdle rate in a private equity fund?
The minimum rate of return that limited partners (LPs) must receive before the general partner (GP) is entitled to any carried interest.
What happens in the hurdle zone of a private equity fund’s profit distribution?
100% of the portfolio’s returns are allocated to the limited partners (LPs) until the hurdle rate is met.
What is the catch-up zone in carried interest calculation?
The phase where the general partner (GP) receives most or all additional returns until their carried interest share (e.g., 20%) is aligned with the LPs’ total returns
What occurs in the full carried interest zone of a private equity fund?
The general partner (GP) earns their full share of carried interest (e.g., 20% of profits), while the remaining profits (e.g., 80%) go to the limited partners (LPs).
What percentage of profits typically goes to the general partner (GP) as carried interest?
Usually 20%, although this can vary depending on the fund’s terms.
Why is the hurdle rate important in private equity funds?
It ensures that limited partners (LPs) receive a baseline return on their investment before the general partner (GP) shares in the profits.
overview Private Equity Management fees and carried interest
What are other important terms in an L.P. agreement?
- GP contribution into the fund
- key person provision
- termination and “divorce” clauses (bad-leaver / good leaver)
- gearing / leverage
- fundraising restrictions
- restrictions on outside engagements
Leveraged buyout funds: General charasteristics
- dinsticion by the size of the companies
1. small cap companies: $100 million to 1 billion sales revenue
2. mid-cap companies: $1 billion to $5 billion
3. large-cap companies: $5 billion and above - almost all LBO structured as limited partnerships
- run by a general partner, typically an LBO firm
- LP are passive investors who rely on the general partners
- general partners do day-to-day operations
- 20 to 50 LP
- typically 20 years lifetime
Auction markets
then vs. now
Then
- LBO deals were simpler
- a single PE firm worked closely with the company’s management
- process took months
Now
- LBO market has grown
- auction process is used
- investment banker is involved
- highest bidder wins
What is a club deal?
- 2 or more PE firms team up to buy a company
- share costs, combine expertise and contribute capital together
- past: everything on its own
- reason for club deal: bigger companies are targeted, PE firms somethines can’t afford the deal due to size
- ## club = deal the resources and work together on bigger deals
Why do LBO funds have less risks than VC funds? (3)
- LBO tend to purchase public companies, that are established and mature. Target: successfull and undervalued companies. Generally longterm operating history
- LBO funds need to be less specialised than VC funds (VC one sector, LBO more diversified)
- IPO is more likely, because they already had public stock outstanding
alternative private equity liquid types
- BDC companies
- Closed end funds
- Listed “corporations” and similar
What are PE funds of funds?
private fund structures with underlying assets composed of private PE funds
What does successful PE investmenting require? (3)
- a wide-reaching network of contacts in order to gain access to high quality funds
- well-trained investment judgment
- the ability to assemble balanced portfolios
Fund of Fund: Fees
- less efficient than single GP funds, because of the additional layer of management fees and incentive fees
- main disadvantage of this structure
- however still more cost-efficient, because you need the resources for knowledge of an institutional investor
pros of fund of funds
- information and control: Funds of funds provide the necessary resources and address the information gap
- inexperienced institutions may initially have little option other than go through a fund-of-funds vehicle
- Diversification
- Liquidity Management and Access
What is PIPE?
- Private investments in public equity
- mostly U.S. phenomena
- shares are sold directly to investors and not on the open market
Why PIPE?
- faster with fewer regulatory hurdles
