Private Equity Industry Flashcards
1
Q
What are limited partners?
A
LPs are the group of investors that provide funding for private equity investments
2
Q
What are typical examples of LPs?
A
Endowmnets, pension funds, SWFs, wealthy individuals, and large corporations
3
Q
In private equity, who are general partners?
A
Co-owners of a PE firm; people that are managing the specific PE fund
4
Q
What is the profit structure of a private equity fund?
A
Returns LPs original investments as well as 80% of the profit.
The private equity firm typically keeps the remainder.
5
Q
What is carry?
A
The remainder of the profit from the realisation of the private equity fund that the private equity firm keep. These profits are split among GPs.
Can be thought of as commission for the PE fund for doing well.
6
Q
Alongside carried interest, what other fees do PE firms receive?
A
Annual management fee to PE firms, amounting to about 2% of total AUM.
7
Q
When does a PE firm raise a new fund?
A
Typically looks to raise a new fund when the current fund is close to fully invested.
This can also be for specific types of funds.
8
Q
What PE deal inspired the book Barbarians at the Gate?
A
KKR’s $31 billion LBO of RJR Nabisco
9
Q
What are examples of some of the largest LBOs?
A
TPC and Goldman buying Texas Utility TXU in 2007 for $44 billion
Blackstone buying Equity Office Properties for $39 billion
Hospital Corporation of America being brought for $33 billion by Bain Capital, KKR and Merrill Lunch
First Data being bought by KKR and TPC for $29 billion
10
Q
What are club deals in private equity?
A
Private equity deals being done jointly by two or more PE sponsors.
11
Q
Why do sponsors do club deals?
A
Usually happens when the equity check for a single private equity fund is too large, and hence spread around multiple PE firms/funds.
12
Q
What are current LBO dynamics?
A
Many LBOs between $10 and $1 billion, but not many over $10 billion and almost no club deals.
Buoyant equity markets in the last decade has led to increased number of portfolio company exits through IPO.
Middle-market firms raising larger funds as the better investments now seem to be in this area.
Some LPs have shown a strong interest in emerging markets
13
Q
What drove the increased PE activity in the 2010s?
A
Main driver is access to very cheap debt and more flexible lending.
14
Q
What is seed capital?
A
Earliest investments into nascent startups.
Funding usually provided by angel investors or VCs.§
15
Q
What are the biggest drivers of returns for seed capital investments?
A
Heavy emphasis on revenue or customer / user growth
16
Q
Difference between seed capital and vc?
A
Can be very similar, but later-stage VC place a greater emphasis on progressing towards profitability rather than top line growth at all costs
17
Q
What is growth equity?
A
Capital to help a young, profitable, high growth business to grow faster
Typically a minority stake (10-30) in common/preferred equity or warrants
18
Q
What do growth equity investors tend to focus on?
A
Heavy emphasis on growing revenues whilst increasing profit margins.
Because of improving financial position, multiple expansion is often targeted here.
19
Q
What are growth buyout funds?
A
Same as growth equity, except taking a majority stake.
Occasionally employs light leverage, although is dependent on company being profitable and having relatively stable cash flows
20
Q
What is PIPE?
A
Private Investment in Public Equity. Purchase of a large common or preferred equity stake (5-20%) in the stock of a publicly traded company
Typically done because it is easier than a follow on offering or rights issue.
21
Q
What is a carve-out / divestiture?
A
Investors purchase a part (often non-core) of a bigger company rather than the whole thing
22
Q
What are the two most common types of private equity?
A
Tends to be growth equity and LBOs.
23
Q
What is the minimum number of investments for a single PE fund?
A
Around 10-12 to remain diversified
24
Q
Why do PE funds charge management fees?
A
Meant to cover a PE firm’s annual operating budget. Fees enable the firm to make new investments and managed their existing portfolio.
25
What is a typical hurdle rate for PE firms?
Approximately 7-8&
26
What is a hurdle rate in the context of PE returns?
Minimum returns required from a PE fund to receive full carried interest
27
In the context of PE fund fees, what are deal fees?
When a PE firm closes a deal, it frequently charges the target a deal fee calculated as a small % of the total deal size. These fees are often shared with LPs.
28
What are monitoring fees?
Portfolio companies frequently pay nominal fees to their PE owners as compensation for the owners' ongoing monitoring and managerial assistance
29
Difference between principal and partner at a PE fund?
Principals typically manage all of the day-to-day activities of deal teams and work closely with partners on dal strategy and negotiation.
Partners are the most senior members of a PE firm and are usually its co-owners.
30
How can a PE firm source deals?
Receive a teaser from an investment bank
PE firm's partners may have an ongoing relationship with a CEO or owner who suddenly wants to sell to you
One of a PE firm's existing portfolio companies finds a potential bolt-on it wants the PE firm to negotiate and finance
The PE firm reaches out proactively to attractive targets.
31
PE funds get a bad rep for just being interested in buying low and selling high. However, PE firms tend to think of themselves as 'industrialists'. What does this mean?
When they buy a company, they examine:
* How can they make it better
* How can they create value
* What constituents should they be mindful of and will factor into a good outcome for everyone
32
Why are early-stage PE and VCs important in a companies life cycle?
Particularly early-stage PE and VC, they provide capital to young businesses that otherwise may not receive funding from typical capital market routes.
33
Relationship between PE fund and PE firm?
A PE fund is a standalone investment vehicle managed by a PE firm on behalf of a group of investors.
34
What does 'blind pool' mean in the context of PE funds?
Although investors in a PE fund have a clear idea of its broad mandate, they have no say in the choice of the individual companies that a fund will invest in
35
How are most PE funds set up?
Closed-end limited partnerships and operate as 'blind pool' vehicles
36
Are LPs involved in the day-to-day running of the private equity firm or fund?
No, they are there purely as passive investors once their capital is called
37
Do GPs also invest in the fund?
Although the majority of capital will be provided by LPs, GPs (and hence PE firms partners and senior professionals) will also commit capital to the fund to align its interest with that of the fund's LPs by ensuring that the firm's partners have "skin in the game".
This stake typically ranges from 1 to 5%, and rarely exceeds 10% of a fund's total capital raised
38
How is management fee calculated?
Usually % remains constant around 1.5 - 2.0%, but as invested capital is returned to LPs, the nominal amount will decline
39
What are the two main relationships in private equity?
Firm's fiduciary duty towards its LPs
The firm's relationship with entrepreneurs, business owners, and management teams in its portfolio companies
40
What is the 10+2 model?
PE funds structured as limited partnerships are typically raised for a 10-year plus two one-year extensions.
Generally speaking, a GP will deploy capital during the first four to five years of a fund's life and harvest capital during the remaining years.
The two optional years allow the Gp to extend a fund's lifespan at its discretion if and when additional time is needed to prudently exit all investments.
41
What is a first closing of a PE fund?
Once an initial threshold of capital commitments has been reached, the fund's GP will hold a first closing, at which time an initial group of LPs will subscribe to the fund and the GP can start to deploy capital.
However, fund-raising will typically continue for a defined period (usually around 12 to 18. months) from the date of the first closing until the fund reaeachies its target fund size and a "final closing" is held.
42
What is the funds committed capital?
The total amount raised by a PE firm for a specific fund.
43
How does a PE fund receive investor funds?
Rather than receiving the committed capital on day one, a GP draws down LP commitments over the course of a fund's investment period.
44
What is a fund's investment period?
Length of the investment period will be defined in a fund's governing documents and typically lasts four to five years from the date of its first closing
Once the investment period expires, the fund can no longer invest in new companies; however, follow-on investment s in existing portfolio companies or bolt-ons are permitted throughout the holding period.
45
What are capital calls?
The way that a GPs fund suitable investment opportunities for their fund. LPs must meet capital calls within a short period of time, typically 10 business days.
46
What happens when a fund remains invested in a company at the end of a fund's life?
The GP has the option to extend the fund's term by one to two years to avoid a forced liquidation.
47
Why is it more difficult to maintain a stable allocation to PE investments for a portfolio manager?
Illiquidity means that it is harder to maintain a stable allocation to any of the liquid assets classes, given that it is difficult to rebalance once you have committed funds.
48
What is the J-curve in private equity context?
Represents an LPs cumulative net cash flow position - the total capital invested along with fees paid to the PE firm minus the capital returned to the LP by the GP.
This looks like a J curve, because capital calls over the funds early years produce an initial dip, before distributions in the later years drags the cumulative net cash flow back above 0 and eventually positive.
49
What is 2+20 in the context of PE remuneration?
2% management fee and 20% carry
80% of funds profits are distributed pro rate to a fund's LPs.
50
Why charge management fees?
Covers all day-to-day expenses of the fund, including salaries, office rent and costs related to deal sourcing and monitoring portfolio investments.
51
In PE, how are yearly management fees decided before and after the investment period has begun?
Charged on committed capital during the investment period, and on net invested capital after the investment period.
52
What is the PE fund distribution waterfall?
Step 1 - LP contributed capital
Step 2 - Hurdle Rate
Step 3 - GP Catch-UP
Step 4 - 80/20 Split
53
How to simply define venture capital?
Minority investors betting on the future growth of early-stage companies
54
What does 'unicorn' mean in the context of venture capital?
Industry term for private companies with valuations above US$1 billion
55
Within its portfolio of companies, how would you consider the distribution of VC fund returns?
Significant emphasis on right-tail events - 1/3 of VC-invested companies eventually fail, so you need the winners to be 'home runs' and generate 10x or even 100x on invested capital
56
How would you compare growth equity to VC and Private Equity?
Growth equity fund occupy the space between venture and buyout investing, providing fast-growing but established businesses with funds and support for a transformational leap in their development
57
Minority or majority equity stakes in growth equity?
Usually minority equity stakes; strategic and operational control of the company will remain with its existing business owners.
58
What do growth equity investors bring to the table?
Financial acumen, in particular experience in optimising capital structures, in buying and selling businesses, and familiarity with capital markets and the initial public offering process.
59
What types of companies make good growth equity targets?
Later-stage venture-backed
Mature SMEs
SPin-Offs from established companies
All of these are going through a transformative stage where the additional funding and oversight can take them to the next level
60
Do growth equity investors use as much debt as buyout firms?
No, value creation tends to come from driving change at the operating company, through strategic, operational and financial initiatives, or professionalisation and governance optimisation
61
Exit timeframe of growth equity investors?
|Similar to most PE investors, growth equity funds will target to exit their investments within three to seven years.
62
What are minority protection rights in growth equity investing?
xxx
63
How does the tenor of bank debt usually compare to that of high yield bonds?
Tenor is usually shorter for bank debt,
64
What type of equity do PE funds usually take?
The equity in a buyout is often divided into a preferred share classs or shareholder loan (typically accounting for the majority of equity capital invested), and common equity.
A PE fund will usually hold the vast majority or all of the preferred shares, while management will own a significant portion of the common equity.
65
What is the difference between "paying for sustained growth" and "buying right and creating value early"?
Paying for sustained growth: Purchasing companies at higher EV / EBITDA ratios because the market is pricing in high-growth over the next few years. This means that buyers effectively spend the first two years standing still, because they have acquired investments at values that have already factored in the profit improvement overr the next few years.
Buying right and creating value early: Involves staying focused on entry multiples and buying assets at or below their intrinsic value, and finding opportunities where value creation can be engineered through the operation of multiple levers early in the life of an investment.
66
What is a management buyout?
The incumbent management team initiatives the buyout of a company or corporate division with the financial backing of a buyout fund. This arrangement allows PE firms to capitalise on the management team's knowledge of the target company and provides a distinct advantage relative to other interested parties.
67
What is a management buy-in?
A buyout fund partners with an external management team to pursue an acquisition of a portfolio company. If successful, new management will replace the incumbent management team.
68
What are carve-outs?
Buyout funds often acquire a corporate division, business unit or subsidiary and set it up as a stand-alone company.
Often is from a non-core piece of the business or a part that was unsuccessfully integrated during an M&A transaction.
69
Is the UK more or less creditor friendly than the US?
UK is less creditor friendly and instead is more debtor friendly.
70
What is direct lending?
Form of corporate lending in which debt funds issue loans directly to a business or acquire these loans in the secondary debt market.
71
What is commercial due diligence?
The main goal of CDD is to better understand the company's business model and explore how the company addresses the needs to its customers, capitalises on key industry trends and navigates the competitive environment.
72
What are some negatives that CDD may highlight?
* Shrinking market size and/or a declining market share
* Disruptive and communisation threats
* Dependence on powerful suppliers or a concentrated customer base
73
What is financial due diligence?
Detailed examination of a target's historical financial statements and management's financial projections.
Often focuses on establishing a normalised EBITDA and target working capital, which form a key input for valuation and negotiation at a later stage in the investment process.
74
What are some negatives that FDD may highlight?
* Off-balance sheet financial insturments
* weakening working capital trends
* Accounting (EBITDA) adjustments to obscure actual performance, could be questionable add backs
75
What is legal due diligence?
Reviewing a target's material legal documentation and assess the legal status of its key stakeholders.
Pending litigation are also examined to determine potential cash flow and repetitional impacts on the target.
76
What are some negatives that LDD may highlight?
* Pending regulatory issues
* Corruption and bribery accusations
* insuffiecient protection of IP
* Questionable ownership rights
77
What is Human Resources DD?
Involves a thorough review of the capabilities of key employees at a target' starting with the management team.
78
What are some red flags indicated by Human Resources due diligence?
* Frequent board chanegs
* The management team deciding to cash out all its equity
* Strong personal loyalty to existing owners
79
Is valuation the starting point for a deal?
No, it is rarely the starting point for an invesment decision; the decision-making process on whether to engage with a company starts long before "valuation" is discussed.
80
How do PE firms view a DCF valuation?
Often see it as complementary, or useful to see how a strategic may value the target. However, they would rarely use this valuation themselves.
81
If a company has no debt or no cash, what value does the EV represent?
Will be the exact same as equity value.
82
Why do PE firms use EV rather than equity value?
* EV facilitates comparison across companies in the same sector irrespective of debt structure
* Also, where a PE invesmtne involves a change of ownership, the change of control will usually trigger mandatory repayment of existing senior debt.
83
After drawing up a peer set, how do you gauge where the target company may sit in terms of valuation within this group?
Look at operating metrics and see how it compares to peers.
84
Why is EV to EBITDA the most commonly used multiple?
EBITDA is largely insulated from the impact of different global accounting standards, simple to calculate, and a proxy for operating cash flow.
However, EV / EBIT its also commonly used, especially in industries where there are large depreciation balances (which can signify large capex)
85
Where is EV / OpFCF used?
Often in capital intensive industries. OpFCF adjusts EBITDA by subtracting estimated maintenance capital expenditure and the estimated change in NWC.
OpFCF thus provides a business's earnings after deducting the spending required to maintain the profitability and competitive position of the company.
86
What types of companies do infrastructure private equity target?
Utilities: Gas / electricity / water distribution, communications infrastructure
Transportation: airports, seaports, roads, bridges, rail
Social infrastructure: hospitals, education facilities
Energy related: Power plants, oil and gas pipelines, oil terminals, renewable energy assets
87
Why is infrastructure PE treated differently to traditional PE?
* Extremely limited downside risk. Hence, they are regarded as low volatility, protected downside, stable cash flow profile.
* Strong cash yield. Vast majority of infra assets have some current dividend yield. Therefore, it is different from traditional PE (where all your return usually comes on the last day on exit)
* Infrastructure assets performance is often implicitly or explicitly linked to macro indicators such as inflation, GDP,l population growth etc. Therefore, many investors naturally see infrastructure as a hedge.
* Defensive resilient performance profile and low correlation with other asset classes (such as PE, equities, fixed income, RE, etc.). Therefore, provides good diversification benefits to an investors' portfolio.
88
Difference between brownfield and Greenfield?
Brownfield is buying operating business, whereas Greenfield is constructing stuff from scratch.
89
What is core infra?
Boring operating assets with most/all of the return coming from cash dividends; most likely state-regulated with limited risk on revenue side. All you need to do is not mess up operating costs. Example would be regulated electricity distribution in the US or Western Europe
As it stands today, you would expect equity IRRs of below 10% for such investments but on the other hand this is still several times above fixed income instruments and risk is much lower than traditional PE. Downside scenario when everything goes perfectly wrong can still yield 3-5% equity IRR.
90
What is core-plus infra:
Somewhat more risky, will include operating asset with some growth story or growth / expansion capex, or vanilla operating infra asset in a questionable jurisdiction (for example, regulated water utility in Poland).
In developed markets, typical equity IRRs would be in low teens.
91
What is value-add infra?
Value add infra: Investment in infrastructure requiring some serious operational involvement, potentially substantial business re-profiling. For example, buying a regional airport with aim to turn it into super-regional hub, or buying bilk liquid seaport and building container-handling facility
92
What is opportunistic infra?
Riskiest type of infra investment, with limited or no dividend yield, with larger downside risks. Here we are talking about equity IRR of 15%+ depending on jurisdiction. This category is quite small and comes closer to the border of traditional PE and LPs would be inclined to invest into PE at these returns because PE firms are bigger specialists in the high-risk-high-return territory.
Examples include infra in emerging markets or infrastructure assets that have a higher exposure to commodity inputs
93
When did infrastructure PE start becoming a thing?
Rather short history of infrastructure PE, circa. 20 years ago it was almost unheard of.
Around the early 2000s, few countries such as Australia and Canada (hence prevalence of Canadian pension funds in infra PE) pioneered attracting private capital infrastructure and monetising construction of new existing assets. Australian bank Macquarie is widely credited as the first-mover who actually started raising PE funds with the mandate to invest exclusively in infrastructure.
94
What is the current landscape of infra PE?
Competition?
Returns?
Crowded space with a lot of fund managers but a constricted supply of good deals. Demand is there, because LPs appreciate benefits of infrastructure's meaningful return with protected downside and low correlation to other assets
95
What are PPPs in infrastructure investing?
Public-private partnerships - private sponsor constructs the infra project with some guarentee from the government on subsidies / revenue guarantees.
96
Minimum sizes of infra assets?
Because of the nature of the assets, hard to find anything below $200+ million equity (and hence around $400m+ EV)
97
Why do PE firms care a lot about NWC requirements?
PE returns are derived from cash, and as increases in NWC reduce cash flow, has an impact on PE returns
