Private Equity

Question 1

How do most investors invest in PE?

Answer 1

Through PE funds

• Fund of funds
• Some can develop a portfolio of PE Funds

Question 2

What do you become as a PE investor?

Answer 2

A limited partner

Question 3

How are gains primarily made in a PE firm?

Answer 3

• Listing
• Sale
• Dividend capitalisation

Question 4

Why do banks invest in PE?

Answer 4

1) Higher profit
2) Leverage off their other activities

Question 5

What are the 4 main PE investment categories?

Answer 5

1) Mezzanine Finance
2) LBOs
3) Distressed Companies
4) Venture Capital

Question 6

Points about venture capital

Answer 6

• Investment in companies in exchange for a share of ownership
• Can be actively involved in management
• startups to later stage small companies
• Small companies don’t have access to bank lending lines
• Investment as partnership

Investment can also take the form of angel investors

Question 7

Points about Distressed Companies

Answer 7

• Take interest in companies with distressed debt piles
• Restructure debt under more favourable terms
• In exchange, gain some control over strategic decisions
• Aim to improve cash flows and increase price of debt

Question 8

Points about LBOs

Answer 8

• Banks, Hedge Funds & PE Group lend money to LBO vehicle
• LBO vehicle aims to buy target equity via borrowed money
• Borrowers provide money for high yielding LBO bonds
• New management team then aim to cut costs.

Question 9

Points about Mezzanine Finance

Answer 9

• Expensive way to raise money as debt is not secured
• Higher yield
• Unsecured in case of bankruptcy
• Ranks between ordinary shares and secured debt

Question 10

What is an example of a private takeover of a public company

Answer 10

Kraft purchasing Cadburys

Led to a change in how foreign firms buy UK companies

It was considered too easy a process

Question 11

Why might a PE firm buyout a public company?

5 reasons:

Answer 11

1) Management Buyouts - acquire strong cash flow businesses
2) LBOs - acquire strong cash flow businesses - and be able to pay with debt
3) Financial Distress - help to turn around struggling companies
4) Avoid registration costs - provide capital without costs of public ipo
5) Raise funds when out of favour with investors - help industries that public markets have shunned

Question 12

Private equity returns?

Answer 12

1) Generally higher than other asset classes
2) Reward for higher risk and lower liquidity

Question 13

Rank private equity types in order of profit

Answer 13

1) Venture Capital
2) Distressed Companies
3) LBOs
4) Mezzanine

Question 14

How has PE performed vs US and global equities

Answer 14

Over 25 years to March 2022
1) 14.2%
2) 4.7% more than US
3) 6.7% more than global

Can be seen as compensation for low liquidity

Question 15

What are 4 risks of Private Equity?

Answer 15

1) Illiquid (complex secondary market)
2) Long term commitment
3) Unique risk of PE is greater (investor needs to be diversified)
4) Cash on demand needed for the investment period (can be 5+ years)

Question 16

What is the riskiest class of PE

What is the least risky?

Answer 16

1) Venture Capital - junior companies

2) Mezzanine Capital - More mature companies

Question 17

What is important about a manager and team in PE?

Answer 17

1) Track record of team
2) Due diligence capabilities (strong analyst team)
3) Management Compensation (can effect the success of the performance)

Question 18

What is information assymetry

Answer 18

Different knowledge / information between buyesr and sellers

Question 19

What can information assymetry lead to in Private Equity?

Answer 19

1) Adverse Selection
2) Moral Hazard

Question 20

When does Adverse selection happen

When does moral hazard occur?

Answer 20

1) Before transaction (lack of disclosure, not enough information to make correct choice)
2) After transaction (manager takes money and changes behaviour)

Question 21

Points about Adverse selection

Answer 21

o Owners and managers known more than investors
o Good points about investment highlighted
o Negatives are hidden
o Able to do this because of lack of mandated public disclosures
o Adverse selection for investor

Question 22

Points about moral hazard?

Answer 22

o After PE financing is in place, managers may alter behaviour and run the business for their own benefit.
o Risk increases after investors have committed funds.

Question 23

What is the largest type of PE fund available to investors?

Answer 23

Buyout Funds

Question 24

Points about buyout funds

Answer 24

• Large Cap or intermediate cap
• Aim to purchase company - privatise then relist
• Profit through IPO
• Dividend capitalisation (a special dividend financed through debt to given to partners)

Question 25

Who are PE funds offered to?

Answer 25

Qualified investors

Largely due to complxity, risk and large initial investment (millions)

Question 26

How long do partnerships last?

Answer 26

They have a fixed contract - usually around 10 years

Question 27

What is the most common form of partnership

Answer 27

Limited form partnership

Question 28

Points about general partners

Answer 28

• Manager of the investments
• only contributes around 1%
• unlimited personal liability for debts of partnership
• Has industry / entreprenuerial experience

Question 29

Points about limited partners

Answer 29

• Institutional investors
• Tend to invest the bulk of the money