Question

Mechanics and Strategies for Private Equity (T480-130) Winter 2019

George Tsetsekos, PhD

Review Questions for the Final Exam

What you need to know about Private equity

1. Define private equity. What are the limitations of PE?

2. What is 2/20 in private equity

3. What is dry powder? Why many investors are looking at the amount of dry powder?

4. Define capital calls. What is committed capital? What is deployed capital

5. What we mean that we have the first and second close of a fund?

6. Explain the key difference between Private equity fund as an organization and public

corporation

7. Define “pre-money” valuation

8. What is Enterprise Value? What is the difference between enterprise value and equity value of a

company?

9. Explain the mechanics in assigning value for the acquisition of a company for a private equity

fund

10. Describe the process/mechanics of a private equity transaction

11. What is the difference between private capital markets and public capital markets?

12. What is the rationale and motivations behind the explosive growth of private equity in the last

30 years or so?

13. Explain the key principles in private equity

14. Explain the significance of Private equity and Venture capital in the free enterprise system

15. What is the difference between a private equity transaction and private equity fund?

16. What do we mean by intermediated flows

17. Explain agency costs and their significance in private equity

18. What are the core principles of capital and finance

19. What is mezzanine finance

20. Describe different “types” of alternative/Private equity funds

21. Discuss details related to each aspect of a private equity transaction (for example, funding, deal

structuring, exit etc)

22. What is the difference between Venture capital and growth equity

23. What is the “shadow” banking system

24. Does private equity transactions improve firm performance?

25. What are the industry-wide spillover effects as a result of private equity/

26. What are the typical components of an LP/GP agreement?

27. Explain the key parts of the due diligence process

28. What is the difference between invested and committed capital

29. What is hurdle rate

30. Many times valuations are based on multiples of EBIT (or EBITDA), for example, 3XEBIT. What

the number 3 signifies? Explain the origin of multiple comparable valuations

31. Explain fund vehicles (What is a primary fund, Feeder fund Alternative investment Vehicle parallel fund)

32. What is carried interest? What is waterfall distributions? How we calculate waterfall distributions?

33. What are secondaries? Why they are important in the PE market place

34. Describe key principles in the due diligence process

35. What are the post-closing price adjustments and remedies?

36. What is the difference between fund of funds Private equity and a public private equity fund

37. What is deal structuring in private equity

38. Describe typical equity instruments in the deal structuring process for Private equity

39. Describe and differentiate among debt instruments in structuring private equity transactions

40. What are representations and warranties? Where these statements are used?

41. What are covenants and why they are important in private equity transactions

42. Explain indemnification provisions in the Sales and Purchase agreement for a PE fund

43. Explain the components of value creation in a PE transaction

44. What kind of resources are needed for a PE firm to impact value creation. Discuss the role of

external and internal resources

45. What is private credit? How you structure a fund for provide private credit

46. Discuss exit paths for a private equity investment

47. What is a GP Catch-up and what is “Clawback” in private equity

48. Often the term co-investing is used in PE. Can you please explain its meaning

49. What is the role of a sponsor in a private equity transaction?

50. What is a closed-end fund? A blind pool?

Answer 1

1.A private equity fund is a collective investment scheme used for making investments in various equities and debt instruments. They are usually managed by a firm or a limited liability partnership.

Limitations of private equity

a.80 % of fund's total value shall be comprised of more than one private equity investments. In case private equities' investment amount for SME's exceeds 10% of total fund value, the maximum investment shall be 51% of total fund.

b.Private equities are not allowed to invest in commodities and gold or forwards that are based on these materials.

c - Short selling is not applicable that obstructs speculations linked to price volatility.
d - Private equity investment funds are able to take advantage of derivatives for the purpose of hedging the currency and interest rate risks which is limited with 20% of total fund amount.
e - Any security transaction on credit is not possible for private equity funds.
f - Fund information document is binding for managing the other assets of fund which are not connected to private equity investments.

2.The 2 and 20 fee structure is the way that most private equity firms are compensated. The 2 represents the 2% annual management fee on capital deployed that is used to pay salaries, cover overheads and generally "keep the lights on." The 20 represents the 20% carry over of a certain return threshold that the private equity firm gets to keep.

3.dry powder is a term that refers to the amount of cash reserves or liquid assets available for use. These cash reserves or short-term marketable securities are usually kept on hand to cover future obligations that may or may not be foreseen. Therefore, the term dry powder can be used in situations of personal finance, in the corporate environment and in venture capital or private equity investing.

Having dry powder on hand can provide investors with an advantage over others who may be holding less liquid assets. For example, a venture capitalist might decide to hold a substantial strategic amount of cash on hand in order to take advantage of private equity investments that may present themselves for immediate funding. This cash would colloquially be referred to as the venture capitalist's dry powder.

4.A capital call is a legal right of an investment firm or an insurance firm to demand a portion of the money promised to it by an investor. A capital call fund would be the money that had been committed to the fund.

Committed capital (also known as "commitments") is a contractual agreement between an investor and a venture capital fund that obligates the investor to contribute money to the fund. The investor may pay all of the committed capital at one time, or make contributions over a period of time.

5.First close basically means that when a certain threshold of money has been raised, the PE firm can begin making investments and actually closing deals and new LPs can still join in by committing capital for a limited time (e.g., 1 year from first close)

6.

Private equity means shares in a private company. Public equity means shares in a public company.

Either way, you have shares in the company. The difference is that a public company has been through a rigorous approval process to enable its shares to be traded on a public market. Among other things, this means that:

• The shares are easy to buy and sell whenever you want
• The company regularly publishes detailed financial results
• The company has a substantial track record and complies with various regulations
• It is likely that several brokers and other researchers are monitoring the company and regularly publishing their views on its performance and prospects

By contrast, a private company is not required to publish much information about its performance.

7.A pre-money valuation refers to the value of a company's stock before it goes public or receives other investments. The term is often used by venture capitalists.

8.Enterprise value calculates a business’s current value similar to how a balance sheet does, while equity value offers a snapshot of that business’s current and potential future value.

13.

a.Private equity is an alternative form of private financing, away from public markets, in which funds and investors directly invest in companies or engage in buyouts of such companies.

b.Private equity firms make money by charging management and performance fees from investors in a fund.

c.Among the advantages of private equity are easy access to alternate forms of capital for entrepreneurs and company founders and less stress of quarterly performance. Those advantages are offset by the fact that private equity valuations are not set by market forces.

d.Private equity can take on various forms, from complex leveraged buyouts to venture capital.

14.

Venture capital is a capital which provides high potential interest generating returns from the growing companies at very early stages. ... The main importanceof it is that it generates high interest returns at very early stages and at a growing pace. It also has high-end companies which supports it in reaching the peak.

The primary function of private equity, as with any other business, is to create a profit for its investors. Private equity firms accomplish this by purchasing smaller companies, increasing their values and selling them at a profit. The process can take several years and comes with high risks

15.

Private equity transaction is, a type of equity transaction and one of the asset classes consisting of equity securities and debt in operating companies that are not publicly traded on a stock exchange.

A private equity fund is a collective investment scheme used for making investments in various equity securities according to one of the investment strategies

18.

a.Principles of risk and return.

b.Time value of money.

c.Cash flow principle.

d.Profitability and liquidity.

e.Principles of diversity.

f.Hedging principle.

19

Mezzanine financing is a hybrid of debt and equity financing that gives the lender the right to convert to an equity interest in the company in case of default, generally after venture capital companies and other senior lenders are paid. Mezzanine financing tends to be completed with little due diligence on the part of the lender and little or no collateral on the part of the borrower. It is treated as equity on a company's balance sheet.

20.Alternative investments is only a descriptive term typically used to describe investments outside the stock market.

a.Real estate is a broad category that can refer to many different types of property, but for this example, lets limit it to residential, commercial, retail, and industrial

b.This is essentially a loan from the bank to you in order for you to buy your home. This is one of the primary functions of banks.

c.Investing in private company stock can be a great way to productively use your capital. There are many of the same risks as with publicly traded companies, but it can also allow you to bring value to the business with your personal expertise.

d.Structured settlements as an investment are similar to bonds. The investor pays a lump sum amount up front, then gets paid back his interest and principal over time.

e.Farmland is technically real estate, but can be used for farming too

22.

Growth capital (also called expansion capital and growth equity) is a type of private equity investment, usually a minority investment, in relatively mature companies that are looking for capital to expand or restructure operations, enter new markets or finance a significant acquisition without a change of control of the business.

Venture Capital is financing given to startup companies and small businesses that are seen as having the potential to break out. The funding for this financing usually comes from wealthy investors, investment banks, and any other financial institutions. The investment doesn't have to be just financial, but can also be offered via technical or managerial expertise.

23.

A shadow banking system is the group of financial intermediaries facilitating the creation of credit across the global financial system but whose members are not subject to regulatory oversight.

26.

The general partner, or GP, sets up the fund and usually makes an investment in it. The GP, who will manage the investment, then seeks limited partners who are usually institutional or high net worth investors. LPs will take no part in the management of the fund.

27.