Private Equity

Question 0

What are 7 control mechanisms utilized by PE firms

Answer 0

Compensation tied to performance 
Tag-along, drag-along clauses 
Board representation
Noncompete clauses 
Priority in claims 
Required approvals 
Earn-outs

Question 1

What are there ways PE firms can add value to portfolio firms?

Answer 1

1. Re-engineer firm to improve operating efficiency
2. Obtain debt financing on better terms
3. Stronger alignment between management and PE ownership

Question 2

What is tag along drag along clause

Answer 2

If acquirer acquires control of company, must extend the acquisition offer to all shareholders including firm management

Question 3

What is noncompete clause

Answer 3

Founders disallowed to compete against firm for a specified period of time

Question 4

What is involved with priority in claims

Answer 4

PE firms receive distributions before other owners (pref dividends) and have priority on firm assets if liquidated

Question 5

What is an earn out

Answer 5

Used in VC - tie acquisition price paid by PE firm to portfolio company’s future performance over period

Question 6

What are key differences in financial characteristics between VC and buyout

Answer 6

CF: low predictability vs. stable
Asset base: weak vs. substantial
Fin levg: low, equity vs. high sr debt
Working cap: inc needs vs. low 
Grow w/+financing: low vs. high

Question 7

What are key differences in operational characteristics between VC and buyout

Answer 7

Prod mkt: new, uncertain vs. strong niche
Products: new vs. established
Mgt: new w/individual record vs. strong experienced
Ops: High burn vs. dec inefficiencies
Goals: bus plan/strat vs. cf, strat plan

Question 8

What are key differences in structure between VC and buyout

Answer 8

Risk: tough vs. easy to measure
Exit: via IPO? Vs. predictable
Due dil: tech/commercial vs. extensive 
Return: some high, some written off vs. rare failures 
Cap mkt: not active vs. active 
GP rev: carried int vs. car int, fees

Question 9

Key valuation characteristics for buyout

Answer 9

Use DCF to est. equity value
Use relative value to check DCF
High debt use
Equity return via earnings growth, ^multiple on exit, v debt

Question 10

Key valuation characteristics for VC

Answer 10

Tough to use DCF and relative value due to uncertain CF/no comparable
Low use of debt - high use of equity
Equity return via premoney valuation investment and subsequent dilution

Question 11

What are 4 typical exit routes

Answer 11

IPOs
Secondary mkt sales
Mgt buyouts (MBOs)
Liquidations

Question 12

What are PE risk factors

Answer 12

Liquidity 
Unquoted investments
Competitive environment 
Agency 
Capital
Regulatory
Tax
Valuation
Diversification 
Market

Question 13

What are costs of investing in PE

Answer 13

Higher than public; include

• transaction
• investment vehicle setup
• admin
• audit
• mgt and performance
• dilution
• placement

Question 14

Know these terms for PE fund

Answer 14

Management
Transaction fees 
Carried interest 
Ratchet
Hurdle rate
Target fund size
Vintage 
Term of fund

Question 15

Know these corp governance terms

Answer 15

Key man clause
Performance disclosure/confidentiality 
Clawback
Distribution waterfall
Tag along drag along 
Removal for cause 
No fault divorce
Investment restrictions 
Coinvestment

Question 16

What is paid-in capital

Answer 16

% of committed funds utilized to date by GP

Question 17

What is distributed to paid-in capital

Answer 17

Cumulative distributions paid to the LPs / cumulative invested capital

(Net of fees/carried int)

Question 18

What is residual value to paid-in capital

Answer 18

Unrealized return

= value of LPs holdings in fund / cumulative invested capital

Question 19

What is total value of paid-in capital

Answer 19

Realized and unrealized return

= DPI + RVPI

Question 20

How to calc portion of firm VC investor must own post investment

Answer 20

NPV: f = new investment / PV firm value at exit

IRR: f = FV new investment at exit / FV entire firm value at exit

Equal with same discount rate

Question 21

PE steps to calc a deal

Answer 21

1. Post = V / (1+r)^t
2. Pre = Post - I
3. F = I / Post
4. y = x(F/(1-F)
5. Price = I / y

Question 22

VC method to valuing companies with IRRs

Answer 22

1. W = I / (1+r)^t (wealth)
2. F = W/V
3. y = x(F/(1-F)
4. price = I/y
5. Post = 1/F = price*(x+y)
6. Pre = post - I = price* x

Question 23

Steps for multi-round financing price

Answer 23

1. Define rate (multiply each years rate)
2. Post2 = V/(1+R2)
3. Pre2 = Post2 - I2
4. Post1 = Pre2/(1+R1)
5. Pre1 = Post1 - I1
6. F2 = I2/Post2
7. F1 = I1/Post1
8. y1 = x1*(F1/(1-F1)) (num new shares)
9. p1 = I1/y1
10. x2 = x1 + y1 (existing mshares)
11. y2 = x2 * (F2/(1-F2))
12. p2 = I2/y2