HomeMy WebLinkAboutReports - 2019.07.03 - 32241Introduction to Private Equity
A Primer for Institutional Clients
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Disclosure
This presentation is provided for educational and informational purposes only and should
not be regarded as investment advice or as a recommendation regarding any particular
course of action. This presentation contains forward -looking statements which may be
subject to various uncertainties which could affect the actual outcomes or results from
those indicated.
Past performance is no guarantee of future results.
AndCo Consulting is an investment adviser registered with the U.S. Securities and
Exchange Commission (“SEC”). Registration as an investment adviser does not constitute
an endorsement of the firm by securities regulators nor does it indicate that the adviser has
attained a particular level of skill or ability.
Proprietary and confidential. Not for distribution to the public. Certain information is based
on sources and data believed to be reliable, but their accuracy and completeness cannot
be guaranteed.
The source of all data, charts and graphs is AndCo Consulting unless otherwise stated.
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The Investment Challenge
Expected return from a traditional institutional portfolio will be challenged to
meet return targets.
Traditional asset classes (Equities and Fixed Income) tend to be highly
correlated.
Source: Expected return and correlation are from the “2019 JPMorgan Long -Term Capital Market Assumptions”
Equities Fixed Income
U.S. Large Cap 6.03%Core 4.06%
U.S. Mid Cap 6.79%High Yield 5.82%
U.S. Small Cap 7.47%
International 7.94%
U.S.
Large Cap
U.S.
Mid Cap
U.S.
Small Cap International Core FI
High
Yield
U.S. Large Cap 1.00
U.S. Mid Cap 0.96 1.00
U.S. Small Cap 0.90 0.95 1.00
International Equities 0.88 0.86 0.76 1.00
Core Fixed Income 0.00 0.00 -0.09 0.10 1.00
High Yield 0.68 0.73 0.64 0.74 0.20 1.00
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Addressing the Investment Challenge
Private Equity has characteristics that can address these challenges:
Two main reasons to include Private Equity within an institutional investor’s portfolio.
Risk -adjusted return potential
•Private equity has a performance target of 300 to 500 bps above public markets.
Lower correlation to other asset classes
•Non-perfect correlation provides diversification benefit.
Ultimately, these benefits improve the risk-return characteristics of a
traditional institutional portfolio, resulting in a more optimal asset allocation
for institutional investors.
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Defining Private Equity
Private Equity is broadly defined as investments in private companies that
are privately negotiated transactions and typically result in private
ownership of businesses.
Private Equity managers are typically independent organizations that often take an
active role in the management of a company in order to create value, enhance
returns, and exit successfully.
Private Equity investing spans a spectrum of investment stages and strategies, which
are generally defined as venture capital, growth equity, buyouts, and
distressed/turnaround.
Private Equity provides an alternative means of gaining equity exposure in portfolios.
Most investors access Private Equity by investing in illiquid, long -term, closed -end
partnerships (Private Equity funds) formed by Private Equity firms.
Private Equity managers may invest in publicly traded companies with the intent to
take them private.
Investors in Private Equity funds are limited partners (LP) investing alongside a
General Partner (GP), which is the Private Equity manager.
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Defining Private Equity
Style Venture Capital Growth Equity Buyouts Turnaround/
Distressed
Investment
Strategy
Investments are made in the
early life of the company, seed
stage, early stage and pre-
revenue
Typically companies have an
innovative business idea for a
proprietary product or service.
.
Provides expansion capital for
small, growing businesses, that
are generating cash flow and
profits.
Generally, these types of
investments have minimal
exposure to technology risk.
Investments in established,
performing companies that
may require capital to
expand and or restructure.
Company is often publicly
held but transaction takes
ownership private.
Investments in companies
that have poorly organized
capital structures or failing
operations.
Can include debt and equity
positions.
Main Sectors
Technology, Communications,
Software, Bio-tech, Healthcare,
Clean Tech
Diversified, Business Services,
Industrial, Consumer
Diversified, Business Services,
Industrial, Consumer
Diversified, Business Services,
Industrial, Consumer
Time Horizon
(post investment)8 to 12 years 5 to 7 years 5 to 7 years 3 to 4 years
IRR* Range/
MOIC**25% to 30%/3x 20% to 25%/2.5x 15% to 20%/2x 15% to 20%/2x
Primary Return
Drivers Capital Appreciation Capital Appreciation Current Income and Capital
Appreciation
Current Income and Capital
Appreciation
Unique Features
Highest risk and return potential.
Typical to have a single
investment drive entire portfolio
performance, the “Unicorn” or
“Decacorn”
Usually a minority investment,
companies that seek growth
capital will often do so to
finance a transformational
event.
Usually can not take on
additional debt.
Seek control positions.
Leverage used at managers
discretion.
Ideally, performance is
driven equally across
portfolio investments.
May involve the purchase of
distressed assets or debt
Countercyclical nature,
negatively correlated to
economic growth.
Shorter turnaround time
Common styles and characteristics of Private Equity:
*IRR –Internal Rate of Return
**MOIC –Multiple of Invested Capital
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Defining Private Equity
Common styles and characteristics of Private Equity:
The earlier an investment is made in a company’s life cycle, the higher potential risk and
return. Venture Capital is the earliest entry in a company’s life cycle while
Turnaround/Distressed is the latest. As companies develop, expand and mature, they
transition into the next phase and their attributes appeal to a different private equity
strategy.
•Venture Capital -not fully operating or profitable
•Growth Equity -rapidly growing and near profitability
•Buyouts -mature, operating cash flows, efficient capital structure
•Turnaround/Distressed -possible disruption due to business plan, market disruption, flawed capital structure
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Examples of Past and Present Private Equity Portfolio Companies
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Institutional investors began investing in the early 1970s, when regulatory and
tax law changes allowed U.S. pension funds to enter the asset class.
In the 1990s, private equity further came into acceptance as there was a
boom in investing and emergence of brand name firms managing multi-billion
dollar sized funds.
Between 1980 and 2005,the private equity market grew from $5 billion to $203 billion.
•As of January 2017,private equity assets under management stands at over $3.4 trillion with
$1.3 trillion waiting to be invested .
•On a global basis,private equity managers raised a close to record $406 billion in 2017 as
investors,new and experienced,look for performance better than public market offerings.
Because it has only been an institutional asset class since the 1970’s, private
equity is relatively young compared with traditional investment products and
will continue to evolve and grow.
Source: Preqin
Introduction to Private Equity
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Benefits of Allocating to Private Equity
Risk-Adjusted Return Potential
Private Equity is anticipated to generate an attractive long-term, risk-adjusted return profile relative to
equites and fixed income.
Return
Standard
Deviation
Private Equity*10.20 21.00
U.S. Large Cap 6.03 13.75
U.S. Mid Cap 6.79 15.75
U.S. Small Cap 7.47 18.25
International Equities 7.94 16.79
Core Fixed Income 4.06 3.50
High Yield 5.82 8.25
Source: Forecast returns are from the “2019 JPMorgan Long-Term Capital Market Assumptions”
*The JPMorgan assumptions for private equity are unlevered returns.
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Benefits of Allocating to Private Equity
Diversification
Private Equity typically has a lower correlation with equities and fixed income.
Private
Equity
U.S.
Large Cap
U.S.
Mid Cap
U.S.
Small Cap International Core FI
High
Yield
Private Equity 1.00
U.S. Large Cap 0.74 1.00
U.S. Mid Cap 0.76 0.96 1.00
U.S. Small Cap 0.69 0.90 0.95 1.00
International Equities 0.78 0.88 0.86 0.76 1.00
Core Fixed Income -0.27 0.00 0.00 -0.09 0.10 1.00
High Yield 0.69 0.68 0.73 0.64 0.74 0.20 1.00
Source: Correlations are derived from the “2019 JPMorgan Long-Term Capital Market Assumptions”
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Implementation Considerations
Buyout Funds Net IRR
$50M to $300M $300M to $1B > $1B
Top Quartile 29.4%24.8%20.1%
Median 18.1%14.0%13.7%
Bottom Quartile 9.1%7.8%8.8%
Spread between Top and Bottom (bps)2,030 1,700 1,130
Proper manager selection and access are critical to successful performance.
Private Equity performance can vary on a vintage year basis. There is even greater return
dispersion between quartiles within styles. Buyouts for example have performance ranges
between 1,130 and 2,030 basis points depending on fund and underlying investment size.
Source: Preqin data as of 9/30/2017; Preqin Buyout Funds data reflects all funds tracked since 1986.
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Private Equity Vintage Year Returns
Vintage Year Exposure: Returns can vary by year and style. Consistent and steady investment pacing
avoids picking bad and/or missing good vintage years and ensures diversification.
-5.0%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%Median IRRBuyout Venture Capital ALL PE
Source: Preqin data as of 9/30/2017
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An investor can gain access to Private Equity via multiple methods
Direct invest or co-invest -investing in a single company or co-investing alongside another
investor directly in single company interests,can require large capital commitments and is not
feasible for most investors.
Direct Funds -investing in a fund that invests in multiple single-company interests through a
limited partnership structure with a general partner is the more common approach to PE
investing .
Fund of Funds (FOFs)-for smaller commitments,a FOFs approach can be taken.
Secondary Funds –similar to FOFs but investments acquired are seasoned and bought from
initial investor typically at a discount.Can generate higher IRR but with a lower MOIC versus rest
of PE universe.
Implementation Considerations
Institutional Investor
PE Fund
10+ companies*
single company
PE Fund of Funds
PE Fund PE Fund PE Fund
PE Fund PE Fund PE Fund
100+*companies
Direct
*Chart for illustrative purposes only. Actual number of portfolio companies will vary by manager and strategy
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Implementation Considerations
Higher-Risk and Complexity -Lower
Lower –Diversification -Higher
Direct Investments /
Co-Investments Direct Fund Investments Fund of Funds (FOFs)Secondary Funds*
Vehicle Legal
Structure
Customizable or Delaware Limited
Partnership
Delaware /Offshore Limited
Partnership Delaware/Offshore Limited Partnership Delaware/Offshore Limited Partnership
Typical Investor
Size >$1 billion >$250 million >$25 million >$25 million
Investment
Minimum Typically >$10 million $5 –$10 million (negotiable)$5 million (negotiable)$5 million (negotiable)
Investment
Diversification
None, only achieved through making
multiple investments each year
One fund with 10+ underlying
investments
15 –25 underlying funds, which each
have 10+ underlying portfolio companies
(approx. 200+ underlying companies)
Similar to FOFs in addition blind pool risk
is eliminated as investments have existing
portfolio companies performing
Vintage Year
Diversification
None, only achieved through making
investments each year
Limited, only achieved through
making investments each year Typically 4 years At least 4+ years pending managers
discretion
Term Of
Investment
Highly dependent on transaction or
public markets, could be 1 year or as
long as 10 years
7 to 10 years plus extensions 10 to 15 years plus extensions 10 to 15 years plus extensions
Capital Deployment
Time Frame
(estimate)
Immediately after investment decision
is made, or up to 1 year 3 to 6 years 4 to 8 years 4 to 5 years
Typical Amount Of
Time Until
Receiving Initial
Distribution
Highly dependent on transaction or
public markets 3 to 5 years 3 to 5 years Can be within 1 year at a minimum, early
distributions may be offset by capital calls
Typical Fee Ranges
No management fee but have a
performance fee of 20% of profits over
a hurdle rate
1.5 –2.5% management fee on
commitment and a performance
fee of 20% of profits over a
hurdle rate between 6 –10%
Two layers of fees –1) similar to the fees
outlined in the “Direct Fund Investment”
column; and 2) 0.75 –1.50%
management fee on commitment and a
performance fee of 5 –10% charged on
profits over an 8 –10% preferred return
Two layers of fees –1) similar to the fees
outlined in the “Direct Fund Investment”
column; and 2) 0.75 –1.50%
management fee on commitment and a
performance fee of 5 –10% charged on
profits over an 8 –10% preferred return
*Secondary Funds are not the focus of this primer
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Implementation Considerations
Cash flow pattern: After commitment, capital calls are made during the investment period, which
typically is three to five years. Distributions occur as investments are partially or fully realized following
the manager’s exit strategy. Capital calls and distributions can happen simultaneously. Capital calls are
at discretion of manager and are not made on a consistent predictable basis.
Harvest Period
Investment Period
IRR%Capital Calls
Distributions
IRR %
J-Curve : Typical profile of private equity returns over the life of a partnership; IRR at the initial
investment is 0%, then drops during drawdowns for fees while manager sources opportunities and
invests, then trends upward with value creation, and finally plateaus as distributions are made and the
fund is liquidated. Investors will typically experience negative performance during the investment period.
Internal Rate of Return (IRR): Due to the unique timing of cash flows, IRR is the standard
performance measurement used for Private Equity. IRR is the rate at which the net present value (NPV) of
a project's cash inflows and outflows, measured over the project's life, equals zero. Considers cash flow
timing and amount.
The above chart is hypothetical and included strictly for illustrative purposes.
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Implementation Considerations –Risks and Unique Characteristics
Illiquid Investment:
•Private Equity funds are closed -end with finite terms. Investment can be locked up for 7 to 15
years, distributions typically start in years 3 to 5. There are limited options to exit early, which can
be challenging and costly.
Long-term nature:
•Given the unique and illiquid nature of the assets, performance is based on final realization. In the
interim, valuations are released quarterly for performance measures. Financial statements are
typically released 45+ days after quarter end.
•Blind Pool Investing:
•During initial fundraising periods, funds typically have not yet completed any investments. Thus,
there is no specific fund holdings data to analyze prior to committing to the fund, and investors
must rely on manager’s track record.
Benchmarking:
•Benchmarking is difficult because of the unique nature of the asset class. While there are a
number of benchmarks to choose from, each has its own quirks. Some investors prefer to use a
Public Market Equivalent (PME) to show Private Equity performance relative to a public equity
index.
•Fees:
•Fees for Private Equity funds are higher than public options. A 2% management fee and 20%
performance fee (carry) is standard. For Fund of Funds and Separate Accounts there is an
additional layer of fees and carry. Fees may be charged on commitment amount.
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Implementation Considerations –Risks and Unique Characteristics
Due to distributions possibly being received prior
to full commitment amount being called,the
value of PE investments will not reach targeted
commitment amount.As shown to the right,a
single commitment of $10M will peak at a value of
$7.3M in year six and decline if follow on
investments are not made.
Over-allocating will achieve target at expected
time frame.A single $18.6M achieves target in
year four.To remain at a 10%target for PE,
investor will then need to allocate $2 to $3 million
annually.Performance,however,will be driven by
the over-commitment in year one.
Calculated by historical commitment drawdown % and residual value to paid in capital % provided by Cambridge
Pacing:
When investors commit to invest in Private Equity, their investments are put to work over
time, unlike public investments that occur at a single starting date. Thus Private Equity
investors need to account for the pacing of contributions and distributions. The following
case study examines a $100 million plan with a 10% target to Private Equity and an
expected growth rate of 7.5% (no legacy investments).
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Implementation Considerations –Risks and Unique Characteristics
Pacing:
To achieve target with a diversified portfolio, a slow, steady, and consistent approach is
recommended. Investing $5M annually achieves and maintains target allocation after
year five. Thereafter, commitment amount required to maintain balance is reviewed
annually and may require adjustments.
Market environment can impact timing and size of capital calls and distributions. Most
private equity programs should expect actual market values to be above or below the
expected target and adopt a policy target with a band of +/-a specified %.
Calculated by historical commitment drawdown % and residual value to paid in capital % provided by Cambridge
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Implementation Considerations –Risks and Unique Characteristics
Leverage:
Though Private Equity funds typically do not carry leverage at the fund level, underlying portfolio
companies typically carry 40% to 70% leverage and are sensitive to credit market conditions.
Access:
Top performing managers can be selective in Limited Partner selection or refuse new investors.
This is more prevalent in VC as successful managers continue to only allow prior Limited Partners
into new funds.
Transparency:
Managers and portfolio companies are typically privately owned enterprises. Financial statements
are not publicly available. Managers protect their investment strategies and details as confidential
trade information.
Exit Strategy:
Exits are central to the Private Equity investing process, and a PE firm will consider a variety of
different exit strategies to realize its return on investment. The GP will seek to optimize value
through the most common PE exit strategies: strategic sale, initial public offering, secondary
buyout, or leveraged recapitalization. The market environment will influence which of these
strategies should be pursued.
Valuations:
Quarterly reporting is done by the Investment Manager in accordance with U.S.GAAP typically 45
to 60 calendar days after quarter-end .Annual audited financial statements are typically available
120 days after year-end .Performance is reported on a quarterly lag compared to public equity.
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Implementation Considerations –Risks and Unique Characteristics
UBTI:
Most funds will structure investments to minimize the impact of Unrelated Business Taxable
Income (UBTI). However, certain investments may result in the generation of UBTI. To remedy this,
managers may have offshore blocker vehicle options. Please consult your tax advisor to determine
the impact of UBTI.
ERISA Fiduciary:
Most Private Equity managers are not ERISA fiduciaries by accepting less than 25% of ERISA
commitments or by becoming exempt by registering as a venture capital operating company
(VCOC). If either of these cases, managers will not comply with ERISA standards.
Secondary investing:
Secondary investing is another method of private equity investing with a different return profile than
typical primary investing. Due to discounts realized at acquisition, a significant IRR can be
achieved. Underlying investments are seasoned and have already provided distributions and
going forward a lower MOIC is expected. Secondary investing can eliminate blind pool risk and
provide vintage year, strategy, and company level diversification. Performance can be cyclical
pending the market cycle.
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Implementation Considerations –Manager/Strategy Selection
What does AndCo look for when evaluating Private Equity managers?
Team stability
Due to the long -term nature of the investments, it is crucial to partner with a team that has had minimal turnover of
key professionals responsible for generating the firm’s track record.
Ability to add value through active management
We look for demonstrated capabilities of adding value through techniques such as adding key management
personnel, negotiating contracts, optimizing the capital structure, and pursuing strategic acquisitions.
Strong network for sourcing deal flow
A long history in the space provides the reputation and relationships needed to generate proprietary deals or
greater participation in limited auctions, which can drive higher returns.
Strong balance sheet for financing
Most private funds are levered at the portfolio company level, so an ability to access attractive terms on debt will
impact total return.
Valuation Policy
Valuations are conducted on a quarterly basis. Managers must follow industry standard best practices that are
audited annually by a third party.
Defined exit strategy
Closed -end funds have a finite life, managers need to demonstrate a clearly defined exit strategy for the assets.
Track record
Ideal managers have demonstrated an ability to generate net returns consistent with the investment strategy
across market cycles. Also, the ability to create balanced performance with proper sizing to investments is
important to our evaluation.
Terms
Fees and terms should be reasonable and consistent with institutional market standards.
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The Private Equity Opportunity
AndCo’s View
Allocating 5% to 10% of an institutional portfolio to Private Equity can be beneficial, depending on the
investor’s objectives.
We view Private Equity as a component of a long term strategic allocation, not a short-term trade idea.
We believe a steady and consistent allocation to private equity will further diversify a portfolio and add
return potential.
We typically avoid listed products promising private equity exposure. These can exhibit different risks
and characteristics that are not consistent with the private equity asset class.
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Alternative Investments: Broadly, investments in assets or funds whose returns are generated through something other than long positions in public equity or debt. Generally
includes private equity, real estate, and hedge funds.
Buyouts Investments made to acquire majority or control positions in businesses purchased from or spun out of public or private companies, or purchased from existing
management/shareholders public equity shareholders in “going private” transactions, private equity funds or other investors seeking liquidity for their privately –held investments.
Buyouts are generally achieved with both equity and debt. Examples of various types of buyouts include: small, middle market,large cap, and growth
Carried Interest: Also known as ‘carry’ or ‘promote’. A performance bonus for the GP based on profits generated by the fund. Typically, a fund must return a portion of the capital
contributed by LPs plus any preferred return before the GP can share in the profits of the fund. The GP will then receive a p erc entage of the profits of the fund (typically 20-25%). For
tax purposes, both carried interest and profit distributions to LPs are typically categorized as a capital gain rather than ordinary income.
Capital Commitment: The total out-of-pocket amount of capital an investor commits to invest over the life of the fund. This commitment is generally set forth on an investor’s
subscription agreement during fundraising and is accepted by the GP as part of the “closing” of the fund.
Catch–up: A clause in the agreement between the GP and the LPs of a private equity fund. Once the LPs have received a certain portion of their expected return, often up to the
level of the preferred return, the GP is entitled to receive a majority of the profits (typically 50%-100%) until the GP reaches the carried interest split previously agreed.
Co-investments –Investment made directly into a company alongside a General Partners investment, rather than indirectly through a fund
Crossover Funds: Contain both private and public securities in their portfolio. While this isn’t a new concept, managers of these funds may employ a long/short strategy with respect
to that portion of their portfolio that is held in the public securities.
Distressed Debt Investing: Practice of purchasing the debt of troubled companies, defaulted, on the verge of default, or seeking bankruptcy protection. Investors have been
referred to as “vultures” as they pick the bones of troubled companies. Investment structures of focus include subordinated d ebt, junk bonds, bank loans, and obligations to
suppliers. It is a way to gain an equity stake in the company as debt owed is forgiven in return for stock. They may try to help the troubled company regain its strength earning
significant returns as the value of the distressed debt recovers. Or Investors may be helping impatient creditors to cut their losses and wipe a bad debt off their books. The Distressed
Debt investor in return, waits for the company to correct itself and the value of the debt to recover. If a distressed company with under assessed strength is identified, the return can
be quite large.
Distribution: When an Investment by a private equity fund is fully or partially realized (resulting from the sale, liquidation, disposition, recapitalization, IPO or other means of
realization of one or more or more portfolio companies in which a GP has chosen to invest) the proceeds of the realization9s)are distributed to the investors. These proceeds may
consist of cash, or, to a lesser extent, securities.
EBITDA Multiple: A common earnings multiple in private equity. It is the total valuation of a deal divided by earnings before interest, taxes, depreciation, and amortization.
Efficient Frontier:The set of portfolios that maximizes the expected rate of return at each level of portfolio risk.
Fund of One: similar to a fund of funds but has a single investor as the sole limited partner. Portfolio can be constructed to investor’s unique objectives and preferences. Investor
retains opt-out and termination discretion.
General Partner (GP):A class of partner in a partnership. The GP makes the decisions on behalf of the partnership and retains liability for the ac tions of the partnership. In the private
equity industry, the GP is solely responsible for the management and operations of the investment fund while the LPs are passive investors, typically consisting of institutions and high
net worth individuals. The GP earns a percentage of profits.
Internal Rate of Return (IRR): The compound interest rate at which a certain amount of capital today would have to accrete to grow to a specific value at a specific time in the future.
Basically, it is the average return on capital over the lifetime of the investment. This is the most common standard by which GPs and LPs measure the performance of their private
equity portfolios and portfolio companies over the life of the investment. IRRs are calculated on either a net (i.e., including fees and carry) or gross (i.e., not including fees and carry)
basis.
J-Curve:The IRR of a private equity investment plotted versus time. The J-curve refers to the fact that net IRRs in the early years of a fund are generally negative, dominated by
drawdowns for fees and investments. As investments accrete in values and are gradually liquidated, returning capital and profits, the fund works through the J-curve and begins to
show positive IRRs and multiples of investors’ capital.
Private Equity Terms
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Leverage:The use of debt to acquire assets, build operations and increase revenues. By using debt (in either the original acquisition of the company or subsequent add -on
acquisitions), private equity investors are attempting to achieve investment returns beyond which they could achieve using eq uity capital. Increasing leverage on a company also
increases the risk that assets and revenues will not increase sufficiently to generate enough net income and cash flow to servic e the increased debt load.
Leveraged Buyout (LBO):The purchase of a company or a business unit of a company by an outside investor using mostly borrowed capital.
Limited Partner (LP):A passive investor in a Limited Partnership. The GP is liable for the actions of the partnership while the LPs are generally protected from legal actions and any
losses beyond their original investment. The LPs receive income, capital gains and tax benefits.
Management Fee: A fee paid to the Investment Manager for its services, typically as a percentage of aggregate capital commitments. Management fees in a private equity fund
typically range from 1.25% to 2.5% of commitments during the fund’s investment period, and then step down to the same or a lower percentage based on the fund’s “invested
capital” remaining in investments. Venture capital funds tend to have higher management fees than traditional private equity funds.
Mezzanine Debt Financing provided by a bank or specialized investment fund to invest in a debt instrument of lower credit quality relative to the senior debt in a company but ranking
senior to any equity claims. The instrument may include equity features such as warrants or options.
Multiple of Invested Capital (MOIC): The total return on an investment as measured by (Total Money Out)/(Total Money In). Multiple of cost and IRR are the two most common
measures of performance in private equity.
Preferred Return: Also sometimes called the ‘hurdle rate’. Preferred returns are typically found in buyout funds. After the cost basis of an investment is returned to the LPs, they will
also receive additional proceeds from the investment equal to a stated percentage, often 8%. Once the preferred return is paid, then the GP will be entitled to its carried interest on all
profits realized from the investment.
Private Equity-The private equity sector purchases the private stock or equity-linked securities of non-public companies that are expected to go public or provides the capital for
public companies (or their divisions) that may wish to go private. Since securities are non public and investments are illiquid,investors in the marketplace must be prepared for
investment horizons from 5 to 10 years. Investment vehicles can take the form of LPs, LLCs, Corporate Funds, and Fund of Fund s. Areas of specialization within each strategy include
industry, geography, stage of financing, and “special situations”.
“Private Equity” is a generic term that encompasses four distinct strategies in the market for private investing: Venture Capital, Leveraged Buyout, Growth Equity, Special
Situation/Distressed Debt Investing
Public Market Equivalent (PME) -A private equity benchmark that represents the performance of a public market index expressed in terms of an IRR, using the same cash flows
and timing as the investor’s investment activity in private equity. The PME serves as a proxy for the return the investor could have achieved by investing in the public market. The PME
benchmark return assumes cash flows are invested at the end of each day
Secondary Investment -Investment made directly into a company, rather than indirectly through a fund
Special Situations are Private Equity funds that do not fall into the category of buyout or venture capital funds. Special situations funds include distressed debt. Special situations
funds typically follow investment strategies that result in more rapid draw-downs and return of capital than traditional private equity funds.
Stage of Financing relates to the timing of the investment. Seed (start up) invest at the very beginning and face the highest potential return, longest holding period, and greatest risk.
At the end of the spectrum is late term financing, getting in after the initial setup and majority of the work has been completed. The expected return turnaround time is shorter and
thus, smaller in size versus seed financers.
Venture Capital is the supply of private equity financing to start up companies that do not have a sufficient track record to attract investment capital from traditional sources. Typically
invest in smaller less mature companies, usually in high growth industries. Start ups lack tangible assets that can be used for collateral and are unlikely to produce positive earnings
for several years. Venture capitalists provide management insight, have the right to hire and fire key managers, provide access to consultants, accountants, lawyers, investment
bankers, and other business that might purchase the start up company’s product. Focus of the VCs attention includes business plans, intellectual property rights, operating history,
start up management team, legal issues, and exit plans. Exit plans may include strategic sales or initial public offerings.
Vintage Year: The year in which a private equity fund had its final closing.
Private Equity Terms
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