Private Equity

1. The Initial investment in a private equity transaction of GBP 5,000 MN. The transaction is financed with
50 per cent debt and 50 per cent equity. The GBP 2,500 MN equity investment is further broken into
GBP 2,400 MN of preference shares owned by the private equity fund, GBP 95 MN of equity owned by
the private equity fund and GBP 5 MN of management equity. The preference shares promised a 12%
annual return (paid at exit). Compounded return The Private equity firm equity is promised 95 per cent
of the residual Value of the firm after creditors and preference shares are paid. Management equity
holders are promised the remaining 5 %. The debt of GBP 900 MN is paid during the course of
operation. Assume that the exit value, five years after the investment is 1.6 times the original cost. Find
the payoff and IRR of equity claimants.

2. A PE firm values a deal of GBP 100 MN investment. Its expected exit value is 1.5 times of investment.
and the duration to exit is 4 years. The investment is financed with 70% debt and the remaining equity.
Out of equity, 75% is in the form of preference shares by the PE firm at the rate of 15% p.a. (paid at the
time of exit), 20% in the form of equity shares of the PE firm and the remaining in the form of equity
shares held by the management. Assume that 60% of the debt is paid during the operation. Find the
payoffs and IRR for each claimant (total equity).

3. Alpha Equity Fund committed capital of $250 million. The GP is entitled to receive carried interest of
20%. The following three investments were made by the fund at the beginning of 2011 and exited at the
end of 2011:
Portfolio of Company Amount invested (USD mil) Proceeds Upon Exit
A 60 85
B 80 75
C 20 40
Calculate the amount of carried interest paid to the GP for 2011, assuming that:
a. Carried interest is paid on a deal-by-deal basis with a hurdle rate of 50%
b. Carried interest is based on the first alternative of the total return method, i.e.) if the Value of the
investment portfolio exceeds the committed capital
c. Carried interest is based on the second alternative of the total return method. i.e.) if the Value of the
investment portfolio exceeds the Value of invested capital by 20%

4. The entrepreneur founders of Tiara Ltd. believe that in 5 years, they will be able to sell the company for
$60 million. However, they are currently in desperate need of $7 million. A VC firm interested in
investing in Tiara estimates that the discount rate commensurate with the relatively high risk inherent in
the firm is 45%. Given that current shareholders hold 1 million shares and that the venture capital firm
makes an investment of $7 million in the company, calculate the following:
A. Post-money valuation
B. Pre-money valuation
C. Ownership proportion of the VC firm
D. The number of shares that must be issued to the VC firm
E. Share price after the VC firm invests $7 million in the company

5. The entrepreneur founders of Tiara Ltd. believe that in 5 years, they will be able to sell the company for
$60 million. However, they are currently in desperate need of $7 million. A VC firm interested in
investing in Tiara estimates that the discount rate commensurate with the relatively high risk inherent in
the firm is 45%. Given that current shareholders hold 1 million shares and that the venture capital firm
makes an investment of $7 million in the company,
calculate the following:
a. The future wealth required by the VC to attain its desired IRR.
b. Ownership percentage of the VC firm
c. The number of shares that must be issued to the VC firm
d. Stock Price per share
e. Post-money value
f. Pre-money value
6. The private equity firm Purcell & Hyams (P&H) is considering a $17 million investment in Eizak
Biotech. Eizak's owners firmly believe that with P&H's investment, they could develop their "wonder"
drug and sell the firm for $120 million in six years. Given the project's risk, P&H believes a discount
rate of 30% is reasonable. The pre-money valuation (PRE) and P&H's fractional ownership,
respectively, are closest to (in millions)

7. A private equity firm is guaranteed to receive 80% of the residual value of a leveraged buyout
investment, with the remaining 20% owing to management. The initial investment is $500 million, and
the deal is financed with 70% debt and 30% equity. The projected multiple is 2.0. The equity
component consists of:
$120 million preference shares.
$25 million private equity firm equity.
$5 million management equity.
At exit in 5 years, the value of debt is $150 million, and preference shares are $300 million. The payoff
multiple for the private equity firm and management, respectively, is closest to:

8. A venture capital firm is considering investing in a private company involved in generating power
through alternative sources of energy. However, the venture capital firm believes that the founders of
the private company are too optimistic and that the chance of the company failing in any given year is
20%. The discount rate after accounting for systematic risk is 35%. Calculate the adjusted discount rate
that incorporates the company’s probability of failure.

9. Compute the terminal value estimate for Blue Horizons Pvt. Ltd. given the following scenarios and their
probability of occurrence:

a. The company’s earnings in Year 5 are $13 million and the appropriate exit price-to-earnings multiple is
8. The probability of occurrence of this scenario is 65%.
b. The company’s earnings in Year 5 are $6 million and the appropriate exit price-to-earnings multiple is
5. The probability of occurrence of this scenario is 25%.
c. The company fails to achieve its goals and has to liquidate its assets in Year 5 for $5 million. The
probability of occurrence of this scenario is 10%.

10. A private equity investor is considering investing in a venture capital firm. The investor values the firm
at $1.5. million following a $300,000 capital investment by the investor. The venture capital firm's pre-
money (PRE) valuation and the investor's proportional ownership, respectively, are:

11. A private equity investor is considering an investment in a venture capital firm, and is looking to
calculate the firm's terminal value. The investor determines that there is equal likelihood of the
following:
a. Expected firm earnings are $2.5 million with a P/E ratio of 8.
b. Expected firm earnings are $3.0 million with a P/E ratio of 10.
The firm's expected terminal value, and the analysis used by the investor, respectively, is:

12. The Milat Private Equity Fund (Milat) makes a $35 million investment in a promising venture capital
firm. Milat expects the venture capital firm could be sold in four years for $150 million and determines
that the appropriate IRR rate is 40%. The founders of the venture capital firm currently hold 1 million
shares. Milat’s fractional ownership in the firm and the appropriate share price, respectively, is closest
to:

13. Wizplus is a young start-up company, and the founders estimate that they will be able to sell the
company for $80 Million in six years. At this time, they need to be able to raise $10 Million. MGL
venture (a venture capitalist) considers this business risky and wants to apply a discount rate of 30%.
The founder of Wizplus owns 2,000,000 shares. Calculate pre and post money valuation, percentage
ownership of VC and Founders and price per share.
 14. Wizplus is a young start-up company, and the founders estimate that they will be able to sell the
company for $80 Million in six years. It will raise $6 Million today and another $4 Million 2 years from
now. MGL ventures will be the investor for the first round, and Camelot Capital is a potential investor
for the second round. The discount rate for such a risky start-up is 30%. The founder of Wizplus owns
2,000,000 shares.
calculate the no of shares to be given to the 1st round of funding and calculate the price per share.
calculate the no of shares to be given to the 2nd round of funding and calculate the price per share.

15. Suppose Tiara Ltd. intended to raise $10 Mn. However, doing so in a single round of financing would
not have been feasible as it would have led to a pre-money valuation of -$0.639 Mn. Therefore, the
company decided to undertake an initial financing round worth $7 Million and to follow that up with
another financing round worth $3 Million after 4 years. The entrepreneur founders of Tiara Ltd. believe
that in 5 years, they will be able to sell the company for $60 million at the end of five years. Given that
investors in the second financing round feel that a discount rate of 25% is appropriate, Calculate the
price per share after a second round of financing.

16. The private equity firm Purcell & Hyams (P&H) is considering a $17 million investment in Eizak
Biotech, of which $10 million is invested today and $7 million in four years. Eizak's owners firmly
believe that with P&H's investment, they could develop their "wonder" drug and sell the firm for $120
million in six years. Given the project's risk, P&H believes a discount rate of 50% is appropriate for the
first four years and 30% for the last two years. The fractional ownership for P&H at the time of the
initial investment would be closest to

17. The Nishan private equity fund was established five years ago and currently has a paid-in capital of $300
million and total committed capital of $500 million. The fund paid its first distribution three years ago of
$50 million, $100 million the year after and $200 million last year. The funds distributed to paid-in
capital (DPI) multiple is closest to:

18. The founders of a small technology firm are seeking a $3 million venture capital investment from
prospective investors. The founders project that their firm could be sold for $25 million in 4 years. The
private equity investors deem a discount rate of 25% to be appropriate, but believe there is a 20% chance
of failure in any year. Calculate the adjusted pre-money valuation (PRE) of the technology firm.

19. Michael Hornsby, CFA, is a senior investment officer at Icarus, a UK-based institutional investor in
private equity. He is contemplating an investment in Europa Venture Partners III, a new late-stage
technology venture capital fund, after thorough due diligence on the fund and the GP. Icarus has been an
investor in Europa Venture Partners’ (EVPs’) previous two funds, EVP I and EVP II, and has been
satisfied with performance so far. Icarus seeks to further expand its relationship with this GP because it
sees it as a niche venture capital firm operating in a less crowded segment of the pan-European
technology markets. In light of its past success, EVP is increasing its carried interest for the third fund to
25% from 20% for the previous two funds. Hornsby has received information about the fund’s financial
performance and is seeking assistance in calculating and interpreting financial performance for several
specific queries, as outlined below.

Europa Venture Partners (EVP) : General Partner Europa Venture Partners (EVP) was established to provide
equity financing to later-stage European technology companies in need of development capital. The GP seeks
to provide strategic support to seasoned entrepreneurial teams and to bring proven new technologies to the
market. The GP targets investment in portfolio companies between €2 million and €10 million.

Established in 2012 Type: Development Capital

Fund Vintage Actual Fund Capital Mgmt. Carried Hurdle Term
Report
Size Called(%) Fees (%) Interest (%) Rate (%) Date
EVP I 2014 125 92 2 20 8 2012 31/12/19
EVP II 2016 360 48 2 20 8 2025 31/12/19
The financial performance for Icarus’ investments in EVP funds follows.

Fund Committed Capital Capital Called Gross IRR Net IRR DPI RVPI TVPI Quartile
(€ Millions) Down (%) (%) (X) (X) (X)

EVP I 10 9.2 16.1 11.3 1.26 1.29 2.55 1

EVP II 25 12.0 1.6 (0.4) 0.35 1.13 1.48 2

Hornsby is also interested in verifying management fees, carried interest, and the NAV of EVP I. He has the
following information about yearly capital calls (assumed to occur on 1 January of the given year), operating
results, and annual distributions (as of 31 December of the given year).

Calls, Operating Results, and Distributions (€ Millions)

2014 2015 2016 2017 2018 2019
Called down 50 15 10 25 10 5
Realised results 0 0 10 35 40 80

Unrealised results −5 −15 15 10 15 25

Distributions — — — 25 45 75

Operating results are the sum of realised results from existing portfolio companies and unrealised results from
the revaluation of investments presently held in portfolio companies. In addition to the information available
on EVP I, Hornsby also knows from the fund prospectus that the distribution waterfall is calculated according
to
the total return method, in which the GP receives carried interest only after the fund has returned the entire
committed capital to LPs. Management fees are calculated based on the paid-in capital. Hornsby also wants to
calculate the DPI, RVPI, and TVPI of EVP I for 2019, and he is interested in understanding how to calculate
gross and net IRRs.

1 Interpret and compare the financial performance of EVP I and EVP II.
2 Calculate the management fees, the carried interest, and the NAV of EVP I. Also, calculate the DPI, RVPI,
and TVPI of EVP I for 2019. Based on EVP I, explain how gross and net IRRs are calculated.

20. XYZ Private Equity Partners purchases ABC @ 200 million Target Company for 5.0x Forward 12
months (FTM) Forward Multiple EBITDA at the end of Year 0. The debt-to-equity ratio for the LBO
acquisition will be 60:40. Assume the weighted average interest rate on debt is 10%. ABC expects to
reach $100 million in sales revenue with an EBITDA margin of 40% in Year 1. Revenue is expected to
increase by 10% year-over-year (y-o-y). EBITDA margins are expected to remain flat during the term of
the investment. Capital expenditures are expected to equal 15% of sales each year. Operating working
capital is expected to increase by $5 million each year. Depreciation is expected to equal $20 million
each year. Assume a constant tax rate of 40%. XYZ exits the target investment after Year 5 at the exact
EBITDA multiple used at entry (5.0x FTM EBITDA). Assume all debt pay-down occurs at the moment
of sale at the end of Year 5

21. Daniel Collin is a junior analyst at JRR Equity Partners (JRR), a private equity firm. Collin is assigned
to work with Susan Tseng, a senior portfolio manager. Tseng and Collin meet to discuss existing and
 potential investments. Tseng starts the meeting with a discussion of LBO firms and VC firms. Collin
tells Tseng, LBO firms tend to invest in companies with predictable cash flows and experienced
management teams, whereas VC firms tend to invest in companies with high EBITDA or EBIT growth
and where an exit is fairly predictable.

Tseng and Collin next analyse potential investment in the leveraged buyout of Stoneham Industries.
Specifically, they assess the expected gain if they elect to purchase all of the preference shares and 90%
of the common equity through the LBO.
Details of the LBO include the following:
The buyout requires an initial investment of $10 million.
Financing for the deal includes $6 million in debt, $3.6 million in preference shares that promise a 15%
annual return paid at exit, and $0.4 million in common equity.

The expected exit value in six years is $15 million, with an estimated reduction in debt of $2.8 million
over the six years prior to exit.

Tseng and Collin next discuss JRR’s investment in Venture Holdings, a private equity fund. Selected
details on the Venture Holdings fund include the following:

 Total committed capital is $115 million.

 The distribution waterfall follows the deal-by-deal method, and carried interest is 20%.
 On its first exit event a few years ago, the fund generated a $10 million profit.
 At the end of the most recent year, cumulative paid-in capital was $98 million, cumulative distributions
paid out to LPs were $28 million, and the year-end NAV, before and after distributions, was $170.52
million and $131.42 million, respectively.
 Tseng and Collin estimate that the fund’s NAV before distributions will be $242.32 million at the end of
next year.

Finally, Tseng and Collin evaluate two venture capital funds for potential investment: the Squire Fund and
the Treble Fund. Both funds are in Year 7 of an estimated 10-year term. Selected data for the two funds are
presented in Exhibit 1.
Exhibit 1 Selected Data for the Squire Fund and the Treble Fund
Squire Fund Treble Fund
DPI 0.11 0.55
RVPI 0.95 0.51
Gross IRR –11% 10%
Net IRR –20% 8%
After reviewing the performance data in Exhibit 1, Collin draws the following conclusions:

Conclusion 1 The unrealised return on investment for the Squire Fund is greater than the unrealised return on
investment for the Treble Fund.
Conclusion 2 The TVPI for the Treble Fund is higher than the TVPI for the Squire Fund because the Treble
Fund has a higher gross IRR.

a. The multiple of expected proceeds at the exit to invested funds for JRR’s Stoneham LBO investment is
closest
b. The distribution available to the limited partners of the Venture Holdings fund from the first exit is closest
to:
c. At the end of the most recent year, the ratio of the total value to paid-in capital (TVPI) for the Venture
Holdings fund was closest to:
d. Based on Tseng and Collin’s estimate of NAV next year, the estimate of carried interest next year is closest
t
e. Which of Collin’s conclusions regarding the Squire Fund and the Treble Fund is correct?
f. Is Collin’s statement about LBO firms and VC firms correct?
22. a. Take an entrepreneur who is looking to raise $500,000. Given the size of its market and the industry,
the entrepreneur’s company expects to reach sales of $80 million over the investment horizon. A typical
 revenue multiple for a revenue-generating business in its industry is 2×. If the VC firm’s ROI is 20× and
the entrepreneur’s company has no debt, then what is the pre-money valuation? And what is the VC
firm’s fractional ownership?

ROI = Value of Equity at Exit / Post-Money Valuation

Post Money Valuation = Value of Equity at Exit / ROI
Pre Money-Valuation = Post-Money Valuation – New Equity Injection

b. If the period is 5 years, then it translates into ROI in the IRR term

23. (i). Imagine a start-up company worth $16 million, and its shareholders own 1,000,000 Shares which
is 100% of the equity. The company raised $4 million in additional equity capital from a venture
capital firm. Calculate the pre-money, post-money, percentage ownership and no. of additional
shares issue to VC firm.

(ii). Back to the above start-up example, let’s say that in addition to the founders holding 10 million
shares, there is an outstanding option pool of 2 million shares. How many shares need to be issued? And at
what price per share? (Recall that the default is to make calculations on a fully diluted basis.) What is the
starting equity stake of the VC firm? What is the VC firm’s equity stake after dilution?

24. Take an entrepreneur looking to raise $500,000 (Series A). Given the size of its market and the industry,
the entrepreneur’s company expects to reach sales of $80 million over the investment horizon. A typical
revenue multiple for a revenue-generating business in its industry is 2×. If the VC firm’s ROI is 20× and
the entrepreneur’s company has no debt, imagine that one year later, the firm raises $2 million in a Series
B financing at 10× ROI. The exit of all investors is expected to coincide, and Series B investors were
projecting an exit valuation of $300 million. Compute each financing round's ownership structure and the
implied ROI for the Series A and B financings.

25. Mavis Krager, manager of alternative investments for the Richmond Group, is considering the merits of
some private-equity opportunities. Richmond Group likes to invest in private-equity funds but will also
do its own deals if the opportunity is right. One deal on the table is an equity stake in Melton Motors, a
privately held auto dealerships chain. The company is well-run but has had hard times lately because of
credit problems. Krager thinks Melton will solve its financial problems and become profitable again. She
is considering investing $7 million in the company. Also under discussion is The Apple House, a large
privately held orchard in Wisconsin. Richmond Group is considering investing $5 million. To determine
whether the deals are worthwhile, Krager estimates a price for each company based on a post-money
valuation, using a discount rate of 13.7%. The investment firm prefers to focus on companies willing to
price their stocks at least 20% below their actual value and fund the investments only once. To calculate
her valuations, Richmond uses the data below:
Details Melton Motors The Apple House
Stock Price offered $17 $42
Number of Shares held by current owners 1.5 MN 80,000
The estimated value of the company at the end of the investment period $51 MN $29 MN
Expected length of the investment 5 years 10 years

Just as Krager finishes her assessment of the two private-equity deals, a contact at The Apple House
calls her and says the management team is considering a leveraged buyout (LBO) and wants Richmond
Group to help finance it. Since the firm hasn‘t financed an LBO for years, Krager gets out a book she
has
not read since college to bone up on the valuation equations and reacquaint herself with terms specific
to LBOs. What action should Richmond Group take with regard to:
a. investment would be closest to:

b .  B)
c .  C)
d. Question #2 of 41 Question ID: 434451
e .  A)
f .  B)
g .  C)
h. Question #3 of 41 Question ID: 416054
i .  A)
j .  B)
k .  C)
l. For a given set of underlying real estate
properties, the type of real estate index that is
most likely to have the lowest standard
m. deviation is a(n):
n. REIT trading price index.
o. appraisal index.
p. repeat sales index.
q. Explanation
r.Appraisal index returns are based on estimates
of property values. Because estimating values
tends to introduce smoothing into
s.returns data, appraisal index returns are likely
to have lower standard deviations than index
returns based on repeat sales or
t. trading prices of REIT shares.
u. Historical data on returns of assets valued
with appraisal methods are to exhibit:
v. downward-biased Sharpe measures.
w. smoothing.
x. overstated correlations with other asset
classes.
y. Explanation
z. Appraisal methods tend to produce
smoothed return patterns understate standard
deviations of returns. This causes correlations
aa. with other asset classes to be understated
and Sharpe ratios to be biased upward.
bb. A British hedge fund has a value of £100
million at the beginning of the year. The fund
charges a 2% management fee based on
cc. assets under management at the end of the
year and a 20% incentive fee with a soft hurdle
rate of LIBOR + 2.5%. Incentive fees
dd. are calculated net of management fees. If
the relevant LIBOR rate is 2.5% and the fund's
Value at the end of the year before fees
ee. is £120 million, the net return to investors