Private Equity (PE) and Venture Capital (VC)

• Study notes on Private Equity (PE) and Venture Capital (VC)

Introduction to Private Equity and Venture Capital

• Private Equity (PE) involves long-term capital investment in private companies, or publicly traded that are delisted, in exchange for equity stakes
• Venture Capital (VC) and Buyouts (LBOs) are included in PE
• Venture Capital (VC) represents a segment of PE, targeting early-stage companies exhibiting high growth potential
• Compared to other forms of investment, VC is riskier, but offers potential for higher returns
• Key players: Limited Partners (LPs), General Partners (GPs), and Entrepreneurs
• Limited Partners (LPs) are the investors who allocate capital
• Examples of LPs include pension funds and endowments
• General Partners (GPs) are responsible for fund management and investment decisions
• Entrepreneurs are founders looking for capital to establish and grow their start-ups

Stages of Venture Capital Funding

• Seed Stage provides initial funding for product development and market research
• Early Stage offers funding to scale operations and acquire initial customers
• Growth Stage provides funding for market expansion and scaling production

Venture Capital Valuation

• VCs assess companies to determine if they are "VC-backable"
• Determining if a company is "VC-backable" involves evaluating if the company addresses a significant problem
• Determining if a company is "VC-backable" involves evaluating if the solution is urgently needed
• Determining if a company is "VC-backable" involves evaluating if the solution is viable
• Valuation Methods include Discounted Cash Flow (DCF), Comparables, and the VC Method
• Discounted Cash Flow (DCF) estimates future cash flows and discounts them to present value
• Comparables use valuation multiples from similar companies
• VC Method estimates future exit value and discounts it back to present value

Key Performance Metrics in Private Equity

• TVPI (Total Value to Paid-In Capital) measures total value generated by a fund relative to the capital invested
• The formula for TVPI is: TVPI = (Distributed Value (DPI) + Residual Value (RVPI)) / Paid-In Capital (PIC)
• TVPI > 1.0 indicates a positive return
• TVPI = 1.0 indicates a break-even
• TVPI < 1.0 indicates a loss
• IRR (Internal Rate of Return) represents the discount rate that sets the NPV of cash flows to zero
• IRR accounts for the time value of money
• IRR assumes reinvestment at the same rate, which may not be realistic
• PME (Public Market Equivalent) compares private equity performance to public market benchmarks

Carried Interest

• Carried interest is the percentage of the fund's profits earned above a certain performance threshold (hurdle rate)
• For a fund that raises $100M and generates $150M in returns, the profit is $50M; with a carried interest of 20%, $10M goes to GPs and $40M to LPs

Exit Strategies

• IPO (Initial Public Offering) involves a company going public by offering shares on a stock exchange
• Acquisition involves a company being acquired by a larger firm
• Secondary Sale involves VCs selling their shares to other investors
• Liquidation occurs when a company fails, and its assets are sold to recover some capital