Private equity / Venture capital

Question 1

Define private equity

Answer 1

Private equity is the provision of equity capital where there is no immediate exit route via the secondary market.

i.e. investment in unquoted securities

Question 2

Reasons why it might be advantageous to take a public company into private ownership: (4)

Answer 2

1. There may be fewer regulatory restrictions on its activities, so giving it greater freedom to make profits.
2. It may benefit from a closer relationship with a typically smaller number of more sophisticated investors who may provide management input.
3. It incurs lower costs in complying with less onerous financial reporting requirements.
4. The lack of a quoted market share price may enable the management to take a longer-term view when making investment decisions.

Question 3

Private equity funds may be appropriate owners of businesses where: (3)

Answer 3

1. the risk profile is unsuitable for public ownership
2. the cost of capital may be reduced under private ownership (for example by using very high levels of financial gearing)
3. where valuation is difficult in the public arena for any other reason

Question 4

Two disadvantages of venture capital finance to the current owners of a business

Answer 4

1. Loss of control over the company
2. The capital may only be made available in tranches with availability and/or cost of the later tranches being dependent on the venture capitalist.

Question 5

Proponents of private equity investment claim that: (2)

Answer 5

1. private equity out-performs (over the long term)
2. it is a loosely correlated asset which may be able to enhance portfolio performance without materially increasing risk, i.e. it is good for diversification

Question 6

Possible disadvantages of private equity investment include: (7)

Answer 6

1. lack of liquidity and marketability
2. variable past performance record
3. difficulty in valuation
4. need for specialist investment advice
5. high costs
6. lack of reliable information
7. regulatory constraints.

Question 7

Choices available for an investor who wants to invest in private equity are: (4)

Answer 7

1. directly by purchasing shares in private companies
2. pay a private equity firm to invest your capital for you (segregated funds managed by private equity firms).
3. invest in a private equity collective vehicle, e.g. an investment trust.
4. invest in a fund-of-funds which invests in a range of private equity funds.

Question 8

Define carried interest

Answer 8

This is the profit share that a private equity manager receives as an incentive to achieve strong performance.

Question 9

First closing date

Answer 9

The first closing date (which is typically 3 to 6 months after marketing of the fund commences), is the date which at which the fund manager can start to call on the investors to hand over the cash they have committed to invest.

Question 10

Final closing date

Answer 10

The final closing date is the end of the marketing period of the fund - i.e. after this date there are no new commitments to provide funds for investment. The final closing date is typically 12 months after the start of the marketing.

Question 11

Investment period

Answer 11

The investment period is the time during which the investors pay over the funds they have committed and the fund manager makes the investments in businesses. The end of the investment period is typically 2 or 3 years after the final closing date.