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Private Equity > Session 1-2 > Flashcards

Session 1-2 Flashcards

1
Q

What are the types of Investment strategies a Private Equity firm can take?

A

Venture capital (VC)

Growth equity

Buyout

Alternative strategies

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2
Q

What is the lifespan of a PE fund?

A

10 +1+1 years

(they have two optional votes where Limited Partners agree to 1y extension.)

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3
Q

Who are the main components and players of a PE partnership?

A

PE Firm
PE Fund
GP (General Partner)
IM (Investment Manager)
LP (Limited Partners)
Subadvisors
Portfolio companies

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4
Q

What are the key components of success for the PE Firm?

A

Funding
&
Investment Deal Pipeline

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5
Q

What is the Success factor “Funding” imply for PE firms?

A

Having good relations with existing and potential investors to secure funding

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6
Q

What is the Success factor “Investment Deal Pipeline” imply for PE firms?

A

Having good relations with entrepreneurs, business owners, management teams in portfolio and potential target firms.

This is to secure future companies to add to the portfolio

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6
Q

What is the role of the General partner (GP)?

A

Makes investment/exit decisions of ONE FUND in particular.

Issues capital calls to investors (LPs)

They invest 1-5% of capital raised to have skin in the game.

They have fiduciary duties to the Limited partners (LP).

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7
Q

What is an SPV?

A

Special Purpose Vehicle

A company or firm set up for one purpose only, once its purpose is complete its dissolved.

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8
Q

What is the Role of the Investment Manager (IM)?

A

Evaluate potential investment opportunities

Advisory services to portfolio companies

Manage audit and reporting processes

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9
Q

What is the Role of the Limited Partner (LP)?

A

Contributing most of the capital to the PE fund

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10
Q

What are the most common Limited Partners nowadays?

A

Institutional investors OR high net worth individuals

Pension funds
insurance cos
banks
companies
family offices
fund of funds

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11
Q

What is the Role of Portfolio companies in a PE fund?

A

These 10 to 15 companies are meant to be sold for profit at the end of the holding period (3-7 years)

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12
Q

How is the PE fund legal structure set up?

A

The goal is to structure a set of SPVs that allow for an optimal capital flows from LPs to the fund and back

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13
Q

What are the different types of fund vehicles?

A

Primary fund

Parallel fund

Feeder fund

Alternative investment vehicle

Co-investment vehicle

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14
Q

What is the “Primary fund” vehicle in Private Equity?

A

Its the main vehicle to which the GP and most LPs commit

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15
Q

What is the “Parallel fund” vehicle in Private Equity?

A

The parallel fund does the exact same investments as the primary fund, but the investors are completely separated from the primary fund investors.

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16
Q

What is the “Feeder fund” vehicle in Private Equity?

A

It aggregates commitments from smaller investors, invests as a larger Limited Partner

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17
Q

What is the “Alternative investment” vehicle in Private Equity?

A

special investment(s) outside primary fund

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18
Q

What is the “Co-investment” vehicle in Private Equity?

A

A fund to offer a particular investor a particular deal.

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19
Q

Why would the PE set up “Parallel Funds”?

A

Tax reasons => parallel can be offshore and primary are onshore.

Religious reasons => Muslims who do not want to be with people who collect interest to maintain their sharia law beliefs.

Political reasons => German companies doing the same as Russian ones (Germany would be seen as supporting the same companies as a warmongering nation).

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20
Q

Why would the PE set up “Feeder Funds”?

A

Typically to allow foreign investors to avoid onshore taxes

pooling capital from multiple clients

21
Q

Why would the PE set up an “Alternative Investment Vehicle”?

A

When primary fund is not an optimal vehicle for a specific deal

22
Q

Why would the PE set up a “Co-Investment fund”?

A

These are set up for their marketing campaign like saying that warren buffet has applied on the PE fund.

Some investors complain about the 2% management fee. so with this individual negotiation this percentage could be lowered or removed.

23
Q

What is Dry powder?

A

Committed capital but uncalled & uninvested

24
Q

What is Contributed Capital?

A

called and invested money

25
Q

What are the PE Funds Different phases?

A

Fundraising

Investment

Holding

Divestment (Exit)

26
Q

What is the “Fundraising” phase of the PE fund lifecycle?

A

This is where the fund raises capital commitments to purchase companies during the investment phase.

27
Q

What is the First closing?

A

The first time the capital is employed, invested.

Closing the first deal/purchase.

28
Q

What is the “Investing period” phase of the PE fund lifecycle?

A

This is where the Dry Powder is called to invest into new ventures.

LPs have 10 business days to provide the capital or they will be sanctioned.

29
Q

How long does the “Fundraising” last?

A

12-18 months

30
Q

How long does the “Investing period” last?

A

4-5 years

31
Q

What is the “Holding period” phase of the PE fund lifecycle?

A

Works with portfolio firms to create value

prepare exit

32
Q

How long does the “Holding period” last?

A

3-7 years from investment

The more successful you are the shorter the holding period

33
Q

What is the “Divestment” phase of the PE fund lifecycle?

A

Full or partial exits, capital and profits redistributed

34
Q

What are some important provisions to know about the “Divestment” phase PE fund lifecycle?

A

Exit proceeds cannot be reinvested except UNLESS

=> to match the amount of capital drawn down to pay fees

=> “quick flip”: exit achieved within 12-18 months

35
Q

When are successors PE funds set up?

A

These are established every 3-4 years.

Usually when 75% of the previous fund capital has been invested.

Yes this means that multiple funds will coexist at different phases of their development.

36
Q

Why is it so important for the PE Fund management that funds coexist?

A

This means that they need to satisfy multiple Limited partners (LPs) at the same time, and reoccurring partners too.

Investment choice needs to be carefully curated to not offend or anger any LP.

37
Q

How do PE funds measure returns?

A

Cash-on-Cash Multiple (CCM)

Internal Rate of Return (IRR)

38
Q

What are the weaknesses of CCM as a return metric?

A

It disregards time value of money.

39
Q

How do you calculate the CCM?

A

𝐶𝐶𝑀 = (1 + 𝐼𝑅𝑅)^t
𝐶𝐶𝑀 = (1 + Hurdle)^t
𝐶𝐶𝑀𝑖 = 𝑋𝑖 / 𝐼(𝑖)

40
Q

How do you calculate the IRR?

A

𝐼𝑅𝑅 = 𝐶𝐶𝑀^(1/𝑇) − 1

41
Q

What is the 2-20 rule of PE?

A

2-20 Alludes to the 2% management fees and 20% net profits for the GP

Leaving 80% of the net profits to the LP.

42
Q

What is the waterfall payment for successful PE fun exits?

A

The fund must first pay LPs their contributed capital and a hurdle rate ~ 8%

A catch-up mechanism then pays GP till it gets 20% of profits paid up to then

Remaining profits are split 80-20

43
Q

How do you calculate how much hurdle rate one needs to pay?

A

Inv * (1+ 8%)^Y

Y = Years of holding
Inv = Capital Investment
8% = Hurdle Rate

44
Q

How are the distributions done on the all capital first model? (EUROPEAN)

A

GP gets carry only after LPs have received

(i) all their contributed capital and
(ii) the hurdle rate

45
Q

How are distributions done based on the Deal-by-Carry model? (USA)

A

GP gets carry after each profitable exit, but only after LPs have received

(i) their capital contributed to the deal. (not all capital invested)
(ii) the hurdle rate.
(iii) any losses on prior deals

46
Q

What kind of terms does the LPAgreement set?

A

Organizational
Capital rules
Management fees
Reporting duties
Dissolution and liquidation

47
Q

What does LPA Stand for?

A

Limited Partner Agreement

48
Q

What are normal GP obligations set on the LPA?

A

Obligation to value portfolio companies, report to LPs regularly

Obligation to prepare and pay taxes on behalf of the partnership AND get exemptions when possible

49
Q

What are normal GP Limitations set on the LPA?

A

Limit on Mandate: Where they buy, what they buy and what strategies.

Limit on investment: how much they can invest in a year before milestones are achieved

Limits on offering: Co-investment, incurring expense, and hedging

Limits on Hiring: Consultants and advisors to execute the portfolio management

Private Equity (6 decks)

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