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initial public offering results in the highest exit value due to increased liquidity, greater access to capital, potential to hire better managers- secondary market sales to other investors or firms results in the second highest company valuation after IPO- in management buyout, the company is sold to management, who utilize a large amount of leverage- a liquidation is pursued when a company is deemed no longer viable and usually results in low exit value
POST = PV (exit value)PRE = POST - INV (investment made)f = INV/POST
(the fraction of VC ownership for the VC investment)or f = FV (INV)/exit
valueCalculate number of shares issued to the VCShareVC =
SharesFounders x f/(1-f)Price/share = INV/share VC
stated total maximum size of PE fund, specified as an absolute figure,
signals GP's ability to manage and raise capital for a fund; negative
signal if actual funds ultimately raised are significantly lower than
target
if the fund underperforms, GP is required to pay back a portion of the
early profits to LPs (usually settled at the terminal of the fund but
can be settled annually - true-up)
specifies the allocation of equity between stockholders and management
of the portfolio company and allows management to increase their
allocation, depending on performance
paid to GP for fund investment banking services, such as arranging a
merger; these fees are usually split evenly with the LPs and when paid,
are deducted from management fees
GP's share of the fund profits and is usually 20% if profits (after management fees)
measure LP's realized return and is the cumulative distributions paid
to the LPs divided by the cumulative invested capital (net of management
fees and carried interest); it is also referred to as the cash-on-cash
return
investment cost + earnings growth + increase in price multiple + reduction in debt = exit value
net of management fees, carried interest, and other compensation to
GP; is the relevant measure for the cash flows between the fund and LPs
and is therefore the relevant return metric for LPs
NAV after distributions in prior year + capital called down - management fees + operating results
- transaction cost- investment vehicle fund setup costs- audit costs-
management and performance costs- dilution costs: as discussed
previously, additional rounds of financing and stock options granted to
portfolio company management results in dilution- placement fees:
placement agents who raise funds for private equity firms may charge
up-front fees as much as 2% or annual trailer fees as a percent of funds
raised through limited partners
companies that private equity firms invest in; sometimes referred to as investee companies
the outside investor who makes an investment in the fund offered by PE firm
carried interest is calculated on the entire portfolio1) carried
interest can be paid only after the entire committed capital is returned
to LPs2) carried interest can be paid when the value of the portfolio
exceeds invested capital by some minimum amount (typically 20%)
- unpredicted cash flow and product demand- weak asset base and newer
management teams- less debt, unclear risk and exit- high demand for cash
and working capital- less opportunity to perform due diligence- higher
returns from a few highly successful companies- limited capital market
presence- company sales that take place due to relationship- smaller
subsequent funding- general partner revenue primarily in the form of
carried interest
capital utilized by GP; can be specified in percentage terms as the
paid-in-capital to date divided by the committed capital (can be
cumulative PIC called down)
liquidity risk; unquoted investment risk; competitive environment
risk; agency risk; capital risk; regulatory risk; tax risk; valuation
risk; diversification risk; market risk
measures LP's unrealized return and is the value of LP's holdings in
the fund divided by the cumulative invested capital, net of management
fees and carried interest
IRR that the fund must meet before GP can receive carried interest, usually from 7% to 10% an incentivizes the GPs
the year the fund was started and facilitates performance comparison with other funds
specifies the method in which profits will flow to the LPs and when GP
receives carried interest - deal-by-deal: carried interest can be
distributed after each individual deal. Disadvantage: one deal could
earn $10million and another could lose $10million, but GP will receive
carried interest on the first deal, even though overall return is not
positive
- manager's compensation tied to the company's performance- tag-along,
drag-along clauses ensure that anytime an acquirer acquires control,
they must extend the acquisition offer to all shareholders and
management- board representation- Noncompete clauses: founders cannot
compete- Priority in claim: PE firms have priority if the portfolio
company is liquidated- Required approval by PE firm for changes of
strategic importances- Earn-outs: acquisition price paid is tied to
portfolio company's future performan
if a key exec leaves the fund or does not specify sufficient amount of
time at the fund, GP may be prohibited from making additional
investments until another key exec is selected
- no secondary market for investment- NAV will be stale if it is only
adjusted when there are subsequent rounds of financing- no definitive
method for calculating NAV- undrawn LP capital commitments are not
included in NAV calculation but are liabilities for LP- different
strategies and maturities may use different valuation methodologies- GP
usually value the fund
- private equity funds have returns that tend to persist; the fund's
past performance is useful information (out performers tend to keep
outperforming and under performers tend to keep underperforming or go
out of business)- the return discrepancy between out performers and
under performers is large (most as 20%)- private equity investments are
usually illiquid, long-term investments; the duration is usually shorter
than expected because when a portfolio company is exited, the funds are
immediately returned
limited partnership where limited partners provide funding and have limited liability; general partners manage the fund
measures LP's realized and unrealized return and is the sum of DPI and RVPI, net of management fees and carried interest
- the ability to reengineer the company- the ability to obtain debt
financing on more favorable term- superior alignment of interests
between management and private equity ownership
NAV before distribution - carried interest - distribution
allows LPs to invest in other funds of the GP at low or no management
fees; provides the GP another source of funds; prevent GP from using
capital from different funds to invest in the same portfolio company- a
conflict of interest would arise if the GP takes capital from one fund
to invest in a troubled company that received capital earlier from
another fund
this specifies the fund performance information that can be disclosed;
note that the performance information for underlying portfolio
companies is not disclosed
life of the fund, usually years
reflect the risk that the company may fail in any given year;
valuation of venture capital is highly dependent on the assumption used r
= (1+r)/(1-q) - 1where:r = discount rate unadjusted for probability of
failureq = probability of failure
fees paid to GP on an annual basis as a percent of paid-in-capital invested, commonly 2%
the IRR can be calculated gross or net of fees; gross IRR reflects the
fund's ability to generate a return from portfolio companies and is the
relevant measure for cash flows between the fund and portfolio
companies
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