PE Flashcards
(27 cards)
what is private equity?
investment in the common equity, mezzanine capital or debt of a private or public (to take private) company with the objective of realizing an exit in the medium term.
how is the strategy based on debt acquisition in PE called? on what’s it based?
Debt-to-own, it requires a debt-to-equity swap to take control of the company
phases of private equity investment
-early stage
-expansion
-replacement and leveraged buyouts
-distress
what’s a take private transaction?
acquire public company through LBO, De list it, restructure it and resell it after 5-7 years.
what are the 2 investment approaches in terms of involvement?
1) Hands-on: when PE funds own the majority of the stake, (putting people in the Board of Director) they have a good business knowledge, and they tend to make the decision to let the company grow using a managerial approach.
2) Hands-off: when PE funds own the minority of the stake, the decisions are made by other shareholders, but the financial side of BS is handled by the PE funds.
what are the usual exit strategies?
The typical exit strategies are:
1) IPO: go public, usually through secondary/mixed IPO to transform the ownership of the shares.
2) Trade Sale: find a strategic buyer that aims to create synergies or sell to another PE fund.
3) Write-off: last resort when the company is doing bad, just write-it off from the balance sheet.
what are the 2 macro effects that caused a drop in the size of the PE market?
1) Raise of IR which made leverage too expensive from the buyer perspective and from the seller perspective low valuation of the firm.
2) Denominator effect: Institutional asset managers must have Unlisted asset below 5% of total asset. Due to the drop in price of equities and bonds (which does not affect PE assets due to illiquidity), the ratio between unlisted and total asset is increasing and they are pushed to sell their investments
what is the trend of Funds raised, Investments and dry powder?
funds raised face slow decrease, same is true for invested capital (AuM), dry powder as a consequence remains constant as a % of AuM
how can a PE firm deploy capital?
The PE firm can decide to deploy money in 3 ways:
* Direct Investments: buy the shares.
* Co-Investments: invest with another stakeholder when the PE firm cannot invest on its own
* Funds-of-Funds model: investing in another PE
difference between GPs and LPs
General Partners are the PE employee that provide management services and are responsible for investment selection, while Limited Partners are the funds providers.
what are the periods of the lifecycle of the PE fund?
There are three different periods:
- Fundraising Period: it is the period before the fund starts operating during which commitment from interested investors are collected.
- Investment Period: it is usually identified as year 0, and it is when the PE firm reach enough money (capital must be fully subscribed) and get authorization to start investing. It is usually long 5 years, and it is the period of collection of funds from investors and their deployment in companies.
- Management & Divestitures: after year 5, it can last up to 5 more years, and it is when PE firm liquidate their investments and harvest the money.
what’s the compensation scheme of PE firms?
- Recurring, so called Management Fee: it is usually around 2% of the committed capital on a yearly basis
- one off, so called Carried interest: it is an incentive for the managers to extract the highest value possible from the investments, and hence it is proportional to the extra value (usually around 20-25%)
what factors affect the percentage of management fee extracted?
The value depends on three different factors: mkt conditions, Early Bird (sooner joiner larger the discount) and Large Tickets (larger amount committed larger the discount).
difference between European and American carried interest
European considers capital gains once you gave back the commitment, while US firms consider gain on single investments even if you did not return the whole capital.
what are the three ways of computing carried interest?
There are three different ways to compute Carried interest:
- Simple Carried Interest: repay committed capital–> remaining part is split between investor (80%) and GP(20%)
- Hurdle Rate: (usually 8% on capital commitment). repay committed capital–> repay hurdle rate–> remaining part is split between investor (80%) and GP(20%)
- Hurdle Rate + Catch-up Clause: compared the classic hurdle rate way, it is more favorable for PE firms. repay committed capital–> repay hurdle rate–> Repay accrued carried interest to GPs (the 20% of total capital gain which was not paid out during distribution of hurdle rate)–> remaining part is split between investor (80%) and GP(20%)
what’s the standard performance measure? what are its weaknesses?
IRR, However it is based on two crucial assumptions: first of all, it is the return if the money are re-invested at the same rate and it also depends on the released vs unreleased investments. (realized vs unrealized IRR affected by widely different degrees of uncertainty)
what is total cash multiple? how is it tied to released cash multiple and unreleased cash multiple?
(Value of distributions to investors + value of unreleased portfolio)/(Invested capital + management fees) , it is equal to released + unreleased cash multiple, where the first only accounts for cash distributed and the second only for the value of unreleased investments.
what is the VC method?
. The VC Method is a way to calculate – given an expected future value of the firm – the price to pay today able to give the PE investor a desired rate of return (IRR) by discounting it at the required rate of return (which is much higher than the usual discount factor).
how can a VC investment be structured in terms of tranches?
The modality can be either Single Stage or Multiple Stage: whether the capital increase is provided in one tranche or more. The single stage is riskier and there is more dilution from the founder point of view. Hence, multiple stage investing is more used because it gives a lower level of uncertainty (different based on entering time) and allows to squeeze the value from investors.
how do you compute the stake required by the investor at time of exit?
(initial investment*(1+RR)^t)/(potential exit equity value)
how do you compute initial stake required by the investor when there are subsequent rounds of investments (dilution)?
(stake required at time of exit)/(100%-stake required at time of exit by all subsequent investors) where the denominator is also called “Retention ratio”
what are the 2 main clauses that affect a sale of shares in PE? who do they protect?
drag along–> protects majority
tag along–> protects minority
what are convertible preferred shares?
they are preferred shares that can freely be converted to common equity at the request of the VC/PE investor. in case the conversion is not favorable they repay the flat amount with seniority.
what are redeemable preferred shares? what is often introduced in a sale of RPS?
they are preferred shares that are first repaid for their initial investment flat, and then are converted into common equity and participate based on % on the remaining distributions. there is often a barrier for conversion, where if the sale surpasses a certain value the RPS are just converted into common equity and their notional is not repaid.
