Private Equity Final Exam Deck Flashcards
Types of Funds
Open-End Funds v. Closed-End Funds
Open End: Hedge funds
Hedge funds are open-ended, short-term term, and more liquid, meaning the investors can invest in/out of the fund.
Closed-End: Private Equity, Venture Capital/Real-estate
PE & VC are most closely related
Longer-term investments, less liquidity (6-10 years total)
Equity investment/Controlling interest
More complex governance structure
Deployment of Capital - 3-5 years
Harvesting/Realization of Return - remaining 3-5 years
Private Funds:
PE and VC
Public Funds:
Mutual funds
Formation
Limited Partnership or LLC
Benefits:
Flow through taxation (only taxed at investor level)
Flexibility – default statutes that can be modified by LPA/LLC Agreement
Generally no personal liability to LPs/Members of LLC
Formation
Preferred Jurisdiction
Domestic:
Domestic: Delaware - typically selected, viewed as familiar/safe by LPs, specialized courts, sophisticated common law, lower administrative costs
Formation
Preferred Jurisdiction
International
Cayman Islands, Luxembourg, Mauritius, etc. - selected by PE funds to invest outside of U.S. because of favorable tax regimes, well-established legal systems.
Parties
Management Company/Investment Adviser
Compensated through a management fee (may be paid to various entities)
Incentives: profit participation, scale of investments
Parties
General Partner
GP commitment – “Skin in the Game”
Carried interest – 80/20 typical
Parties
Limited Partner
- Institutional Investors (largest group): Public and Private Pension Plans, University/Foundation Endowments, Insurance Companies, Corporations, Fund of Funds, Sovereign Wealth Funds, Government Agencies, etc.
- Wealthy Individuals (HNWIs) and Family Offices
- Incentives: high rate of return, access to large transactions, diverse investments, expert investment team
Parties
Portfolio Companies
Documents
Limited Partner Agreement (LPA) or Operating Agreement
- Governs all investors in the Fund
- Controls relationship between GPs and LPs
Documents
Subscription Booklet/Sub-Agreement
- Every investor has their own sub agreement.
- Governs the relationship between the LP and the Fund
Documents
Private Placement Memo (PPM)/Offering Memo
- Describes what the fund is going to be; directors, previous success/failures, risk disclosures
a. Larger Funds/Well established Funds will have more disclosures - Term Sheet
Documents
Side Letter:
- Additional agreement for for larger investors for future investments
- Ability to co-invest
- Information rights
- Waiver of certain fees
- More reporting
Economics
Income Streams for Managers (no law for breakdown but this is common practice)
- Performance Fee = Carried Interest (20%)
- Management Fee = 80%
Economics
The Private Fund Waterfall and Carried Interest
- Waterfall is distribution of proceeds
- Step 1: Return of Capital
a. American Model (GP Friendly): Return all contributions in respect of realized investments before GP receives carried interest.
GP Clawback:
b. European Model (LP Friendly): Return all contributions before GP receives any carried interest
Economics
The Private Fund Waterfall and Carried Interest
Step 2: Preferred Return
a. When LPs want a minimum level of profit (usually 8%) before GP starts sharing in profits.
b. Not all funds have preferred return (e.g. VC funds).
c. Preferred return is also referred to as a “disappearing hurdle” because of the catch-up step next.
Economics
The Private Fund Waterfall and Carried Interest
a. After Preferred Return, the LPs will have received 100% of the profit distributions.
b. But the business deal is that profits are split 80/20, so the GP needs to catch up to its designated share of profits. Give money to the GP so the split will be 80/20 again before the distribution of the remaining profits.
c. Catch-up can be fast (GP gets 100% of distributions in this step) or slow (GP gets 80% or 50% of distributions in this step).
Economics
Tax Considerations
Economics
Lifecycle of the Fund
Deploying capital
Investment Company Act Status (Investment Company Act of 1940)
