PE Flashcards
PE types
1) VC
2) buyouts
3) Mezzanine debt
4) distressed debt
5) PIPEs
VC
relates to capital invested with entrepreneurs to fund their young and potentially fast-growing companies.
Buyout funds or buyout transactions or public-to-private transaction
are related to capital provided in the mix of debt and equity to acquire shares in an established business or one of its business units. In most cases buyout transactions involve the use of leverage, which leads one to refer to them as leveraged buyouts or LBOs.
Mezzanine debt
derives its name from its position in the capital structure of a firm: between the
ceilings of senior secured debt and the floor of equity.
Secondary market
facilitates trading among investors of previously existing securities.
Fund of funds
is a hedge fund or private equity fund with underlying investments that are predominantly investments in other hedge funds or private equity funds.
Evergreen funds
are unlisted open-end funds which allow investors to subscribe to or redeem from these funds on a regular basis.
Partnership agreement
is a formal written contract creating a partnership.
Private placement memorandum (PPM)
is used interchangeably with Offering Memorandum and seeks to accomplish four key functions such as limited partner education, risk disclosure, risk assignment, assignment of decision-making authority.
Distressed debt
is the outstanding debt of troubled companies, and is, therefore, subject to substantial risk.
PIPEs
private investment in public companies
PE structure
- The private equity fund manager (who’s the general partner), who generally manages pooled money in the private equity fund on behalf of the investors in the fund, although there has been a recent growth in managed accounts and direct investing.
- The private equity fund – a pooled investment fund that gains investments from limited partners, as well as the senior members of the private equity fund management company.
- The portfolio company, including both its shareholders and its management; and in the case of a leveraged buy-out, the bank proposing to lend money.
- Outside advisors, who are hired by the general partner to help with monitoring and management of the portfolio companies.
PE manager role
- Raise funds from investors. These funds are used to make investments, principally in businesses, which are, or will become, private companies.
- Source investment opportunities and make investments.
- Actively manage investments.
- Realizing returns, which come from income and dividends, as well as from exiting the investments through sales to strategic or financial buyers or to public markets in the form of an initial public offering (or IPO).
role of the buyout managers
Buyout managers look to leverage their expertise to turn around underperforming businesses, improve profitable businesses or to organize the company’s balance sheet and its finances.
Venture capitalists often play an active role in
the company’s operations by either sitting on the board of directors or becoming involved in the day-to-day management.
dry powder refers
to the amount of committed capital that has yet to be called by the general partner.
life cycle pf PE fund
stage-1: Organizing and Fundraising (1-2 years)
stage-2: Identifying Potential Investments (1-4 years)
stage-3: Allocation of Capital (1-4 years)
stag-4: Management of Portfolio (2-7 years)
stage-5: exit or harvesting (4 year and more)
PE fund source of income
1) management fee = 1-2% of the committed capital/raised fund
2) transaction fees paid by the portfolio company
3) deal fee/carried interest/incentive fee = a share in the profits of the fund;
hurdle rate
pre-agreed rate of return (8% per annum) alculated on the amounts actually invested.v
clawback provision
When a fund may perform very well in the first few years, and then investments may be unprofitable towards the end. In such cases, LPs could recover some of the incentive fees that were paid in earlier years
PE risks
1) manager selection
2)
performance measures
IRR (Internal Rate of Return)
TVPI (Total Value to Paid-In Ratio/total return)
DPI (Distribution to Paid-In Ratio/realized return)
RVPI (Residual Value to Paid-In /unrealized return).
Paid-in-Capital
Paid-in-Capital = the capital contributed by LPs to the fund. Paid-in-capital is also known as “contributed capital” or “called capital” or sometimes “drawn capital.” Note that Paid-in-Capital is different than Committed Capital. Recall that an investment in a private equity fund occurs over time. An investor in the fund, known as a limited partner or LP, agrees (commits) to invest a certain amount in a fund, say $10 million, as and when the manager of the fund, known as a general partner or GP, needs the capital. In this case, the $10 million is the LP’s commitment. As the GP asks for a portion of this commitment (known as a “call”), the amount paid by the LP to the fund is known as Paid-in-Capital, or PIC (this is also known as “called capital”).
Distributions
= the value of the cash and stock that the fund has given back (distributed) to the LPs. Distributions are typically low early in a fund’s life, ramping up over time as investments are exited.
Residual Value
= the remaining value of the fund at a given point in time. Residual value is the value of the fund’s investments plus other fund assets (cash, etc.) less fund liabilities. So, for example, if the fund has 12 remaining investments with an aggregate estimated fair value of $100 million and another $3 million in cash, the Residual Value of the Fund is $103 million. Early in a fund’s life when investments are being made residual value is typically high (reflecting the value of the investments) and declines over time as the fund exits its investments and makes distributions to the LPs.
Total Value
= the total value of the fund, which is the sum of the distributions and the residual (remaining) value of the fund at a given point in time. The mathematical relationship among these metrics is:
IRR
speed at which investment yields returns. Solved through equation,
NPV=0=-PV(1+IRR)^-0+FV(1+IRR)^-n1+FV(1+IRR)^-n2 etc
n= number of years
NPV= net past value
FV=future value
IRR=internal return rate or discount rate
-PV(1+IRR)^-0 =-PV
DPI (Distributions to Paid-in-Capital).
Distributions to Paid-in-Capital is the ratio of Distributions to Paid-in-Capital, and that value is expressed as a multiple, such as 0.5, 1.2, 2.0, etc., but also expressed as 0.5x, 1.2x, 2.0x, etc. The DPI equation is as follows: DPI=D/PI
To me, DPI is a critical evaluation tool. The higher DPI, the better. A DPI of 1.0x means that the fund has returned to LPs an amount equal to their Paid-in-Capital. A DPI of 3.0x means the fund has returned to LPs an amount equal to 3.0x their Paid-in-Capital. A 3.0x DPI for a fund is a good result.
RVPI (Residual Value to Paid-in-Capital).
Residual Value to Paid-in-Capital is the ratio of Residual Value (the remaining value of the fund) to Paid-in-Capital, which is also expressed as a multiple, such as 1.0 or 1.0x. The RVPI equation is as follows: RV/PI
TVPI (Total Value to Paid-in-Capital).
Total Value to Paid-in-Capital is the ratio of Total Value to Paid-in-Capital, also expressed as a multiple, such as 1.0x or 2.0x. The equation is as follows: DPI+RVPI (or D+RV/PI)
Track record is
financial performance of a management team based on their previous ventures.
Committed capital is
the cash investment that has been promised by an investor but not yet delivered to the fund.
Milestone is
a set of goals that must be met to complete a phase and usually denotes when the entrepreneur will be eligible for the next round of financing.
Angel investing refers to
the earliest stage of venture capital, in which investors fund the first cash needs of an entrepreneurial idea.
Business plan
should clearly state the business strategy, identify the niche that the new company will fill, and describe the resources needed to fill that niche, including the expenses, personnel, and assets.
Early-stage venture capital denotes
the funding after seed capital but before commercial viability has been established
Junk-bonds are
debt instruments with high credit risk, also referred to as high-yield, noninvestment-grade, or speculative-grade debt.
Balance sheet
a summary of assets, liabilities, and partners’ capital.
Primary market refers to
the methods, institutions, and mechanisms involved in the placement of new securities to investors.
Middle market refers to
companies that are not as large as those companies that have ready access to the financial markets but are larger than companies seeking venture capital.
Distressed debt investing is
the practice of purchasing the debt of troubled or bankrupt companies, requiring special expertise and subjecting the investor to substantial risk.
Chapter 7 bankruptcy is
entered into when a company is no longer viewed as a viable business and the assets of the firm are liquidated. Essentially, the firm shuts down its operations and distributes its assets to various claimants and creditors.
Chapter 11 bankruptcy is
a reorganization process that attempts to maintain operations of a distressed corporation that may be viable as a going concern.
Plan of reorganization is
a business plan for emerging from bankruptcy protection as a viable concern, including operational changes.
Reorganization process (chapter 11 in U.S. bankruptcy laws),
has the goal of preserving the firm’s activities as a going concern.
Return target is
a level of performance deemed necessary to satisfy the goals of the owners or beneficiaries.
Spending rate is
the fraction of asset value spent each year. U.S. law requires that foundations spend a minimum of 5% per year on operating expenses and charitable activities.
Modern portfolio theory (MPT) is
based on Nobel Prize–winning economist Harry Markowitz’s insight that because they have unique risk and return characteristics, less than perfectly correlated assets can be combined in a way that maximizes return for any given level of risk.
Lumpiness
describes when assets cannot be easily and inexpensively bought and sold in sizes or quantities that meet the preferences of the buyers and sellers.
Mixed approach
either starts with a bottom-up strategy, to which increasing top-down optimization is added, or starts as an iterative short process cycle, in which bottom-up screenings are followed by top-down analysis and then by bottom-up screenings.
Vintage year is
the year a particular private equity fund commences operations.
J-curve is
the classic illustration of the early losses and later likely profitability of venture
capital investments.
Established team is
a group of general partners that have been able to generate a top-quartile performance for most of its funds (more than three funds) through at least two business cycles.
Emerging team is
a group of general partners with limited joint history but with all the characteristics to become an established team.
LIBOR
London Interbank Offered Rate
