Private Equity Session 1 - Introduction

The total value of a company calculated by adding its equity value to its outstanding debt and subtracting cash on hand.

A financial metric used to value a company's assets by considering its earnings before interest, taxes, depreciation, and amortization.

A method of valuing a company's future worth by discounting its projected future value based on a high required rate of return.

A document outlining a company's business strategy, market niche, resource needs, and financial projections, used by Venture Capital (VC) investors to make investment decisions.

An option that gives the holder the right, but not the obligation, to buy another option at a predetermined price in the future. A VC investment can be viewed as a series of options that grant the investor the right to invest in subsequent stages of the venture.

A type of investment that focuses on companies with high growth potential, typically occurring after the initial VC stages and before an IPO or buyout.

A minority equity investment that provides the investor with a significant share in liquidation proceeds, often structured as convertible preferred stock or debt.

A stage of investment that focuses on providing funding to support the growth of a company's revenue and profitability.

A method of valuing VC assets based on the company's earnings before interest, taxes, depreciation, and amortization (EBITDA) and a multiple applied to that figure.

The rate of return required by venture capitalists to justify their investment, calculated as a percentage.

The final financing round before a company goes public (IPO) or is acquired.

The process of acquiring a controlling interest in a company using a significant amount of debt financing.

Publicly traded funds with underlying assets like equity or equity-like positions in small private companies.

A closed-end fund structure facilitates liquid ownership of illiquid assets like shares in private companies.

Private fund structures with underlying assets composed of private PE funds. They offer access to multiple PE funds, but come with double layers of management and incentive fees.

Privately issued equity or equity-linked securities placed outside of a public offering. Used by publicly traded companies to raise capital directly from investors.

An IPO is more likely for an LBO than for a VC deal because LBOs typically involve established companies with a clear path to profitability and a stronger track record, making them more attractive to public investors.

Funds of funds can be a good starting point for individuals new to private equity investing because they provide access to a diversified portfolio of private equity funds with less risk than individual investments.

BDCs do not always diversify portfolios better than listed equities because their performance is closely tied to the performance of the broader equity market.

Investing in private equity successfully requires specific skills, including building wide networks, making sound investment judgments, and assembling well-balanced portfolios.

Loan market where institutions and individuals lend money to borrowers directly, bypassing traditional banks.

Large institutions, such as banks or funds, that specialize in lending large sums of money to businesses and individuals.

A type of loan that is not backed by an underlying asset, such as a house or car. These loans are considered riskier and typically carry higher interest rates.

The difference between the interest rate a borrower pays on a loan and the interest rate a lender earns on the same loan. It is often used as a measure of risk.

A rating system used to assess the creditworthiness of borrowers, which in turn influences the interest rates they pay.

Large loans that are typically too big for traditional banks to handle. They are often issued by specialized institutions in the primary and secondary loan markets.

These types of loans are issued by banks in the traditional sense.

Investment banks that are actively involved in lending and providing financial services.

A requirement imposed by a lender that a borrower must maintain a minimum income level to ensure interest payments can be made.

A prohibition placed on a borrower by a lender, restricting certain actions like increasing debt levels.

A covenant that requires the borrower to take or avoid specific actions when a particular event happens. For example, maintaining a debt-to-EBITDA ratio below a certain limit.

A type of covenant stricter than an incurrence covenant, requiring the borrower to meet a specified condition periodically, such as every quarter. This gives lenders early warning of potential problems.

The mix of debt and equity used to finance a company's operations.

The order of priority for different types of debt and equity in a company's capital structure, determining how much each investor gets in a bankruptcy scenario.

The percentage of the original investment that a creditor can expect to recover in the event of a company's default.

The ability of a lender to control risk through covenants by limiting the size of the loan relative to the value of the company's assets.

A hybrid form of financing that combines debt and equity characteristics. It offers a higher return than traditional debt but lower risk than equity.

A type of debt financing typically used by companies that have reliable cash flows, but may not qualify for traditional bank loans. It often involves higher interest rates than traditional debt, but also includes equity kicker.

A provision that gives the mezzanine debt holder the right to purchase equity in the company at a pre-defined price (usually a very low strike price). This is often used to increase returns for the mezzanine debt holder.

A security that gives the holder the right to buy a certain number of shares in a company at a specific price (strike price) within a certain period of time.

Mezzanine financing is typically used by companies that are too small or risky for traditional bank loans, but not yet ready for public markets. This is due to inefficiencies and imperfections in the capital market for these companies.

Mezzanine financing can lower overall capital costs for a company by reducing the need for equity financing. This is because mezzanine debt holders are willing to accept a higher risk than traditional debt holders.

Mezzanine debt is often seen as an equity investment due to the potential for a higher return through the equity kicker. However, it is still technically considered debt.

Mezzanine financing typically involves negotiated transactions between the lender and borrower, making it less liquid than traditional debt or equity markets.

VC investments are typically valued using EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and a multiple applied to it.

In VC modeling, the future enterprise value is discounted using a high required rate of return, which is typically reflected in the target IRR (Internal Rate of Return).

A compound option is the right, but not the obligation, to invest additional capital at a later stage, similar to buying a call option in finance. This option can be exercised or abandoned at the expiration date.

Identifying underestimated potential in projects, gathering information to assess profitability, and abandoning failing investments without attachment to sunk costs are key to successful VC investing.

Growth equity is a later stage investment after VC, often used for expansion or IPO readiness. It's not clearly separated from late-stage VC, and the stages can overlap.

Growth equity valuation uses projected future revenue and a revenue multiple to estimate the future enterprise value.

Leveraged Buyouts (LBOs) involve acquiring control of a company with significant debt financing, aiming to improve profitability through operational improvements and debt repayment.

An LBO differs from traditional investments by using a large amount of debt to finance the acquisition and focusing on improving the acquired company's profitability and debt repayment.

Loans with high interest rates and low credit ratings, often used for acquisitions, refinancing, or working capital.

This strategy aims to invest in young companies that have high growth potential but lack a strong track record. The goal is to help them grow into publicly traded companies.

This strategy focuses on providing capital to companies that have already demonstrated growth and are on the brink of IPO. These companies are larger and have a more established track record.

This strategy involves acquiring a publicly traded company, taking it private, and then often taking it public again after some improvements. The goal is to create value by improving operations and financial performance.

Venture capital (VC) invests in early-stage companies with high growth potential but limited track records. They aim to help these companies grow into large, successful businesses.

VC securities are privately held stakes in companies, often in the form of stock or equity-linked securities. Their goal is to become larger and eventually go public.

VC exits are the ways in which investors realize their gains from VC investments. The most common exit strategy is through an IPO, where the company goes public and investors sell their shares.

Investing in VC requires understanding that big wins need to cover many failures. Not all investments will be successful, but the ones that do can generate significant returns.

The amount of capital that investors have committed to a PE fund but has not yet been called upon by the fund manager. It represents the fund's potential to make future investments.

A type of private equity fund where investor commitments are called only as needed.

A limited partnership structure where investors (Limited Partners) provide capital and share in profits, but liability is limited to their investment. The general partner (GP) manages the fund and has unlimited liability.

A private equity investment strategy where the investor focuses on both the value of the underlying asset and the potential to improve the company's value.

PE funds act as financial intermediaries by pooling capital from investors, investing in private companies, and providing management expertise. They bridge the gap between investors seeking high returns and private companies needing funding.

The most senior debt security in a company's capital structure, most likely to be repaid with equity during a reorganization.

The process where a PE fund raises capital from investors to invest in private companies. This capital is committed but usually not collected until needed for specific investments or expenses.

Bonds are publicly traded debt securities with higher liquidity, while loans are privately traded and more illiquid, requiring an illiquidity premium.

The stage where the PE fund actively seeks potential investment opportunities. This involves analyzing business plans, conducting due diligence, and assessing the company's potential for growth.

Loans are typically the most senior debt instrument in the capital structure, with a higher recovery rate in bankruptcy than bonds.

The stage where the PE fund manager decides which companies to invest in and allocates capital from the fund. This involves making capital calls to the investors (Limited Partners) to draw down committed capital to fund the investment.

Bonds typically have fixed interest rates and are not callable, while loans often have floating rates and are callable.

The stage where the PE fund actively manages its portfolio companies through monitoring performance, providing guidance, and seeking to maximize returns. This can involve improving operations, restructuring, or finding strategic buyers.

When interest rates rise, fixed-rate debt declines in value, and this risk is measured by duration.

The stage where the PE fund seeks to exit its investments, typically through an IPO (Initial Public Offering), a sale to another company, or a buy-back by the management team. This strategy aims to maximize returns for investors

Floating rate coupons adjust periodically to new market interest rates, minimizing interest rate risk.

An investment advisor assists private equity firms in managing their funds. The investment advisor often operates as a separate entity and receives a management fee for their services. The investment advisor agreement outlines the advisor's responsibilities, including where to invest, and the management fee is a crucial aspect of the agreement. Typically, the investment advisor is owned by the general partner (GP).

Institutional investors like pension funds, insurance companies, and state funds are major contributors to private equity investments. They often provide significant capital, representing a large percentage of the total money invested in private equity. Examples include CalPERS (California Public Employees' Retirement System) in the United States and CPP (Canada Pension Plan) in Canada.

The most direct way to invest in private equity is by directly investing in companies. This way, you don't require a fund to facilitate your investment.

A fund-of-funds is an indirect approach to investing in private equity. The investor invests in the fund-of-funds, which then invests in other funds that ultimately invest in companies.

Private equity investors can also invest directly in a fund. This approach allows them to participate in a fund's investments without managing the fund themselves.

Co-investments involve investors who are already part of a fund also directly investing in a company. They buy shares alongside the fund, allowing them to save on fees since they are directly invested in the company. Typically, investors allocate around 90% of their capital to the fund and 10% to co-investments.

Private equity funds typically raise capital from investors but don't collect it all at once. Instead, they draw down capital as needed when they make investments. Investors are required to provide the committed capital on a short timeline when the fund asks for it.

Personal networks play a crucial role in sourcing private equity investments. Venture capitalists often rely on their connections and industry relationships to identify promising opportunities.

A method of calculating returns that assumes reinvestment at a predetermined rate, aligning manager and investor interests and avoiding manipulation.

A metric used to measure the return on individual investments within a private equity fund, as opposed to the fund as a whole.

A situation where one can manipulate cash flows to inflate the IRR, even if it leads to a decrease in the overall value of the investment.

A weakness of IRR where it's difficult to compare returns against benchmarks like stock indices because of varying investment patterns over time.

A situation where IRR calculations produce multiple solutions or don't converge due to complex computational processes.

The percentage of the original debt amount that creditors can expect to recover from a company's assets in a bankruptcy scenario.

A type of bankruptcy where a company negotiates with its creditors to restructure its debts and continue operating. This is usually preferred for companies with strong potential but struggling financial performance.

A type of bankruptcy where all creditors get a fair share of the company's assets based on their priority, with senior debt holders usually getting paid before junior debt holders and equity holders.

Investing in debt securities of companies facing financial distress or potential bankruptcy, often with the expectation that the company will restructure or recover through bankruptcy.

A pre-negotiated bankruptcy plan where creditors have already agreed to the terms before filing for bankruptcy, simplifying the process and potentially reducing costs.

A type of bankruptcy where a judge can impose a plan on creditors, even if they don't agree, if it's considered fair and in the best interest of all involved.

A method of valuing VC assets that uses EBITDA (earnings before interest, taxes, depreciation, and amortization) and applies a multiple to it.

A method of VC modeling where the estimated future enterprise value is discounted using a high required rate of return, often reflected by the target IRR (Internal Rate of Return).

The right, but not the obligation, to invest additional capital at a later stage in a VC-backed company. This can be viewed as buying a call option in finance.

A clause in a private equity fund agreement that allows limited partners (LPs) to reclaim incentive fees paid to general partners (GPs) if the fund's returns fall below a certain threshold.

The percentage of realized profits from a private equity fund that is distributed to the general partner (GP) as an incentive fee.

A minimum return that limited partners (LPs) must receive before the general partner (GP) starts to earn carried interest.

A situation where the design of fees and incentives in private equity funds can lead to fund managers taking excessive risks or making sub-optimal investment decisions.

A visual representation of the typical return profile of a private equity investment over time. It shows a period of initial negative cash flows followed by a sharp increase in returns.

The risk that an investor in private equity may not be able to easily sell their investment due to the lack of a liquid market for private company shares.

The relationship between the general partner (GP) who manages a private equity fund and the limited partners (LPs) who invest in the fund, evolving over time as the fund matures.

A clause in a private equity fund's investment agreement that ensures investors receive a return on their investment above a certain hurdle rate before the general partner receives any carried interest.

Private equity funds that use a significant amount of debt financing to acquire companies, aiming to improve profitability through operational improvements and debt repayment.

The fees charged by private equity fund managers to manage the fund, often a percentage of the fund's assets under management.

A clause in a private equity investment agreement that guarantees investors the same terms or better as any other investor in the fund.

The initial public offering process, where a private company becomes publicly traded on a stock exchange.

The process by which private equity investors exit their investments, typically through an IPO, sale to another company, or buyback by the management team.

A type of private equity fund that invests in other private equity funds, offering investors access to a diversified portfolio of private equity investments.