What two roles do PE firms play in a partnership and how do carried interest and management fees line up with those two roles?
General Partner: 20% of distributions as incentive fee
Investment Advisor: 1.5 - 2-5% management fee of commited or invested capital
Describe the five stages of the life cycle of a VC fund
1) Fundraising: securing capital commitments from LPs
2) Investment Period: deploying committed capital into portfolio companies (3-5 years)
3) Monitoring: actively managing and adding value to portfolio companies
4) Exits: selling portfolio companies via IPOs, mergers or acquisitions
5) Liquidation: distributing proceeds to LPs and closing the fund
What are the three phases in the LP-GP relationship?
1) Entry and Establish: GPs build a track record to attract LP commitments
2) Build and Harvest: LPs maintain loyalty as GPs grow and succeed
3) Decline or Transition: LPs may lose trust or shift allocations if GP performance declines or market dynamics change
Describe bad-leaver and good-leaver clauses in PE partnerships
Good-Leaver clause: applies when a partner departs due to retirement, illness, or mutual agreement -> retains certain rights to carried interest and equity stakes
Bad-Leaver clause: activates if a partner exits under unfavorable circumstances (misconduct, breach of contract) -> rights to carried interest and other benefits are forfeited or reduced
What is a Club Deal?
- a collaborative investment by multiple PE firms to acquire a company
- this approach mitigates risk and pools resources, especially for large transactions, but can lead to coordination challenges
Discuss the following statement: empirical evidence indicates that investors in listed BDCs are subject to greater return volatility and enjoy less diversification benefits than investors in PE that is not publicly traded
- listed BDCs are publicly traded, subjecting them to greater market volatility and correlation with broader equity markets
- unlike private PE, listed BDCs provide less diversification as their valuations fluctuate with public markets rather than reflecting underlying asset fundamentals
- BDC investors also face lower returns due to public market inefficiencies compared to the illiquidity premium enjoyed by private PE investors
Why can PE fund of funds suit new investors?
- it provides diversification across multiple funds, reducing risk
- grants access to established PE managers
- mitigates the need for extensive due diligence expertise
What is the difference between a traditional PIPE and toxic PIPE?
Traditional PIPE: involves private placement of equity or equity-linked securities at a negotiated discount, often used for growth funding
Toxic PIPE: includes features (adjustable conversion ratios) that can lead to shareholder dilution and stock price depreciation, often favoring the PIPE investor at the expense of existing shareholders
Name 6 differences between typical PE and Hedge Fund fees
1) Fee Basis:
- PE fees are based on committed or invested capita
- HF fees are based on assets under management
2) Carried Interest:
- PE typically 20% of profits above a preferred return (hurdle rate)
- HF 20% of all profits with no hurdle rate
3) Management Fees:
- PE 1.5-2.5%, decreasing after investment period
- HF typically 2% of AUM throughout
4) Clawback Provisions:
- PE GPs return excessive carried interest if the fund underperforms
- HF no clawback provisions
5) Performance Measurement:
- PE focus on IRR and multiple on invested capital
- HF emphasize annualized returns
6) Investment Horizon:
- PE long-term (7-10 years)
- HF short-term, with frequent liquidity events
What are PE management fees and its purpose?
- annual charges paid by LPs to GPs to cover operational costs of managing a PE fund
- typically 1.5-2.5% of either committed capital (during funds investment period 3-5 years) or invested capital (after investment period)
- independent of fund performance
What is carried interest and its purpose?
- share of profits GPs earn from fund’s investments (performance-based)
- typically at 20% of profits after hurdle rate (typically 8%)
- clawback provisions require GPs to return excess carried interest if fund’s performance under hurdle rate
What are BDCs and key features?
- support growth and development of small to mid-sized companies
- provide private-equitiy-like capital with the liquidity of a publicly traded entity
- closed-end investment funds listed on public exchange
What is a PIPE?
a form of financing in which institutional or accredited investors purchase securities (stock or convertible instruments) directly from a publicly traded company at a discounted price -> provides the company with quick access to capital without public offering -> when in need of liquidity
