Private Equity Final Exam Deck

Question 1

Types of Funds
Open-End Funds v. Closed-End Funds

Open End: Hedge funds

Answer 1

Hedge funds are open-ended, short-term term, and more liquid, meaning the investors can invest in/out of the fund.

Question 2

Closed-End: Private Equity, Venture Capital/Real-estate

Answer 2

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

Question 3

Private Funds:

Answer 3

PE and VC

Question 4

Public Funds:

Answer 4

Mutual funds

Question 5

Formation
Limited Partnership or LLC

Answer 5

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

Question 6

Formation
Preferred Jurisdiction
Domestic:

Answer 6

Domestic: Delaware - typically selected, viewed as familiar/safe by LPs, specialized courts, sophisticated common law, lower administrative costs

Question 7

Formation
Preferred Jurisdiction
International

Answer 7

Cayman Islands, Luxembourg, Mauritius, etc. - selected by PE funds to invest outside of U.S. because of favorable tax regimes, well-established legal systems.

Question 8

Parties
Management Company/Investment Adviser

Answer 8

Compensated through a management fee (may be paid to various entities)

Incentives: profit participation, scale of investments

Question 9

Parties
General Partner

Answer 9

GP commitment – “Skin in the Game”
Carried interest – 80/20 typical

Question 10

Parties
Limited Partner

Answer 10

1. Institutional Investors (largest group): Public and Private Pension Plans, University/Foundation Endowments, Insurance Companies, Corporations, Fund of Funds, Sovereign Wealth Funds, Government Agencies, etc.
2. Wealthy Individuals (HNWIs) and Family Offices
3. Incentives: high rate of return, access to large transactions, diverse investments, expert investment team

Question 11

Parties
Portfolio Companies

Question 12

Documents
Limited Partner Agreement (LPA) or Operating Agreement

Answer 12

1. Governs all investors in the Fund
2. Controls relationship between GPs and LPs

Question 13

Documents
Subscription Booklet/Sub-Agreement

Answer 13

1. Every investor has their own sub agreement.
2. Governs the relationship between the LP and the Fund

Question 14

Documents
Private Placement Memo (PPM)/Offering Memo

Answer 14

1. Describes what the fund is going to be; directors, previous success/failures, risk disclosures
   a. Larger Funds/Well established Funds will have more disclosures
2. Term Sheet

Question 15

Documents
Side Letter:

Answer 15

1. Additional agreement for for larger investors for future investments
2. Ability to co-invest
3. Information rights
4. Waiver of certain fees
5. More reporting

Question 16

Economics

Income Streams for Managers (no law for breakdown but this is common practice)

Answer 16

1. Performance Fee = Carried Interest (20%)
2. Management Fee = 80%

Question 17

Economics

The Private Fund Waterfall and Carried Interest

Answer 17

1. Waterfall is distribution of proceeds
2. 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

Question 18

Economics

The Private Fund Waterfall and Carried Interest

Answer 18

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.

Question 19

Economics

The Private Fund Waterfall and Carried Interest

Answer 19

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).

Question 20

Economics

Answer 20

Tax Considerations

Question 21

Economics

Lifecycle of the Fund

Answer 21

Deploying capital

Question 22

Investment Company Act Status (Investment Company Act of 1940)