Mastering Private Equity

Author

Claudia Zeisberger

Genre

InvestingPrivate EquityGrowth EquityVenture Capital

Last Read

February 2, 2022

Cover

Stars

★★★★★

Review

I read the paperback version of this book and it was a great semi-textbook read. The quality of the research in demystifying PE, strong prefaces from industry veterans, engaging schematics and real-life examples brought the material here to life. The book covers an overview of investment strategies across maturity (from venture to buyouts), doing deals in PE, managing PE investments, fund-management, GP-LP relationships (very useful) and the evolution of PE.

Because I don’t have direct Kindle highlights from the book (I encourage you to use the book as a reference guide instead), I have provided a glossary of the key terms discussed (as this also helps me remember the key topics).

Please do purchase the book and support the authors, as they have done a phenomenal job here! I have personally thanked them for their work on this.

There are ~150 terms in this glossary.

Glossary

Term	Definition
100-day Plan	A plan that outlines clearly the changes to be achieved by a company during the first three months post-investment.
500-day Plan	Exit plan by a private equity (PE) firm to prepare the portfolio company for sale.
Affiliate Transaction	Transaction between two funds managed by the same sponsor.
Agency Risk	Part of agency theory. Risk of management (the agent) pursuing their own interests instead of shareholders (the principal).
Alternative Investment Vehicles (AIVs)	AIVs are structured to accommodate one or more special investments made outside of the primary fund (and/or a parallel fund).
American-style Waterfall	Also known as deal-by-deal waterfall: this structure entitles a general partner (GP) to carried interest after each portfolio company’s exit, provided investors have received their invested capital and any preferred return including a “make whole” payment for losses incurred on prior deals.
Amortized	For a loan: repaid on an annual basis over the life of the loan.
Anti-dilution	A clause that gives investors the right to maintain their percentage ownership in a company by buying additional, proportional shares in the company in future financing rounds. In the event of a “down-round” the conversion price of the preferred share class will be adjusted downwards to the level of the new valuation; as a result, shareholders who invested at a higher valuation will receive additional shares to maintain their ownership stake in the start-up.
Articles of Association (AOA)	A mandatory agreement entered into between the company and its shareholders and filed with a government institution post-closing. An AOA typically includes a limited amount of information that the company and its shareholders are required to disclose. Also referred to as the articles of incorporation, certificate of incorporation, and other names in different jurisdictions.
As-converted Basis	A metric to determine the total equity base by assuming that all preferred shares have been converted into common shares based on a prespecified conversion ratio.
Auction	A sales process involving multiple competing parties to maximize the price for the seller.
Back-testing	Process of applying an allocation or trading strategy to historical data to gauge the effect on portfolio or investment performance.
Bankruptcy	Legal status in which an insolvent company (which cannot fully repay its debt) is declared bankrupt, typically by court order.
Base Case	Scenario based on the company’s expected/most likely operating performance.
BidCo	The legal entity that executes the acquisition of a target company.
Blind Pool	A fund in which investors don’t know which assets will be acquired or have any influence over investment decision-making.
Break-up Fee	Financial penalties imposed on the party terminating an agreement, referred to as break-up or break fees in the case of termination by the seller and reverse break-up fees in the case of termination by the buyer.
Bridge Loan	A short-term loan that bridges funding until the arrangement of long-term financing.
Bullet Repayment	A single, lump sum repayment of the entire principal of a loan and accrued interest at the end of its term.
Burn Rate	Rate at which a new company spends its cash before reaching positive cash flow. It is typically measured in $/month.
Business Plan	A document describing a company’s strategic vision, key value drivers and forward-looking risks and opportunities with a multi year financial forecast.
Buyout	Acquisition of a controlling equity stake in a company. If initiated by the firm’s incumbent management it’s called a management buyout, if driven by an external management a management buy-in, and if by the PE firm then an institutional buyout. Buyouts that use significant amounts of debt are called leveraged buyouts (LBOs). Transactions in which a PE fund sells a company to another PE fund are called secondary buyouts.
Capital Calls	Drawdowns of limited partner (LP) commitments over the investment period of a fund. “Capital calls” fund investments and pay for a fund’s fees and expenses.
Capital Structure	The way a company finances its assets and operations by using different sources of funds such as equity, debt or hybrid securities.
Carve-out	Acquisition of a corporate division, business unit or subsidiary and conversion into a standalone company.
Cash Conversion Rate	Proportion of profits converted into cash flow (typically operating cash flow/operating profit).
Cash Sweep	Requirement that any excess cash be used to repay a loan facility (the principal) before dividend payments are made to shareholders.
Closed-end fund	A closed-end fund issues a fixed number of shares (and is not open to new investors.) In the context of PE, funds have a finite lifespan (term) with no redemption prior to the expiration of the fund.
Closing Mechanism	Clauses in the sale and purchase agreement (SPA) that define the manner in which the final purchase price is established.
Co-investing	Investing side by side with a PE fund directly in an operating company.
Co-investment Funds	Co-investment funds are vehicles set up by the GP to invest alongside the primary and parallel funds for a portion of a single investment. The co-investment is typically provided by one or more of a fund’s LPs at lower (or no) fee and carried interest terms; at times the funds may be drawn from an external party.
Co-leading	Active co-investing. In active co-investing the LP is invited early on to join forces with a PE fund and shares in the work, cost and risk of a not yet completed transaction.
Collateralized Loan Obligations (CLOs)	Security backed by a pool of loans. Sold on to investors in various tranches with different interest rates reflecting their different riskiness.
Common Equity	Common equity is the most junior instrument in a company’s capital structure and provides a residual claim on cash flows and company assets after claims of all other capital providers are satisfied.
Completion Accounts Mechanism	A pricing mechanism that adjusts the preliminary purchase price based on the difference between a company’s net debt and target working capital at signing and the actual balance sheet values at closing.
Conditions Precedent (CPs)	Specific events or states of affairs that must be satisfied or waived for a transaction to proceed.
Conversion Rights	The right of preferred shareholders to convert their preferred shares to common shares; the conversion rate—at the outset usually 1:1 of preferred to common—is clearly defined.
Convertible Debt	A type of debt instrument that can be converted into equity or cash.
Covenants	Financial covenants are a promise by the borrowing company that certain activities will (affirmative covenants) or will not (negative covenants) be undertaken. They protect lenders from borrowers defaulting on their obligations. Some covenants are checked on a regular basis (maintenance covenants) while others are only tested upon the occurrence of a specific event (incurrence covenants).
Data Room	A database (physical or virtual) established by a target company and its advisors that contains all material documentation for due diligence.
Deal Flow	Investment opportunities available to a PE firm. If sourced by a PE firm directly it’s called “proprietary” deal flow, if through an advisor (e.g., banks, accountants) then “intermediated” deal flow.
Deal-by-deal Structure	In a deal-by-deal fund structure, a dedicated vehicle will be created for the purposes of making an investment in a single target opportunity.
Debt Capacity	An assessment on the amount of debt a company can service and pay back over a certain period.
Debt Commitment Letter	An agreement in which a lender sets out the terms on which it is prepared to lend money to the borrower. In an LBO, this letter is typically addressed to a buyout fund’s acquisition vehicle by the lead arranger of an LBO’s debt financing. Securing a debt commitment letter is often required before a seller will sign an SPA to provide funding certainty for the seller.
Debt Free/Cash Free	The seller receives all cash and pays off all debt of the target at the time of sale.
Debt Multiple	A measure of a company’s debt relative to a key metric, typically earnings before interest, tax, depreciation and amortization (EBITDA) (debt/EBITDA).
Debt Push-down	To transfer the debt of a “BidCo” to the target company. By executing a debt push-down, senior lenders have a direct claim on target company assets and eliminate the structural subordination of senior lenders to trade creditors.
Debt Servicing	Payment of interest and agreed mandatory repayments of debt over a certain time period.
Direct Investing	Investing directly into private companies instead of through a fund.
Distressed Debt Investing	Acquiring stakes in the debt obligations of distressed companies to generate returns through the appreciation of the debt or an eventual restructuring of the target company.
Distribution “Waterfall”	The order of priority and timing of distributions made to a fund’s LPs and its GP. See also European-style Waterfall and American-style Waterfall.
Distributions	Capital returned to LPs plus LPs’ share of profits.
Dividend Recapitalizations	Repayment of a portion or all of a fund’s invested capital via a special dividend funded by either releveraging the portfolio company’s balance sheet through the issuance of debt securities (leveraged recap) or from cash on hand in the company (non-leveraged recap).
Down-round	A round of funding raised at a lower valuation than the previous financing round.
Drag-along Provision	A drag-along provision provides the majority shareholder with the right to force minority shareholders to sell their shares in a third-party transaction at equal terms.
Dry Powder	A fund’s uninvested committed capital. Also used to describe the PE industry’s total uninvested capital.
Earn-out	Represents an agreement to pay a portion of the purchase price at a later date based on the performance of the business.
EBITDA Multiple	Enterprise value expressed as a multiple of EBITDA.
Economic Net Income (ENI)	Non-generally accepted accounting principles performance measure used by several listed PE firms adjusting regular net income for income taxes, non-cash charges related to vesting of equity-based compensation and amortization of intangible assets.
Employee Stock Ownership Plan (ESOP)	An ESOP sets aside a percentage of shares in a company to non-founder/owner employees in the form of stock options to attract, reward and retain talent.
Enterprise Value (EV)	A company’s total value—calculated as equity value plus net debt.
Equity Commitment Letter	An agreement addressed by a PE fund in an LBO to its acquisition vehicle, which provides a limited guarantee for the equity financing detailed in an SPA. Securing these letters is often required for the PE fund to enter into an SPA and to satisfy buyer financing reps and warranties. In some instances, the PE firm may directly provide a limited guarantee on the equity component of the transaction.
European-style Waterfall	Also known as all capital first waterfall: a GP is entitled to carried interest only after all capital contributed by investors over a fund’s life has been returned and any capital required to satisfy a hurdle rate or preferred return has been distributed.
Family Office	Wealth management advisory firms that manage the portfolios of high-net worth individuals or families. Usually run by professional managers.
Feeder Funds	Feeder funds aggregate commitments from one or more investors and invest directly into the primary fund as an LP
Fiduciary Duties	Highest standard of care between a fiduciary and beneficiary.
Financial Distress	Situation when a company cannot meet or has difficulty meeting its financial obligations.
First Closing	PE firms raise capital for a fund by securing capital commitments from investors through a series of fund closings. The first closing is when an initial threshold of capital commitments has been reached and the fund can begin deploying capital.
First Lien Term Loan	Typically, senior secured loans with first priority on payment.
Free Float	Proportion of shares of a listed company that is traded in the stock market.
General Partners (GPs)	A fund’s GP is wholly responsible for all aspects related to managing a fund and has a fiduciary duty to act solely in the interest of the fund’s investors. A GP will issue capital calls to LPs and make all investment and divestment decisions for the fund in line with the mandate set out in the limited partnership agreement (LPA).
High-yield Debt	Also known as high-yield bonds, they are bonds rated below investment grade. They offer higher interest rates than investment-grade bonds to compensate for the additional risk and low ranking in the capital structure.
Hurdle Rate	The preferred return to investors before a carried interest is permitted. The hurdle rate, frequently set at 8%, will be negotiated during fundraising.
Indemnification	Contractual obligation by one party to compensate the other party from losses incurred following a breach of contract, removing the uncertainty of pursuing a legal claim in court or arbitration.
Information Memorandum	Typically, the first formal document shared by a target that provides an up-to-date overview of its business and the investment opportunity.
In-kind Distributions	Distributions to LPs made in the form of marketable securities, typically listed shares of portfolio companies after an initial public offering (IPO).
Interest Coverage Ratio	EBITDA/interest expense. Measures a company’s ability to pay interest on its outstanding debt.
Investment Committee (IC)	An IC makes the binding investment and divestment decisions for the fund under delegated authority from the GP.
Investment Period	The time period during which a fund can draw down LP commitments to make investments. It typically lasts for three to five years from the date of the fund’s first closing.
IRR	Internal rate of return—a widely used measure of the return earned by investors from an individual investment, fund or portfolio of funds. It represents the discount rate that renders the net present value of a series of cash flows zero. Effective compounded annual interest rate of return.
J-curve	A J-curve in PE represents an LP’s cumulative net cash position in a fund over time. The curve starts with an increasingly negative net cash position as capital is drawn down during the investment periods before reversing direction as LPs start receiving distributions from a maturing portfolio.
Jump Bid	A bid in the second round of an auction that is substantially higher above perceived bids of the first round in an attempt to lock up the deal.
Letter of Intent (LOI)	An LOI functions as a bidding document and sets out key economic (e.g., bid price) and procedural terms that form the basis for further negotiations in an acquisition process. These provisions are non-binding and seen as a “good faith” representation of a bidder’s intent. PE firms and sellers use LOIs to ensure that there is general alignment on key terms before incurring the expense of in-depth due diligence and negotiating a definitive sale and purchase agreement.
Leverage	The use of various debt instruments to increase the equity return of an investment. Also the amount of debt used in an LBO.
Leveraged Loan	A loan issued by one or a group of banks. In an LBO, bank(s) often sell it on (syndicate) to other banks or investors.
Limited Partners (LPs)	Investors. LPs participate in PE funds as passive investors, with no involvement in the fund’s day-to-day operations, with an individual LP’s liability limited to the capital committed to the fund. LPs legally commit to provide capital for investment when it is drawn down (or “called”) by the PE fund and they receive distributions of invested capital—and a share of profits—upon successful exits of the underlying assets in the fund.
Limited Partnership Agreement (LPA)	A fund’s LPA sets out the general terms and conditions applicable to all participants in a fund, in particular a fund’s GP and LPs. It covers, among other things, their rights and responsibilities related to fundraising, capital calls and distributions, expenses and profit sharing, fund governance and reporting, and fund termination.
Liquidation Preference	Refers to the priority claim that preferred shareholders hold on the proceeds (dividends or exit including bankruptcy). These shareholders receive their investment back first (and in the case of multiple liquidation preference, several times) before other shareholders participate.
Listed Funds (LFs)	Publicly traded PE funds—also referred to as evergreen funds. Investing in an LF provides retail investors with returns through both share price appreciation and dividends.
Listed PE Firms (LGPs)	Publicly traded PE firms. Shareholders of an LGP participate in all revenues generated by the firm, including carried interest and fees.
Locked-box Mechanism	A fixed-price mechanism that fixes net debt and working capital values at a specific date (known as the locked-box date) before the signing of the SPA.
Lock-up Period	Time period in which a large shareholder cannot divest shares following an IPO, commonly lasting 3 to 12 months.
Majority Control	Control of more than 50% of a company’s voting rights (typically linked to the economic interest in the company). The majority shareholder controls the board of directors and hence can dictate strategic and operational decision-making.
Management Fee	A fee charged by a PE fund’s investment manager to cover day-to-day expenses of the fund, including salaries, office rent and costs related to deal sourcing and monitoring portfolio investments. It typically ranges from 1 to 2.5% depending on the size and strategy of the fund and the bargaining power of the PE firm during fundraising.
Management Fee Offset	Reduction of a fund’s management fee by a percentage of the fees collected from a fund’s portfolio companies.
Material Adverse Change (MAC) Clause	A legal provision that provides a buyer with the right to terminate an acquisition contract in case of an event that substantially impairs the value of the acquisition target. In an SPA, the specific definition of what constitutes a MAC at the target company varies from transaction to transaction and is formalized in the definitions of the agreement.
Mezzanine Financing	A form of junior unsecured debt or preferred equity raised in the private institutional market. Mezzanine loans may provide additional upside by including an “equity kicker” through a convertible debt feature or attached warrants.
Minority Equity Stake	A shareholding of less than 50% of a company’s equity, which is not a controlling stake.
Minority Protection Rights	Rights and safeguards to mitigate the risks associated with a minority shareholding. These rights will enable the minority shareholders to monitor their investee firms, influence the proceedings, and pre-empt or mitigate potential conflicts of interest with the majority shareholder.
Multiple Expansion	An increase in the valuation multiple.
Multiple of Money Invested (MoM)	Also known as the investment multiple, it is the ratio of the realized and unrealized fund/equity value divided by the capital invested in the fund/company.
Net Asset Value (NAV)	Value of a fund’s assets minus liabilities.
Net Debt	Net debt is arrived at by subtracting the value of a company’s liabilities from the value of its liquid assets. The main components of net debt are interest-bearing bank borrowings and cash. Which additional elements of debt-like liabilities and cash equivalents will be included in net debt is often the subject of intense negotiation.
Net Invested Capital	Net invested capital consists of contributed capital, minus capital returned from exits and any write-downs of investment value.
Non-disclosure Agreement (NDA)	A legal agreement, also known as a confidentiality agreement, that restricts access for third parties to information that parties share. NDAs can be structured to protect a one-way or a mutual flow of information.
Open-ended (Evergreen) Vehicles	In an open-ended (evergreen) fund structure, funds can be raised at any time during the life of the fund and the fund has an indefinite term.
Opt-in/Opt-out Funds	Investment vehicles through which investors make “soft commitments” to the fund prior to its investments being identified. Investors are given the right to “opt in” to (or “opt out” of) each investment opportunity that the manager of the fund presents.
Paid-in-kind (PIK) interest	PIK interest refers to interest on an instrument paid with additional amounts of that instrument instead of cash, i.e., PIK interest is rolled up and added to the principal amount of the loan.
Parallel Funds	Funds set up to accommodate the special legal, tax, regulatory, accounting or other needs of an individual or group of LPs participating in a fund offering. These vehicles invest and divest side by side with the primary fund.
Partial Exit	The divestment of part of a PE fund’s holdings in a portfolio company.
Post-money Valuation	Value of a company after injection of new capital, i.e., invested capital plus “pre-money” valuation.
Preferred Shares	A senior form of equity that provides shareholders with certain preferential rights relative to common equity shareholders.
Pre-money Valuation	Valuation of a company before the injection of new capital.
Price/Earnings to Growth Multiple	Ratio of price-to-earnings divided by the expected future earnings growth rate of the company.
Private Debt	Non-bank lending from institutional investors (e.g., funds and insurance companies). Includes direct lending, mezzanine, venture debt and distressed debt.
Private Investment in Public Equity (PIPEs)	Private placement of shares of a publicly listed company to selected investors.
Privatization	Transfer of a business from public to private ownership, i.e., acquisition of a state-owned company.
Public to Private (P2P)	The acquisition of a publicly listed company and subsequent delisting. Also referred to as “going private” and a “take private.”
Real Assets	Tangible, physical assets that include infrastructure, real estate and natural resources.
Real Option Pricing	A valuation technique that specifically takes flexibility of corporate decisions into account. Mostly used for capital budgeting decisions.
Redemption	Withdrawal; return of an investor’s capital.
Redemption Rights	Redemption rights provide the holder of an equity stake the right (a put) to sell the equity stake back to the company.
Representations and Warranties	Statements of fact and promises that underpin specific elements of the transaction set out in an agreement. Reps and warranties are principally used to offer protection to a buyer in case a vendor’s statements of fact regarding the target business prove to be false, to allocate a portion of performance risk at the target company to the seller and to provide an opportunity for a buyer to gain additional information on the target.
Return on Capital	Measures the return an investment generates for capital contributors, i.e., debt and equity holders.
Return on Investment	Measures amount of return on an investment relative to the investment cost, often expressed as a percentage and calculated as net profit/cost of investment.
Revolving Credit Facility	A line of bank credit predominantly used to fund a target’s working capital needs.
Sale and Purchase Agreement (SPA)	A contract entered into between a buyer and a seller that governs the terms and conditions of the envisioned transaction and the acquisition process.
Search Fund	Investment vehicle through which investors finance an entrepreneur’s efforts to locate, acquire and manage a company.
Second Lien Term Loans	Second lien loans are used as a bridge between first lien term loans and junior unsecured debt. They are secured against the same collateral as first lien loans but are only entitled to claims on it after the first lien debtholders are paid in full.
Secondary Transactions	Sale and purchase of interests in a PE fund (limited partnership secondaries) or sale and purchase of equity stakes in PE-backed companies (direct secondaries).
Seniority	Order (priority) of repayment in the event of a sale or bankruptcy of the issuer.
Share Subscription Agreement (SSA)	An agreement between investors and a company specifying the purchase price for a certain amount of new shares in the company. It expands on the provisions of the term sheet and adds representations and warranties from each party.
Shareholder Loans	The most junior form of debt provided by shareholders. Shareholder loans typically roll up interest (PIK), which is repaid together with the principal on exit or in the case of a refinancing.
Shareholders’ Agreement (SHA)	A private agreement that defines the relationship among shareholders and between shareholders and the portfolio company. An SHA is more flexible than an AOA and can include nearly any provision; as a private document, it often includes more sensitive agreements among shareholders.
Shareholding Structure	The various classes of shares that a company has issued and their rights.
Special Purpose Vehicle (SPV)	A legal entity set up for a special purpose and to isolate financial risk.
Standstill Provisions	Terms in an agreement that restrict the seller from engaging with other potential buyers over a specified period of time to protect the interests of the winning bidder, who is going to incur substantial transaction cost (primarily in connection with finalizing legal documents) during the final phase of the process.
Stapled Secondary	A sale of an LP interest combined with a commitment to invest in a GP’s next fund.
Successor Funds	PE firms will try to raise a new (successor) fund as soon as permitted by its current fund’s LPA, typically after a significant portion of the current fund (e.g., 75%) has been invested, resulting in a new fund about every three to four years.
Sweet Equity	Equity (or options) issued to management at a discount to incentivize and align interests of management with shareholders.
Tag-along Provision	A tag-along provision provides minority shareholders with the right to sell their shares in conjunction with the majority shareholder in a third-party transaction (instead of being forced to).
Turnaround Investing	Acquiring majority equity stakes in mature companies under considerable operational duress with the aim of affecting change in the company to restore profitability.
Valuation Multiple	An expression of the market value of a company relative to a key statistic driving that value.
Vendor Debt	Debt provided by a target’s sellers, essentially rolling a portion of seller proceeds back into the target company. Vendor debt is typically unsecured and subordinated to junior and senior debt, but senior to shareholder loans and equity.
Vesting Schedule	Defined timeline for the process in which employees accrue rights to share incentives (i.e., options or shares).
Vintage	The year in which a fund has its first closing and can start investing.
Warrants	Options to purchase a company’s shares at a predetermined price, often when certain trigger events occur (such as a change of control, a sale or an IPO)