private equity 101 Flashcards
private equity
ownership shares not publicly traded or listed on an exchange
Limited Partners
Limited partners are usually institutional or high-net-worth investors interested in receiving the income and capital gains associated with investing in a private equity fund. Limited partners do not take part in the fund’s active management. They are protected from losses beyond their original investment as well as any legal actions taken against the fund
General Partners
responsible for managing the investments within the private equity fund. They can be legally liable for the actions of the fund.2 For their services, they earn a management fee, typically 2% of commitments paid annually although there are exceptions when the rate is less.3 In addition, the general partners earn a percentage of the fund’s profits, which is called carried interest
carried interest
the general partner’s share of the profits of the investments made within a private equity fund.4
The share can range from 5% to 30% of the profits.
Preferred Return/ hurdle rate
is basically a minimum annual return that the limited partners are entitled to before the general partners may begin receiving carried interest. (80%)(
clawback provision
gives the limited partners the right to reclaim a portion of the general partner’s carried interest in case losses from later investments cause the general partner to withhold too high a value of carried interest.
Committed Capital
capital committed by LPs
Drawdowns/ capital calls
issued to limited partners when the general partner has identified a new investment and a portion of the limited partner’s committed capital is required to pay for that investment.
Residual Value
the market value of the remaining equity that the limited partners have in the fund. It is common to see a private equity investment’s net asset value, or NAV, referred to as its residual value, since it represents the value of all investments remaining in the fund portfolio.
Investment Multiple (tvpi)
total value to paid-in (TVPI) multiple. It is calculated by dividing the fund’s cumulative distributions and residual value by the paid-in capital. It provides insight into the fund’s performance by showing the fund’s total value as a multiple of its cost basis. It does not take into account the time value of money.
DPI/ realization multiple
dividing the cumulative distributions by paid-in capital. The realization multiple, in conjunction with the investment multiple, gives a potential private equity investor insight into how much of the fund’s return has actually been “realized” or paid out to investors.
RVPI
current market value of unrealized investments as a percentage of called capital. The RVPI multiple is calculated by taking the net asset value, or residual value, of the fund’s holdings and dividing it by the cash flows paid into the fund. Cash flows are representative of the capital invested, fees paid, and other expenses incurred by the limited partners to the fund.
PME
return metric that compares the return of a private equity fund (or a portfolio of funds) to the hypothetical return of a chosen public stock market index, such as the S&P 500 or Nasdaq, using the cash flows as the fund as a basis for investment in the stock market index. For example, a fund may have an IRR of 15%, while the PME obtained using the S&P 500 as the index is 10%, suggesting that the fund has outperformed the S&P 500 by 500 basis points (bps).
LN PME/ Index Comparison Method ICM
The LN PME matches each contribution and distribution of a fund with a hypothetical purchase and sale of a reference public market index, such as the S&P 500. The residual value of the fund is not matched to the LN PME; rather, the LN PME residual value is based on the performance of the hypothetical invested capital in the index. With these cash flows, an LN PME return for the public market index is compared directly against the IRR for the fund. If the fund’s IRR exceeds the LN PME, then the fund has outperformed the public market index. If the LN PME IRR exceeds the fund’s IRR, then the fund has underperformed the public market index. Note that the IRR generated using LN PME isn’t a “real” IRR – it’s an estimation because of the manipulation of the residual value.
KS PME
In effect, the fund’s individual calls and distributions are revalued to their future value at the time of the evaluation. The nice thing about this is that the fund’s residual value stays the same, as it is already expressed in the future value. These values are then totaled to provide a future value for all of the calls, and a future value for all of the distributions plus the residual value. These figures are used to calculate the KS PME metric.
The KS PME provides a multiple, such as 1.7. If the KS MPE multiple exceeds 1.0, then the fund has outperformed the index. If the KS MPE multiple is less than 1.0, then the fund has under-performed the index.
