The world of Private Equity investments is exciting, but it shouldn’t be mysterious. Keep on reading to understand the key fundamentals and broaden your investment know-how.
Private Equity FAQ
Accredited Investor A qualified investor with a certain net worth or meeting income tests, as per Rule 501 of Regulation D of the Securities Act.
(see Regulation D)
Bridge Financing Short term capital provided by investors until the next round of capital raise. Commonly structured as convertible debt or as Simple Agreements for Future Equity -SAFE.
Capital Stack All of the invested capital combined in the project is known as the capital stack. Highest risk and higher return investments at the top, and lower risk and lower return investments at the bottom of the stack.
Here is an example of a project investment stack:
1. Sponsor and common equity
2. Preferred equity
3. Mezzanine investors (hybrid debt and equity)
4. Second and other junior mortgages
5. Investment-grade first mortgages
(see LP, GP, and preferred and common share)
Cap rate: Capitalization Rate The cap rate helps indicate the rate of return, helpful in analyzing how fast an asset repays itself and begins to make a profit. Defined as the net income an asset produces in a year, divided by its purchase price. Can vary from year to year.
Carried Interest Carry, or carried interest, is what the general partner receives as a share of the profits in the project. Commonly 20% and peaks at 30%. Redeemable yearly and at end term.
Cash Flow Statement A financial statement that reflects changes in balance sheet accounts and breaks the analysis down to operating, investing, and financing activities.
Common share A percentage of a company or fund, and a way to designate ownership and returns. Common shares hold more risk than preferred risk, as they are paid out last, but they come with the potential for more profit
(see preferred share)
Common share partner An accredited investor in a fund. In contrast to a preferred partner, common shares are paid out last, but with more potential profit.
(see preferred partner)
Coupon A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity.
Exit Strategy The means and methods of ending one’s investment in a project while realizing maximum profit.
EBITDA: Earnings Before Interest Taxes Depreciation and Amortization. Simply put, EBITDA helps gauge a company’s cash flow.
General Manager or General Partner of the Partnership: GP The general partner of a private equity fund is the entity which manages the fund. In the case of BAI Capital projects, BAI is the General Partner as they are the entity managing the fund.
(See PP, CP and LP)
Interests The price paid for borrowing money. It is expressed as a percentage rate over a period of time property.
IRR: Internal Rate of Return There are two types of Internal Rates of Returns, Gross and Net, similar to general business models of profit. Gross IRR is profit BEFORE taking in management fees, fund expenses and carried interest. Net IRR is return on investment AFTER taking to account these associated expenses.
Interim Internal Rate of Returns are used to help disperse profits on a yearly or annual basis to preferred and common investors. Final IRR is calculated at project completion after all investments have been returned to investors.
Investment rounds The investment period is the time during which the fund will make investments in new opportunities. Most funds make all initial investments in a 2-3 year time frame, after which it will make follow-on investments rounds. This investment period is part of the fund’s investment strategy.
LLP: limited liability partnership A business partnership in which the liability of all of the partners is limited to the capital they have invested.
Limited partner LP Multiple investors in a limited partnership, as distinct from the general partner, who manages the investment.
(see PP, CP, GP)
Mezzanine Loan Mezzanine loans rank above equity loans in the capital stack and below the bank or senior debt. Used similarly to equity financing.
(See capital stack)
Preferred Equity Partner An accredited investor in a fund. In contrast to a common partner, preferred shares are paid out first, but with less potential profit.
(see common partner)
Preferred Equity Financing Preferred equity shares are a type of hybrid investment that hold characteristics of both bonds and common shares. Preferred shares pay more regular returns than common shares.
Preferred Return A preferred return is a carried interest provision providing the preferred equity investor with a threshold return before the CP’s and GP are entitled to receive any carried interest. The preferred return often provides the preferred partner with an 8% annual return on their investment before the and common partners and general partners can receive any of their interest.
(See common return)
Private Equity Private equity is a type of asset class organized as limited partnerships, such as investment funds, that are not publicly traded.
(see Regulation D)
Private Placement Memorandum A document explaining a new private offering of securities. A private placement memorandum sells shares without SEC registration. Therefore, the placement must explain exactly why the offering complies with SEC Regulation D; this is done to protect both the issuer and the investors. According to Regulation D, a PPM must contain a complete description of the security and the terms of the sales. It must also include applicable information about the issuer’s financial situation and applicable risk factors.
Redeem of shares Preferred equity investors have a provision to redeem their shares in the fund by having the issuer buy back the investment at an agreed date and rate.
Regulation D Reg. D is part of the Securities Act of 1933. Shares in private equity funds are often issued under exemption Rule 506 of Regulation D, whereby shares can be sold to accredited investors without being publicly traded. Fund issuers (ie the General Partner) must file a Form D with SEC with the following information: the company’s promoters, executive officers and directors, and some details about the offering.
(See Securities and Exchange Commission, accredited investor)
ROI: Return on Investments The “return on investment” or “ROI” is the gain or loss on an investment, expressed as a percentage.
SAFE – Simple Agreement for Future Equity An agreement where capital is loaned in exchange for equity in a new fund.
(see bridge financing)
SEC: Securities and Exchange Commission The SEC is the US government agency responsible for overseeing all securities transactions that are bound by the Securities Act.
(See Regulation D, accredited investor)
Senior Loan The senior loan holds priority over the other debts and fund investments. It is secured using the company’s assets.
(See capital stack)
Source of funds SOF refers to the origin of the funds used in a particular project, invested by the general partner, limited partners and lenders.
(See use of funds)
Use of funds Where all the raised funds will be used in all stages of the project, from start-up to to construction to management and completion.
(See source of funds)
Waterfall of distribution Related to the capital stack, the distribution waterfall allocates capital gains between the preferred, common and general partners.
(See capital stack)
Entering the world of private equity can be daunting if you aren’t familiar with the framework and terminology. Yet, the balanced investor knows how to assess risks vs returns and chooses the right equity investment that is best suited for their needs. An investment fund may be just what you are looking for to add to your portfolio wealth, either as a preferred or unlimited partner.