Lecture 1

Question 1

What is private equity ?

Answer 1

Equity capital that is not quoted on a public exchange

Question 2

What is a venture capital fund ?

Answer 2

Financial intermediary = take investors’ capital and invest it directly in portfolio companies.

Question 3

What are the 4 types of PE funds ?

Answer 3

• Venture Capital
• Mezzanine
• Buyout
• Distress

Question 4

What is the maturity difference between PE and Hedge funds ?

Answer 4

PE has longer maturities (6 yrs vs few months)

Question 5

What is the venture capital flow of funds ?

Answer 5

1. Limited Partners (investors or LPs)
2. VC Funds managed by general partners
3. Portfolio companies
4. Exits = Sale of portfolio companies to public markets (IPOs) or to other companies
   → back to 1.

Question 6

What does it mean when a Venture Capital fund takes an active role ?

Answer 6

It monitors and helps the companies in his portfolio

Question 7

What does it mean when a Venture capital fund only invests in private companies ?

Answer 7

This means that once the investments are made, the companies cannot be immediately traded on a public exchange:
• No simple market to market
• No liquidity

Question 8

What is a Venture capital fund primary goal ?

Answer 8

Maximize his financial return by exiting investments through a sale or an initial public offering

Question 9

Depending on expected time to exit, a venture capital fund investment can be classified in three categories, which ones ?

Answer 9

• Early stage
• Mid-stage
• Late stage

Question 10

What are buyout funds ?

Answer 10

• They raise money from investors and acquire public companies with the purpose of making them private
• Deals are partially funded by debt = leveraged buyouts
• Buyout funds = largest category of private equity
• Operate internationally and not locally like venture capital funds

Question 11

Who uses a buy-and-build strategy and what is it ?

Answer 11

Buyout funds

Acquire and integrate businesses in a fragmented sector.

Question 12

What are mezzanine funds ?

Answer 12

Participate to the financing of late stage venture capital investments or buyouts. Often financing comes in form of subordinated debt.

Question 13

What are distress funds ?

Answer 13

Buyout firms that specialize in buyout of firms that have trouble meeting debt obligations

Question 14

How do most PE firms organize their activity ?

Answer 14

Set up PE funds which assume the legal form of limited partnerships. The same PE firm typically runs multiple PE funds at the same time

Question 15

What role do those PE firms assume ?

Answer 15

General Partners, responsible for making and managing the investments into private firms, which form the fund’s portfolio

Question 16

What is the role of investors ?

Answer 16

Finance the PE funds and are the limited partners, because their liability is limited to the amount invested.

Question 17

Who are the LP’s ?

Answer 17

• Angel investors
• Endowments
• Pension funds
• Corporations
• Sovereign wealth funds
• Intermediaries

Question 18

How is a PE partnership structured ?

Answer 18

• When fund is raised, LP’s promise to provide a certain amounts of capital at given dates or at the GP’s discretion
• Once committed capital has been raised, the fund has been closed
• Fund invests capital into portfolio companies within the investment or commitment period
• The fund can then make only follow-on investments in current portfolio companies
• Some investments will prove fruitful through IPO or buyout exit

Question 19

How are the capital provisions called ?

Answer 19

Capital provisions = capital calls, drawdowns or takedowns

Question 20

How is the total promised capital called ?

Answer 20

Total promised capital = committed capital

Question 21

What are the two annual management fees ?

Answer 21

• Level = amount/yr

* Basis = % of investment of committed capital or net invested capital

Question 22

What are lifetime fees ?

Answer 22

Total amount of fees paid over the lifetime of a fund

Question 23

What is an investment capital ?

Answer 23

= committed capital - lifetime fees

Question 24

What is an invested capital ?

Answer 24

= cost basis for investment capital of the fund that has already been deployed at a given point
or
part already paid from investment capital

Question 25

What is the net invested capital ?

Answer 25

= invested capital - cost basis of all exited and written-off investments or amount of money still under management

Question 26

What are carried interest ?

Answer 26

% of the realized fund profit, defined as cumulative distributions in excess of carry basis, that gets paid to GPs.

Question 27

What are the key terms in PE partnerships ?

Answer 27

``` 1. Compensation structure • Management fees • Carried interest 2. Covenants • Activities of the fund • Activities of individual GPs ```

Question 28

What are contributed capital ?

Answer 28

= invested capital + management fees that have been paid to date

Question 29

What is a fully-invested and completed fund ?

Answer 29

Contributed capital = investment capital + lifetime fees = committed capital

Question 30

What are priority return ?

Answer 30

For some funds, some minimum rate of return must be achieved by LPs before GPs receive carreid interest ! More common among late-stage funds than early-stage funds

Question 31

What ar catch-ups ?

Answer 31

Once priority return threshold achieved, catch-up period during which GPs receive disproportionately high ratio of profit until the aggregate profit is split according to the carry rule.

Question 32

What are the differences between priority with catch-up and without catch-up ?

Answer 32

* Priority with catch-up affects timing of CFs but not eventual aggregate profit split if sufficient exits (more common) * Priority without catch-up permanently affects eventual aggregate profit split

Question 33

What are the covenants on fund activities ?

Answer 33

* Investment focus * Investment size * Co-investments across funds * Reinvestments of profit (often permitted but restricted

Question 34

What does investment focus mean ?

Answer 34

``` The LPs want Gps to focus on their area of expertise • Limits investment in asset class other than private portfolio companies • Limits investment in sector/stage other than fund’s defined specialization ```

Question 35

What does investment size mean ?

Answer 35

GPs have incentive to place big bets and increase variance in fund returns → solution = limit size of a single investment

Question 36

What does co-investments across funds mean ?

Answer 36

• Later funds may be used to salvage investment gone away in earlier funds • GPs may do this when raising another fund → Solution = require approval by LPs, co-investment y earlier fund, or by third party

Question 37

What are the covenants on GPs ?

Answer 37

* No co-investment by GPs themselves | * Devotion to the fund

Question 38

What does it mean by co-investment by GPs themselves ?

Answer 38

LPs don’t want GPs to spend time on companies they’re personally invested with → Solution =? Require LPs’ approval, restrict investment size, timing and terms.

Question 39

What does the devotion to the fund mean ?

Answer 39

LPs want GPs to ve devoted to their fund • Future fundraising activities are not allowed till sufficient amount of investment is made for current fund • Sale of GPs’ interests not easily allowed • Inclusion of new GP’s = restricted

Question 40

Can invested capital be higher than committed capital ?

Answer 40

Yes, it can by reinvesting the profit