Private Equity Structure

Firms that invest in equities of private companies with an aim to exit at higher valuations in future.

*High Risk * High Returns * High Fee Structure

Illiquid Investment (LP can’t get their money back immediately), less regulated as not accessible to retail investors.

PE Funds are close end investment vehicle, it means there is limited window to raise funds, once this window is
close no further funds can be raised or introduce this is called subsequent closing. This investment generally formed
as limited partnership or Limited Liability Company by PE fund. Few People or Institutions come together to create a
fund (XYZ PE fund), but they will not bring capital o their own. To generate required funds they reach out to big
Institutions, HNI, Pension funds, LIC and they collected all required funds. Using these funds they will invest in various
businesses and make them sustainable business and sell them to someone. So these peoples, institutions are call as
General Partners and the Person who had provided the funds are called Limited Partners with limited liability with
funds that they had provided. Trading that is buying and selling of investment is mostly done on Term loan, Asset
back securities (ABS), Mortgage back securities (MBS). Trade gets booked on T+1 basis.

Parties to PE:

General Partners:

GP contributes 1 to 3 % of total fund size and rest funds are contributed by Limited partners. GP are investment
manager of PE, they need to manage & run the funds to invest in securities.

Limited Partners:

These are the investors who contribute almost 98% of funds as they expect high/more returns. Limited partners
make agreed commitment for specific time (more than 5 yrs). So once they are ok, they need to sign an Agreement
with GP which is called Limited Partnership Agreement (LPA)

PPM:

Private Placement memorandum, this is nothing but a legal document which is having details like investment, % of
minimum returns, profit sharing %, fees structure etc.

Fees Structure in PE: 2 & 20

2% Management Fees on Asset under management every year, 20% Performance Fees over and above set
benchmark (Hurdle rate), (out of total Investment GP suppose to generate maximum returns over and above
benchmark to earn Performance fees.)

Fee structure with Eg:

Initial Pre
Total Performance
Investme decided Profit/Loss MGMT Fees
Returns Fees
nt Return %
Total Return- 2% of
1,000,000 10% 1,500,000 Investments Investment 20% of Net Profit
100000 500000 20000 400000-20000 = 380000
20% of 380000 = 76000
So once performance fees (profit) distributed to GP the remaining profit will be distributed to limited partners.

Types of Private Equity:

Venture Capital:

When PE invests in Portfolio Company which is at initial or starting phase (with just an idea of business) then it is
called as venture capital.

Growth Capital:

When PE invests in establish Company with sustain revenue and cash flows it is known as growth capital. PE
supports capital supports to such type of company for their further growth.

Leverage/Distressed Bay out:

When PE invests in distress Portfolio Company who is facing issues in paying financial commitments, PE buys all
shares of said company and gets it delisted and manages it. In LBO returns are higher for PE.

Carried Interest:

Share of profit gained by private equity fund or fund manager on exit of investments after achieving the Hurdle rate.
Profit sharing is divided between GP & LP in 20 & 80% ratio respectively.

Drawdown:

Peak to through decline during a specific period. % of reducing in total equity value from the all time peak till that
period. Even though value is increase than previous day, but it is less than you’re all time peak till that period there will
be drawdown.

Commitment or Committed Capital:

Is that each LP commits to contribute to GP, basis on this payment of MGMT & Performance fees are paid.

Capital call schedule:

When GP asks LP to provide decided funds in tranches it is called Capital call schedule. GP need to send capital call
to LP at least 14 days before to invest.

Capital Call with Single LP

 Capital Call with Multiple LP

Investment Allocation:

Thus different Capital Call amounts to different LP’s are made as per their investment allocation principle mentioned
in LPA.

NPA: A non performing asset (NPA) is a loan or advance for which the principal or interest payment remained
overdue for a period of 90 days.

Cat-Up:
On total Investment GP earns profit (Preferred return) , after specific tenure GP returns the Initial investment amounts
+ Preferred returns (as per LPA) to LP and on remaining balance GP gets 20% as incentive/catch up to investment
manager or GP.

Catch-up takes effect when an investor's returns reach the defined hurdle rate, giving them an agreed level of
preferred return. The manager then enters a catch-up period, in which it may receive an agreed percentage of the
profits until the profit split determined by the carried interest agreement is reached.

Water fall :

The method of distributing/allocating capital gains or investment returns across all investors at winding up of funds.
This is also mentioned in LPA.

1. Return of Principle Amt to LP

2. Return of preferred return amt to LP

3. Catch up payment to GP

4. Carried Int to GP 20% & LP 80%

Types of Waterfall:

American

The method of distributing/allocating capital gains or investment returns across all investors deal by deal basis is
called American waterfall, this benefits the investment manager/GP.

European

The method of distributing/allocating capital gains or investment returns across all investors at the end is called
European waterfall.
Claw back:

Claw back in PE occurs when GP is required to return excess Performance fees paid to them.

If there are few early successful exit and GP collects Performance fees for the same, but if there are other
investment which are yet to realized and later realized a loss, if that happens then one need to calculate overall
performance fees that GP deserves vs GP had already collected. If notice that GP had collected lot more performance
fees than they actual deserve then LP triggers Claw back clause which states GP have to return all the excess
performance fees to LP.

Committed Capital:

Investment/Money which is committed by limited partners to the fund is called committed capital.