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Alternative Investments > Private Equity > Flashcards

Private Equity Flashcards

1
Q

What is Private Equity?

A

It encompasses 4 different strategies in the market for private investing:

  1. Venture Capital, equity financing for start up companies; ownership in equity claims
  2. Buyouts purchase and conversion of established companies into private companies ownership in equity claims
  3. Mezzanine Financing, combination of private debt and private equity financing ownership in debt claims
  4. Distressed debt financing, investing in established trouble companies ownership in debt claims

VBMD

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2
Q

What is the call option view of private equity?

A

Ir reflects its frequent losses and sporadic gains, in particular venture capital

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3
Q

What are the 2 primary types of private equity investments and what is the main difference?

  • What is Venture capital?
  • What is Buyour?
A
  • VC and Buyout

VC is equity financing provided by professionals in young, rapidly growing companies

PE Buyouts involve the purchase of a public company by a private comapny

They are 2 extremes of EQUITY TYPES Hedge Funds,

In investment strategies, VC rely on new technology or innovation, Buyouts identify where operating efficiencies can be improved or product distributions can be expanded

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4
Q

What is meant by the following:

  1. Vintage year
  2. Burn rate
  3. Equity Kickers
A
  1. Year in which private equity fund beigns operations
  2. The rate at which start up companies use up thier cash
  3. Equity kickers are offers of equity positions (for instance, stock options) in deals involving loans. They are given to lenders as inducement to lend money to the company and are often used in mezzanine financing.
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5
Q

What is meant by merchant banking?

A

Practice of buying non financial companies by financial institutions

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6
Q

What are the 2 main types of PE investments that involve ownership in debt claims.

Describe each

A
  • Mezzanine debt and Distressed debt

Mezzanine debt begins as a risky debt claim,

Distressed debt is debt whose credit worthiness has deteriorated

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7
Q

What is meant by:

  • Charge off loans
  • Incurrence covenants
  • Maintenance covenanants
A
  • Charge off loans: Loans that have been written off as bad
  • Incrrence covenant: If a borrower is to maintain a limit of 5 times EBITDA loan, if debt falls above the 5 times because EBITDA went down, borrower is not in violation
  • Maintenance covenants: in the case above, the rule is srictly enforced
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8
Q

Leveraged loans

A

Bank loans can be classified into 2 broad categories:

  1. Made to companies with investment grade credit ratings (i.e. BBB by S&P or Baa by Moody’s and above)
  2. Leveraged loans, syndicated loans made to companies with non-investment grade credit ratings (i.e. BB and Ba, and below)

Syndicated loan is a loan underwritten by a group of entities

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9
Q

Business development companies (BDC)

A

Publicly traded closed end funds that invest in the equty of small, private companies

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10
Q

What are BDCS, SPY and IWM

A

They are ETF’s

  • TracksUS BDC sector,
  • Tracks S&P 500 and
  • Tracks Russel 2000
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11
Q

What are the recent changes in private equity markets

A
  1. Increased activity in secondary markets through BDCs)
  2. PIPE (Private Investment in Public Entity)
  3. Transition of hedge funds into PE

PIPEs are generally

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12
Q

What is Equity line of credit? (ELC)

A

Relates to PIPE, contractual agreement that enables investors to purchase a formula based quantity of stock at set intervals of time

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13
Q

What are the 2 general classes of PIPEs: traditional and structured

A
  1. Traditional PIPEs, invovles purchasing preferred stock or debt with a fixed price or conversion ratio;
  2. Structured PIPEs have floating conversion price. This can result in toxic PIPE or death spiral
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14
Q

Contrast PE funds and Hedge Funds

A

Deal terms and fee structures are more attractive for hedge fund managers

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15
Q

What is the difference in equity stake of the investment in VC and buyout

A

VC: Minority, but substantial

Buyout: Control of company

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16
Q

What are VC funds?

A

They are PE funds that pool investors’ capital to fund start up companies. Most funds are structured as limited partnerships, the venture capitalist is the GP.

The fund investors are typically limited partners.

17
Q

What are the 2 types of VC fees?

A
  1. Management fee, usually 2 to 2.5%, they are based on the committed capital;
  2. Incentive fee < usually 20%. they usually have clawhack provisions
18
Q

Related to VC, what is a capital call?

A

The VC manager can demand for investors to contribute capital if he deems there is an investment opportunity

19
Q

What is the J-curve?

A

J-curve follows the life stages of VC fund’s portfolio of companies.

It starts with Fundraising (capital commitment)and ends with Windup and liquidation

20
Q

What are the 5 discrete stages of VC financing?

A
  1. Angel investing (F,F &f), $50-$500k;
  2. Seed capital, about $1-$5 million
  3. First or early stage ventur capital, generally more than $2M. Manufacturing has begun
  4. Second-or late stage/ expansion venture capital, $5-$25m of financing is provided
  5. Mezzanine venture capital
21
Q

What is a compound option?

A

Option on an option.

The option holder has the option of committing additional capital

22
Q

What are the return characterestics of VC investments?

What are the risks of VC investments?

A

Return: They are similar to out-of-the money call options (i.e. manly losses and few instances of large profits), this the retruns are right skewed

Risks:

  • Business
  • Liquidity
  • Lack of diversification
23
Q

What are the 2 keys to successful VC investing?

A
  1. Accessing top-tier VC managers (for persistent returns)
  2. Vintage year diversification, VCs tend to follow a cycle of boom and bust, hence the need to diversify across funds with different vintage.
24
Q

What is meant by LBO?

What are the 3 different ways in which LBOs differ from publicly traded equity?

A

LBO transforms a publicly traded company into a highly leveraged private firm

  1. LBOs take control of company. Traditional equity investments are passive
  2. LBO’s siginificant leverage
  3. LBOs are not publicly traded
25
Q

What are the subcategories of LBOs

A
  1. MBO: LBO led by the current management
  2. MBI: LBO led by outside management team which replaces the current management
  3. Buy-in management buyout: Combination of new and incumbent managers
  4. Secondary buyout: PE form selling a privae company to another PE firm
26
Q

What is the average life time of a PE Fund?

How many companies does PE funds typically invest in?

A

10 years with provision to increase it by 1-2 years

10-30 portfolio companies

27
Q

What are the 5 general categories of LBOs and how do they create value?

A
  1. Efficiency buyout: Improve operating inefficiencies
  2. Entreprneurship: Focus on innovations
  3. Dismantling conglomerates: breakup inefficient conglomerates
  4. Buy and build straegies: Opposite of dismantling conglomerates
  5. Turnaround strategy: pursue poorly managed underperform companies with extremely high leverage.

merging with another company is not a typical LBO strategy

28
Q

What are auction and club deals?

A

They are the result of influx of capital into private equity

Auction is among several private equity firms

Club deals are several LBO firms working “in clubs’ with the same target company

29
Q

What are the 5 LBO funds exit strategies?

A
  1. Sale to strategic buyer: the most common strategy
  2. IPO
  3. Another LBO
  4. Straight refinancing
  5. PE firm sells one of its portfolio companies to another buyout firm. One-third of pe deals are buyout to buyout
30
Q

Give 3 reasons why LBO funds are less risky than VC funds?

A
  1. VC funds are subject to significant risks of start up companies
  2. LBO firms are less specialized and hence more diversified
  3. Exit strategy usng an IPO is more likely to succeed for an LBO because its traget firm was initially public.
31
Q

What are the typical management and incentive fee structure of an LBO firm?

A

management fee of 1.25% to 3% and

incentive fee of 20% to 30%

32
Q

what is mezzanine debt?

A

Mezzanine debt is an

  • unsecured,
  • medium-term, (4-6) years
  • highly illiquid debt instrument
  • has lower priority than leveraged loans,
  • does not involve amortization,
  • does not require credit ratings to be issued,
  • and has a fixed coupon rate higher than the coupon rate on senior debt.
33
Q

What is chapter 11 Bankruptcy procedure?

A

The company files a reorganization plan and seeks approval of the plan from its creditors and the courts.

34
Q

Give the risk spectrum of private equity strategies

A

The risk spectrum of private equity strategies, from least to most risky, is

  • mezzanine debt,
  • distressed debt,
  • LBOs, and
  • venture capital.
35
Q

What is the general purpose of mezzanine financing?

A

To fill a gap in company’s capital structure

36
Q

What is the the annual compounded return for an LBO?

A

The rate that equates the compounded initial equity investment to the amount of total cash flow after all debt has been repaid

37
Q

What is compound option?

A

Like real estate development, venture capital can be described as a compound option (i.e., a string of real options), where the option holder delays committing additional capital until new information is received. The value of the option comes from being able to defer decisions until there is less uncertainty about the investment.

38
Q

What is a story credit?

A

A story credit is a private debt issue of good credit and senior secured standing that involves a special circumstance (e.g., a corporate reorganization) that has an interesting story to sell it.

Story credits are associated with mezzanine debt in that mezzanine debt provides financing for those who fall in between the junk bond market and story credits (i.e., they can do better than junk bonds but cannot issue story credits).

Mezzanine debt is not able to issue story credits.

39
Q

Relaed to the characteristics of mezzanine debt, what is meant by

  • Blanket subordination
  • Spring subordination
  • Takeout provisions
A
  • Blanket subordination, prevents payment of principal and interest to mezzanine debt investors have been fullh paid off until completely;
  • Spring subordination: Allows INTEREST payments to ne made to mezzanine debt investors while senior debt is outstanding, but subordination “springs up” to stop such payments in the event that the issuer defaults on the senior debt or a covenant is violated.
  • Takeout provisions: give md investors the right to purchse the senior debt after after a certain portion of it has been repaid

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