New Venture

Types of PE: venture-extensive technology risk, vast business/investment upside from operating leverage, high failure rate, 3-4 yr is the typical return. Growth- established but not large mature co. 4-7 Buyout- limited technology risk, limited business upside create a need for financial leverage, generally lower failure rate, need to create risk to get better returns, debt, 2-5 yrs (Hertz). Typical 10 year Fund: invest- Ð'ÐŽÐ'onew nameÐ'ÐŽÐ'± investment during first three years, often some follow-on investment, generally 10-30 portfolio co. Manage- 3-6 yrs, watch companies Harvest- IPOs, sales to Ð'ÐŽÐ'ostrategicÐ'ÐŽÐ'± (looking for something better) or Ð'ÐŽÐ'ofinancialÐ'ÐŽÐ'± (interested in returns) buyers, recapitalization or dividends. GP-recruit investors, screen and make investments, manage portfolio; usually 2-10 people, horizontal. LP- long-term investors who value higher returns over lower risk over liquidity. Valuation: $25 invested in co. valued at $15. post valuation=inv+pre=$40. fund ownership = inv/post=62.5%. so fund receives 62.5% of companyÐ'ÐŽÐ'Їs eventual value.

Carry: (proceeds-calls = profit)*20%. Gross Return Multiple(GRM): proceeds/investment. Net Return Multiple(NRM): distributions/calls. Gross CF: proceeds-investment. Net CF: Distribution-calls. Fees: % of fund size. Rules of Thumb: net is always less then gross, in PE fund net is typically Ð'ЁÐ"â„- - 1/3 less than gross, target multiples are roughly 3X and 2X, target IRRs are roughly 30% and 20%, with GRM and NRM fees and time factor affects multiple so could be misleading. Conservative carry: only take carry after proceeds exceed fund size. Aggressive carry: allocate fund size proportionate to invested capital.

Ex.1 $12m PE fund, single $10investment, 5yrs,2-20 fee schedule. Find distributions and IRRs with diff. proceeds.

Limited Partners Capital calls General Partner Investment Portfolio Companies

Ð'ÐŽÐ"¦ Fees Ð'ÐŽÐ"¦

Ð'ÐŽÐ"§ Ð'ÐŽÐ"§

Distribution Carry Proceeds

Fees: 12m*.02=.24*5=1.2 total

GRM: 20/10=2X, 30/10=3, 100/10=10

NRM: 18.24/11.2=1.64X, 26.24/11.2=2.34, 82.24/11.2=7.34 GrossIRR for 30:(-10,(0,0,0,0,30)(1,1,1,1,1))=24.8% NetIRR Ð'ÐŽÐ'o= (-10.24, (-.24,-.24,-.24,-.24,26.24)=19.3%

18.24 1.76 20

26.24 3.76 30

82.24 17.76 100 *if limited partners are guaranteed a 2X return on their capital before the GP begins receiving their 20% carry then instead of the called capital of $11.2, it is 20% of the difference between proceeds and twice called capital which is $22.4. ex. at 30, (30-22.4).2=1.52 so 30-1.52=28.48 distr.

Ex. 2 $165 invest+ $42(fees) =$207call, 165*3=$495-207*.20=57.6, 495-57.6=$437.4 distribution. NRM= 437.4/207=2.11 * if LPs could earn more than 2.11X on direct investments, they would do better without GPs.

T Inv Fees Calls Proceeds carry Dist GCF NCF Cons. Carry Dist NCF Aggr. Carry Dist. NCF

0 20 2 22 0 -20 -22 -22 -22

1 20 2 22 0 -20 -22 -22 -22

2 20 2 22 0 -20 -22 -22 -22

3 20 2 22 5 5 -15 -17 5 -17 5 -17

4 2 2 0 0 -2 0 -2 0 -2

5 2 2 130 130 130 128 8.75 121.25 119.25 21.25 108.75 106.75

6 2 2 0 0 -2 0 0 -2 0 0 -2

7 2 2 45 45 45 43 11.25 33.75 31.75 5 40 38

8 2 2 0 0 -2 0 0 -2 0 0 -2

9 50 33 17 50 17 13 37 37 6.75 43.25 43.25

T 80 18 98 230 33 197 150 99 33 197 99 33 197 99

Ex. 3

a.What is the fundÐ'ÐŽÐ'Їs gross return multiple? 230/80=2.875 b. What is the fundÐ'ÐŽÐ'Їs gross IRR? 22%(use GCF