PE Definitions.pdf

Private Equity Definitions 1. Leveraged Buyout (LBO) Definition: A Leveraged Buyout is the acquisition of a company primarily using borrowed funds, often secured by the assets of the company being acquired. Example: Company A wants to acquire Company B valued at $100 million. Company A may put down...

Private Equity Definitions 1. Leveraged Buyout (LBO) Definition: A Leveraged Buyout is the acquisition of a company primarily using borrowed funds, often secured by the assets of the company being acquired. Example: Company A wants to acquire Company B valued at $100 million. Company A may put down $20 million in equity and borrow the remaining $80 million to complete the purchase. The intent is to pay down the debt through Company B's cash flows or by selling its assets. 2. General Partner (GP) Definition: In the context of Private Equity, the General Partner is the individual or entity responsible for managing a private equity fund. GPs make investment decisions and often co-invest in the fund. Example: In a Private Equity firm called "HighValue Capital," the team of professionals who decide which companies to acquire are the General Partners. They are also responsible for fund management and typically earn management fees and a percentage of the profits (carried interest). 3. Limited Partner (LP) Definition: A Limited Partner is an investor in a private equity fund managed by a General Partner. LPs provide capital but do not participate in the day-to-day management of the fund. Example: A pension fund investing $50 million in "HighValue Capital" would be a Limited Partner. They contribute capital but rely on the General Partner to make investment decisions and generate returns. 4. Internal Rate of Return (IRR) Definition: IRR is the discount rate that makes the net present value (NPV) of all cash flows from an investment equal to zero. Example: If an investment of $1 million in a start-up returns $2 million in five years, the IRR would be approximately 14.87%. 5. Carried Interest Definition: This is a share of the profits of an investment that the general partner receives as compensation. Example: In a fund with a "2 and 20" structure, the GP takes 20% of the fund’s profits as carried interest. 6. Management Fee Definition: Fees paid by the limited partners to the general partner for managing the private equity fund. Example: In a "2 and 20" structure, the 2% represents the annual management fee on the total assets under management (AUM). 7. Due Diligence Definition: The rigorous investigation of a potential investment, involving financial, legal, and operational assessment. Example: Prior to acquiring a tech company, a PE firm would scrutinize its intellectual property, contracts, and financials. 8. Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) Definition: A measure of a company's operational profitability. Example: For a company with an income of $10M, interest of $1M, taxes of $2M, depreciation of $1M, and amortization of $1M, the EBITDA would be $6M. 9. Private Placement Definition: The sale of securities to a small group of private investors. Example: A start-up raises $5 million by selling equity stakes to five accredited investors. 10. Fund of Funds Definition: An investment strategy where a fund invests in multiple other types of funds. Example: A Private Equity Fund of Funds might invest in venture capital, buyout, and mezzanine funds. 11. Direct Investment Definition: An investment directly into a single entity, bypassing any pooled mechanism like a fund. Example: Instead of going through a PE fund, an institutional investor directly buys a 10% stake in a private company. 12. Dry Powder Definition: Unallocated capital that a private equity firm has available for investment. Example: A PE fund with $100 million in committed capital but only $20 million invested has $80 million in dry powder. 13. Capital Call Definition: A demand by a private equity firm for a portion of the committed capital from its limited partners. Example: Upon finding an investment opportunity, the GP might call 20% of the LPs' committed capital to finance the deal. 14. Clawback Definition: A provision that allows investors to reclaim part of the general partner's carried interest under certain conditions. Example: If a fund loses money in later investments, the LPs can use clawback to recoup some of the carried interest previously paid to the GP. 15. Distribution Waterfall Definition: A legal framework outlining the process for distributing the profits generated from an investment among the investors and the fund manager. Example: Profits might be distributed first to LPs until they achieve a certain return, then split with the GP. 16. Portfolio Company Definition: A company that is owned or managed under the umbrella of a private equity firm. Example: If a PE firm buys a majority stake in a software company, that company becomes a portfolio company. 17. Co-investment Definition: Direct investment in a company alongside a private equity fund. Example: An LP co-invests $10 million directly into a tech company that the PE fund also invests in. 18. Mezzanine Financing Definition: A hybrid of debt and equity financing typically used to fund acquisitions. Example: In a $100 million acquisition, a PE firm might use $50 million of equity, $25 million of senior debt, and $25 million of mezzanine financing. 20. Convertible Notes Definition: A debt instrument that can be converted into equity at a future date. Example: An early-stage start-up might issue convertible notes that convert into equity at a Series A fundraising round. 21. Lock-up Period Definition: A time frame during which investors are restricted from selling their shares. Example: Following an IPO, a 180-day lock-up period is common to prevent insiders from immediately selling their shares. 22. Tag-Along, Drag-Along Rights Definition: Clauses that protect minority shareholders by giving them the right to join (tag-along) or force them to sell their shares (drag-along) in certain transactions. Example: If a majority shareholder sells their stake, tag-along rights allow minority shareholders to join the deal on the same terms. 23. Anti-Dilution Provisions Definition: Contractual measures that protect an investor from dilution resulting from subsequent equity offerings at a lower valuation. Example: If a company issues new shares at a lower price, anti-dilution provisions can adjust the price of existing shareholders' shares. 24. Exit Strategy Definition: A planned approach to monetize an investment, often through a sale or IPO. Example: A PE firm may plan to exit an investment via a strategic sale to a larger competitor within 5 years. 25. Preferred Stock Definition: A class of stock with preferential treatment in terms of dividends or asset distribution. Example: Preferred stockholders may receive dividends before common stockholders. 25. Secondary Market Definition: The marketplace where previously issued financial instruments, like stocks and bonds, are bought and sold. Example: In PE, the secondary market can involve the sale of an LP’s interest in a fund to another investor. 26. Deal Sourcing Definition: The process of identifying potential investment opportunities. Example: A PE firm might have an in-house team focused solely on sourcing deals or might leverage industry contacts. 27. Syndication Definition: The process of involving multiple investors or lenders to fund a deal. Example: A large buyout may be too risky for a single investor, leading to syndication where risks and returns are shared. 28. Term Sheet Definition: A non-binding document outlining the basic terms and conditions under which an investment is made. Example: A term sheet sets the groundwork for more detailed, legally binding documents like the Share Purchase Agreement. 29. Hurdle Rate Definition: The minimum rate of return on an investment required by a manager or investor. Example: If a PE firm has a hurdle rate of 8%, it won’t consider investments expected to earn less. 30. Capital Structure Definition: The mix of debt, equity, and other financing sources used by a company. Example: A company with a high level of debt compared to equity has a leveraged capital structure. 31. Financial Sponsor Definition: An investment firm, often a private equity firm, that makes investments in companies and takes an active role in management. Example: A financial sponsor might lead a buyout, providing both capital and strategic guidance. 32. Enterprise Value (EV) Definition: A measure of a company's total value, taking into account not just its equity but also its debt and excluding its cash and cash equivalents. Example: EV gives a more comprehensive picture of a company's worth than market capitalization. 33. Vesting Definition: The process by which an employee gains ownership of employercontributed assets over time. Example: In private equity, a common vesting schedule might be a four-year vesting period for a management team. 34. Cap Table Definition: A table providing an analysis of a company’s percentages of ownership, equity dilution, and value of equity in each round of investment. Example: A cap table is crucial in a funding round to understand how ownership gets diluted. 35. Earn-out Definition: A contractual provision stating that the seller of a business will receive additional payment based on the business achieving certain financial metrics. Example: Earn-outs are often used to bridge a valuation gap between a buyer and a seller. 36. Debt-to-Equity Ratio Definition: A financial metric indicating the relative proportion of shareholders' equity and debt used to finance a company's assets. Example: A high debt-to-equity ratio often means a business has aggressive financing practices, which might be risky. 37. Exit Multiple Definition: A ratio used to estimate the expected payoff from an investment, usually calculated by dividing the exit enterprise value by certain financial metrics like EBITDA or revenue. Example: If a PE firm buys a business for $100 million and sells it for $300 million, the exit multiple is 3x. 38. Accredited Investor Definition: An individual or institutional investor who meets specific regulatory criteria, including income, net worth, asset size, governance status, or professional experience, allowing them to participate in higher-risk, higher-reward investment opportunities. Example: In the United States, an accredited investor is generally someone with a net worth of at least $1 million, excluding the value of their primary residence. Pro-rata Rights Definition: The right but not the obligation for an investor to maintain their percentage ownership in a company by buying a proportional number of shares in any future issuance of the company's equity. Example: If you own 10% of a startup and it decides to issue more shares, prorata rights allow you to buy enough new shares to maintain your 10% stake. Downside Protection Definition: Strategies or features within an investment agreement designed to limit the investor's potential losses. Example: A common form of downside protection in venture capital is the use of liquidation preferences, which ensure that the investor gets paid back before other stakeholders in the event of a company sale. Vesting Definition: The process by which an employee or investor earns the right to receive full ownership of an asset over time, often stock options or shares. Example: In many startups, employee stock options typically vest over a four-year period, with a one-year cliff. Cap Table Definition: Short for "Capitalization Table," this is a spreadsheet or table that provides an analysis of a company's percentages of ownership, equity dilution, and value of equity in each round of investment. Example: A cap table will show that the founders own 60% of the company, while investors own the remaining 40%. Earn-out Definition: A provision that allows the seller of a business to obtain additional payment based on the future performance of the business sold. Example: In an M&A deal, the acquiring company might offer an earn-out based on the target's revenue over the next three years. Debt-to-Equity Ratio Definition: A financial metric used to evaluate a company's financial leverage, calculated by dividing its total liabilities by its stockholders' equity. Example: If a company has $100 million in debt and $50 million in equity, its debt-to-equity ratio would be 2.0. Exit Multiple Definition: A valuation metric that compares the valuation of a company at exit (e.g., sale, IPO) to a specific financial metric such as EBITDA, used to assess the return on investment. Example: If a company is sold for $200 million and had an EBITDA of $25 million, the exit multiple would be 8x. 39. 40. 41. 42. 43. 44. 45.