6.1

Front 1

Describe a private equity firm.

Back 1

Private equity firms are intermediaries who both raise funds and manage the investments of these funds. A private equity fund invests in private equity portfolio companies (a.d. private equity securities), which are investments in underlying business enterprises.

Front 2

What is a limited partnership agreement

Back 2

The limited partnership agreement (LPA) of the private equity fund defines the legal framework for the partnership. The life expectancy of the fund is typically 7 - 10 years with a possible extension of up to three years. Private equity fund shares (also known as limited partnership interests) are not registered with the SEC, so they cannot be traded on public exchanges

Front 3

What is venture capital

Back 3

Venture capital involves senior equity investments in start-up ventures that are unable to attract capital from more traditional sources often due to their negative cash flows. Venture capitalists raise funds and invest in these start up firms. Venture capitalists take an active role in the venture's strategy and management. Venture capital investments are illiquid and investors often have to commit capital for 5-10 years. Proper exist strategies are critical to ensure the eventual realization of value.

Front 4

What is a leverage buyout

Back 4

A leverage buyout is an investment structure desgined to take a public company private by purchasing all outstanding stock using a large quantity of borrowed capital. LBOs are typicall financed by using the firm's assets and cash flows to secure debt financing. LBOs, like other forms of private equity investing, are long-term in nature and illiquid. When the investor or group of investors is the firm's current management team, the transaction is referred to as a management buyout (MBO). After an LBO, controls shifts to the LBO firm and management. Public shares are eliminated.

Front 5

Merchant banking

Back 5

Merchant banking is the purchase of nonfinancial firms by financial institutions. Merchant banking deals are quite similar in structure to LBO firms. However, for merchant banking deals, the financial institution (i.e., the merchant bank) is always the general partner. Merchant banking allows investment banks the ability to earn additional fees by providing loans, underwriting services, business advice, and recapitalization services.

Front 6

What is Mezzanine debt

Back 6

Mezzanine debt is a hybrid of debt and equity and falls between senior secured debt and equity in a company's capital structure. The typical form of mezzanine debt is an intermediate term bond with an equity kicker. The bond or note may have payment in cash or payment in kind (PIK), whereby the debt is repaid with additional debt.

Front 7

How is Mezzanine financing used

Back 7

Mezzanine financing is used to bridge financing gaps as a firm grows and evolves. These gaps include gaps in time (e.g., a private firm has exhausted its initial venture capital but is trying to get to the IPO stage), in capital structure (e.g., mezzanine debt provides debt financing beyond what secured lenders are willing to lend, but without significantly diluting the firm's outstanding equity holders) and in an LBO deal (mezzanine financing may be used to complete financing of a buyout deal). Mezzanine debt fills the gap in capital markets for financing available to middle market companies (i.e., firms with a market capitalization of $200 million to $2 billion).

Front 8

distressed debt usually meets which three crteria

Back 8

1. credit rating of debt issues, if available, is equal or lower than CCC (S&P) or Caa (Moody's)
2. the current market value of the debt issue is lower than 50% of its principal
3. The yield to maturity for the debt issue is at least 10% higher than the current risk-free rate.

Front 9

What two types of risk are generally in distressed debt strategies

Back 9

1. business risk
2. liquidity risk.

Front 10

The market for distressed debt investments grew substantially from 2000-2009 due to the following reasons:

Back 10

1. new types and increased issuance of commercial loans
2. active portfolio management by lenders
3. increased debt levels.
4. increased level of mergers, acquisitions, and buyouts.
5. Growth of covenant light loans

Front 11

Leverage loans

Back 11

Leveraged loans are loans made to borrowers who do not carry an investment grade credit rating. Leveraged loans refer to loans that are made to borrowers that have a coupon rate greater than LIBOR + 125 bps and are subordinated to other senior secured loans. Loan syndication, where several lenders provide various parts of a large loan, which is administered by one or more commercial or investment banks, is becoming a regular characteristic of leveraged loans.

Front 12

why did the leveraged loan market grow and what was the effect

Back 12

The rapid growth of the leveraged loan market can be largely attributed tot eh establishment of a well-functioning secondary market. This secondary market became much more useful in 1995 when Moody's decided to begin giving credit ratings to bank loans. This action increased market liquidity, which in turn increased investor's interest in the market. This increase in popularity has caused the leveraged loan market to overtake the high yield bond market in terms of size.

Front 13

What are the advantages of a secondary market to buyers

Back 13

1. greater access to future private equity funds.
2. More effective vintage year diversification
3. Faster profit realization
4. opportunistic buying

Front 14

What is a PIPE

Back 14

With a private investment in public equity (PIPE) transaction, an investors group deals directly with a public firm to acquire a private equity position. The discount associated with PIPEs is the key reason private firms are interested in this market. In the public market, private equity firms often are forced to pay a premium if they want to acquire a sizable share of a company. the primary reason for public firms to engage in PIPE transactions is because they are less costly and can be done relatively quickly (e.g., several weeks) compared to public offerings, which take considerably longer and are are much more expenseive

Front 15

Distinguish between a traditional PIPE, structured PIPE, and Toxic PIPE

Back 15

* In a a traditional PIPE, the issuer privately sells covertible debt or convertible preferred stock with a fixed common equity conversion ratio.
* in a structured PIP transaction, the issuer privately sells convertible debt or convertible preferred stock with a floating common equity conversion ratio.
* A toxic PIPe situation occurs when a structure PIPE receivers greater and greater amounts of common equity as the price of the issuer's stock falls. this creates a death spiral for a company issuing a PIPE since the price of the issuer's outstanding, publicly traded common stock tends to decline after the PIPE is issued.

Front 16

Dual term advantages for hedge funds over private equity firms (six):

Back 16

1. Hedge fund incentive fees are based on changes in net asset value (NAV), while private equity fund incentive fees are based on realized profits
2. Hedge funds typically do not have provisions for the clawback of management or incentive fees, while private equity funds do.
3. Hedge funds typically target a hurdle rate in excess of cash (e.g., LIBOR + 5%), while private firms try to achieve returns of greater than 20%.
4. Hedge fund managers receive incentive fees earlier than private equity managers do.
5. Hedge fund incentive fees are collected on a regular basis, while private equity fees are only collected after existing investments.
6. Hedge funds can receive incentive fees at any time, while private equity funds receive incentive fees only after returning capital to investors