SESSION 1 Flashcards
the 2 forms of compensation that GPs receive
management fees + carried interest (carry)
paid based on committed capital because at the beginning of a fund’s life, the main workload is for the GPs to search and identify potential investments
management fees
a profit sharing arrangement that serves to align GP and LP interests
represents the share of profits generated by the fund that accrues to the GPs
carried interest (carry)
80% / 20 % structure is typical
20% goes to GPs
the maximum pledge of capital by LPs to a PE fund
committed capital
the amt of capital called by the GPs as investments are identified and funding is required for them
contributed capital
also known as: capital call, takedown, or drawdown
- contributed capital less management fees
- the amt of capital that is actually invested by the fund that can grow and produce returns
invested capital
( bc mgmt fees are used to pay the GPs salaries and admin Exp, those monies accrue to the GP and are not invested in portfolio companies )
the cumulative amt of contributed capital since fund inception
paid in capital
defines the priority of payments between GPs and LPs
waterfall agreement
GPs to not receive any carried interest until the LPs have been paid back the entirety of their capital contributed to the fund
make-whole (whole fund)
determines the amt of carry based on the amount of capital contributed to a specific deal
deal-by-deal
LPs are primarily interested in the fund performance net-of-fee-and-carry basis
net-of-fee
net ____ and net _____ are calculated based on cash flows to LPs
IRR ; TVPI
time weighted return that acocunts for the timing of the amount of capital calls
net IRR (internal rate of return)
sum of distributions to date plus the remaining undistributed vaklue of the funds assets divided by paid-in capital
net TVPI (total value of paid in cap)
- used to measure income to GPs
- paid up front and carry from distributions arise later in the fund life
- asseses the time weighting of the up front fees and the back end carry
- requires a discount rate to complete the calculate (assume 15% per yr)
NPV (net present value)
commited capital, mgmt fees, LPs share of profits, GPs share of profits are all _______
assumptions
capital calls, payment of management fees are events that occur at the ____ of year
beginning
cash flows, distributions from exits, payment of preferred return are events that occur at the ____ of year
end
performance metrics are measured beginning w the year of the fund’s inception
SI (since inception)
the year of the fund’s inception is known as its _____ _____
VY (vintage year)
time weighted return that accounts for the timing of the amount of the capital calls
NPV (net present value)
used to measure income to GPs
IRR (internal rate of return)
an asset class consisting of equity securities in operating companies that are not publicly traded on a stock exchange
*includes VC and buyout funds
private equity
_____ _____ is a critical component of modern finance
private equity
illiquid investments in equity of an operating company that is not publicly traded on a stock exchange
illiquid investments
terminology used for companies are under direct ownership of a PE investment firm
portfolio company
____ provide working capital to the portfolio company to nurture expansion, new product dev, or restructuring of the company’s operations, mgmt, or ownership
investments
____ _____ rarely invest directly in portfolio companies. instead they place their capital with PE firms that act as appointed managers betw the _____ _____ and the portfolio companies
pension funds ; xx
private equity funds are organized as ____ ______ are are formed and managed by management companies which are formed by the GPs of each limited partnership
also governed by the terms set forth in the LPA
limited partnerships
2 advantages of structure
- limited liability to investors (investors liability is limited in that they can lose no more than the sum of their total investments)
- pass through taxation (income generated from the partnership is taxed only once as it flows to the partners)
private investment vehicle that permits investors to pool their capital for investment in portfolio companies
PE fund
- managers of the day-to-day operations of the private equity fund
- manage relationships w investors
- manage portfolio companies
- operate w advisory committees (AC)
- report to LPs
- typically invest 1% in the fund which provides tacit assurance that they have a significant stake in the fund
GPs
investors in PE funds
- they do not influence day to day ops of the fund as doing so would cause them to lose their limited liability status
- they receive quarterly statements relating to portfolio companies receiving investment, capital deployed to date, investment returns + other matters
LPs
monitors the fund’s activities
advisory committee
- have legally bound limited lifetime
- typical lifetime of PE fund is 8-10 yrs
life limited entities
the period of time for which PE firms hold a portfolio company
holding period
companies that are not publically traded; hence there is no liquid market (valuation is uncertain)
illiquid
an event through which investors exit an investment. the event could be an IPO, private sale or merger
liquidity event (harvest)
desirable characteristics of an LP
- has been w fund for a long time
- understands PE cycles
- understands PE time frame
- responds quickly to capital calls
- brings connections and contacts
- brings a marquee name
memorializes the relationship between the GPs and the LPs and the provisions govern
- lifetime of the fund
- management fees
- expense reimbursements
- split of profits from exits
- sequence of distribution from exits
- extensions
- coinvestment
LPAs (limited partner agreements)
investors in PE funds
- pension funds
- foundations
- uni endowments
- corps
- banks
- insurance companies
- sovereign wealth funds
4 stages of a funds lifetime
- organization/fundraising (formulate fund strategy and promote funding) YEARS 0-1.5
- investment (originate deals and acquire companies) YEARS 1-4
- management (manage portfolio companies to increase value) YEARS 2-7
- harvest (exit through IPO or direct sale or liquidation) YEARS 4-10
fund promotions generally are accomplished through =
reputation, follow on investors, networking
once GPs raise sufficient funding that reaches their minimum target level
fund closing
some funds have 2 closings: “first” and “second and final”
3 models of deal sourcing
- rolodex model
- cold calling
- hybrid marketing model
investment teams are constantly in a fundraising mode
GPs will raise a fund on average every ___ to ___ years
2 1/2 ; 3
fund raising for the next generation fund begins __ years after closing of prior fund
3
most common investment strategies
- LBOs (CASES: panera bread, hertz, toysrus)
- VC
- leveraged recapitalization (CASE: hertz)
- growth capital (CASE: square)
- mezzanine capital (CASE: robosoft)
- secondaries (CASE: enfoca)
- distressed investments
- funds of funds
refers to a strategy of making equity investments as part of a transaction in which a company, business unit, or business asset is acquired from the current shareholders typically w the use of financial leverage
- companies involved in these transactions are typically mature and generate operating cash flows
- different from VC in which those investors invest in young or emerging companies and rarely obtain majority control
LBO (leveraged buyout)
a broad subcategory of PE that refers to equity investments made, typically in less mature companies, for the launch, early dev, or expansion of a business
- most often found in the application of new technology, new marketing concepts, and new products that have yet to be proven
- often subdivided by the stage of development of the company ranging from early stage cap (startups) to late stage + growth cap (used to expand existing business)
VC (venture capital)
_______ ______ are done to refund the PE fund’s cap inv w the diff between the new and initial debt
*high risk
- after LBO acquires a portfolio, it increases the initial lev of the acquisition
- distributes the diff betw the new lev and existing lev
- increase overall risk of LBO by reapplying lev during inv in portfolio co
- distribution (payout) reduces GPs incentive to outperform the business plan
leveraged recapitalizations
refers to equity investments, most often minority investments, in relatively mature companies that are looking for capital to expand/restructure ops or enter new markets or finance major acq w/o change of control of the business
- companies that seek this will often do so in order to finance a transformational event in their life cycle
growth capital
refers to subordinated debt or preferred equity securities that often represent the most junior portion of a company’s capital structure that is senior to the company’s common equity
*this form of financing is used by PE investors to reduce the amt of equity capital req to finance a LBO or major expansion
mezzanine
often used by smaller companies that are unable to access the high yield market, allows such companies to borrow additional capital beyond the levels that traditional lenders are willing to provide through bank loans
mezzanine capital
in compensation for the _____ ____, mezzanine debt holders req a higher return for their investment than secured or other more senior lenders
increased risk
- investments made in existing PE assets
- provide institutional investors w the ability to improve diversification, particularly for investors that are new to the asset class
- typically experience a diff cash flow profile
- made through 3rd party fund vehicle, structured similar to a fund of funds
- sellers of PE fund investments sell not only the investments in the fund but also their remaining unfunded commitments to the funds
secondaries
may be used by GPs to reach qualified investors
placement agents
may be used by LPs to assist in allocating capital
gatekeepers
capital available for investment
dry powder
the amt, typically 1%, that GPs invest in funds in order to provide LPs tacit assurance that they have a significant stake in the fund
‘skin in the game’
AUM
assets under management
