RSM 2314 – Private Equity and Entrepreneurial Finance – Fall TERM, 2021

Instructor: Professor Alexander Dyck

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TEST/EXAM INFORMATION & INSTRUCTIONS:

Duration: 2 hours
Total number of questions: 14
Total number of pages: 12
Total number of points: 100

EXAM AIDS :
• This is a.closed-note / closed-book test / exam
• You may use a calculator. Memory must be cleared. Sharing is not allowed. .

Write all answers directly on the Test / Exam. No additional pages will be accepted or
marked.
Focus on your main points, rather than filler words for all questions. If in doubt about
how to interpret a question, write down your interpretation and proceed.

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 1. In comparing term sheets from California with those from other jurisdictions, the term sheets in
California are generally more ‘founder-friendly’ than in many other jurisdictions. Provide two
plausible reasons for this difference. [4 points]

Reason 1:

Reason 2:

2. Why does your Professor say ‘convertible preferred’ is a beautiful thing and facilitates
entrepreneurial finance? [3 points]

3. An incentive not identified in the Limited Partnership Agreement is the expected gain for GPs
from raising a subsequent fund. Circle which of the following types of GPs is this incentive the
weakest, and briefly explain your answer [4 points]
a) First fund, buyout fund
b) First fund, VC fund
c) Third fund, VC fund
d) Third fund, buyout fund
Explanation:

4. The typical debt used in an LBO includes both senior and junior debt. Identify 3 ways in which
the senior debt terms are likely to differ from the junior debt terms [3 points]
a)

b)

c)

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 5. You have been hired by a pension plan and asked to review the returns with various funds you
have invested with in the past. Below is the performance data you have: [6 points]

fund cash in cash out cash out and remaining value

i. Georgian II 100 150 300
ii. Erie II 100 250 300
iii. Huron II 100 200 200
iv. Superior II 100 150 200

a) Circle the best performing fund you would report to your boss. (2 points)
b) Suppose all of these funds were in the process of raising their third funds, but your pension plan
only had enough funds to invest in one of them. Circle how valuable this information is for
deciding which fund to invest in, then explain your answer. (4 points)

Very valuable Not valuable It all depends

Explanation:

6. Research has found that payments to GPs from fixed fees, and from their carry, amounts to
18% of committed capital for VCs, and 12% of committed capital for buyouts. [4 points]

a) Explain what research suggests accounts for these differences in payments to GPs between VCs
and buyouts. (2 points)

b) Explain why there are greater percentage payments to GPs for VCs compared to Buyouts. (2
points)

7. You have been hired by the Canada Pension Plan (CPP) and assigned to work in their
department that manages their LP relationships with more than 100 GPs globally, where they
are almost always the most significant investor in the fund. As part of your role, you review
proposed limited partnership agreements for new funds being raised. For each of the following
clauses, state YES or NO, that CPP would be supportive of including this clause the limited
partnership agreement? [4 points in total]

Yes No: (a) The inclusion of a hurdle rate.

Yes No: (b) Carry of 25 percent, with fixed fees of 1.5% per year.

Yes No: ( c) Side letter that provides co-investment opportunities to all fund investors.

Yes No: (d) Side letter that provides advisory board rights only to the largest LPs
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 8. Circle the most common type of private equity fund in each of the following bolded
geographies (5 points):

Emerging markets,
a) Buyout
b) VC
c) Growth equity

Developed markets
d) Buyout
e) VC
f) Growth equity

If there is a difference across geographies, please explain why.

9. Which of the following firm characteristics would make it attractive for a LBO? Circle all that
apply. (2 points)
a) A very large firm
b) A firm with a strong competitive position
c) A firm with stable cash flows
d) A firm with significant reinvestment needs

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 10. You are working for a GP that is anticipating taking a firm private and has consulted their debt
market specialists. There are two debt schedules offered by competing banks, each very similar
to the debt schedule as part of the investment committee exercise. [8 points]
i. Bank A offers a debt schedule that allows the portfolio company to borrow up to 5x EBITDA,
with 7.5% amortization.
ii. Bank B offers a debt schedule that allows the portfolio company to borrow up to 5x EBITDA,
with 7.5% amortization, and provides a revolving credit facility that, fully drawn, would be
0.5X EBITDA.
a. Circle the offer would you take [1 point]
b. explain why your choice is best [2 points]
c. explain the most important factors you will consider in determining the optimal financing [2
points]
d. explain the specific tests you would conduct to finalize how much of the available debt you
would use in your proposed transaction to the investment committee. [3 points]

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11. [22 points] You have been hired as an associate at BQuest, a Toronto based mid-market buyout
fund. You have been asked to come with some calculations and a clear recommendation to
offer to BQuest’s investment committee of whether, given the information provided, BQuest
should be prepared to offer a bid to buy the publicly traded firm TORH, a TSX listed issuer,
and take it private.

The deal is expected to close Jan 1, 2022. It is now late 2021 and the 2021 financials are
thankfully already finalized and available to you as indicated below. TORH is an established
firm in a well-established industry. You have been provided information on the historical
financials, and management projections as to the values for an exit for TORH both 1 year from
now (end of 2022) and 2 years from now (end of 2023).

The tax rate is 20%. Based on advice of your M&A advisor, you think you will be able to
purchase the firm today for an EV/EBITDA (2021) of 10.0x. Existing debt for TORH at end of
2021 is $80 mn at an interest rate of 8%. You have been told to model assuming BQuest will
use Senior debt of 5.0x EBITDA at an interest rate of 10%. The debt would be taken on
immediately, with first interest payments due end of 2022. The debt has a covenant requiring a
‘cash sweep.’Y our M&A advisor also tells you that the exit multiple to expect for the firm
both in case of an exit 1 year from now, and 2 years’ time from now is the current multiple.

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• All numbers in ‘000s
Historical 2021 Management Management
(2016-21) (TTM) Forecast Forecast
2022 2023
Revenue 10% CAGR 200,000 240,000 288,000
EBITDA Margin 20% 20% 20% 20%
EBITDA 40,000 48,000 57,600
DA 20,000 20,000 20,000
Other Items
Capex 10% of 20,000 20,000 20,000
Revenue
NWC 10% of
Revenue 20,000 21,600 25,920

(a) What is the cash flow to equity holders at the end of 2022, before any additional paydown of
debt required by a ‘cash sweep’? What is the cash flow to equity holders at the end of 2022
assuming a cash sweep? [8 points]

2021 (TTM) Forecast 2022

Revenue 200,000 240,000

FCFE (before cash sweep)

FCFE (after cash sweep)
Balance Sheet Items

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(b) What would you report as the expected IRR and MIC to the investment committee with an exit
at the end of 2022? [6 Points]

(c) You are anticipating the investment committee (IC) will try to pick apart your projections.
Identify two aspects of your forecasts that you anticipate would get the most attention? For
each of these modeling choices, explain things you could do in the rest of the deck to anticipate
and address investment committee concerns. [6 points]

IC concern number 1 ________________________________

How you could address this concern:

IC concern number 2 ___________________________________

How you could address this concern:

(d) Your boss comes up to you just before the presentation and says the following. “I should have
mentioned this before. Of course, we plan on having existing management buy-in as part of the
deal. Please model this with them having a 10% equity stake.” How, if at all, does this change
the numbers you would put forward to the investment committee? [3 Points]

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 12. You work for a GP. The GP purchases a portfolio company that is a public target with an
EBITDA (TTM) of $50 million, with debt outstanding of $100 million, at an Enterprise
Value/EBITDA multiple (TTM) of 10.0x. You fund this purchase, in part, by raising debt
finance at 6.0x EBITDA, and by Management Equity investment of $10,000,000. [12 points]

a) Please complete the following Sources and Uses Statement. Assume there are no transaction
fees. [4 points]

Capital Uses EBITDA Multiple Capital Sources EBITDA Multiple

Total

b) (Question continued) Three years later, you sell the portfolio company to a strategic buyer at an
EV/EBITDA multiple of 11x. At the time of sale, the portfolio company has $170 million of
debt outstanding, and has an EBITDA of $70 million. Suppose this is the only portfolio
company the fund has, the LP has a capital commitment equal to the equity investment. The
limited partnership agreement specifies that the LP has to pay no fees to the GP, and that the
GP is entitled to 20 percent of the profits, defined as distributions in excess of committed
capital. [8 points]

What is the LPs net_IRR? [3 points]

What is the LPs net_MIC? [1 point]

Is this the most [typical_exit_route] for an LBO-sponsored transaction? [1 point]

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 Circle the appropriate answer if the patterns in this example are typical of the experience in
recent years for, respectively, [3 points]

(a) purchase multiple – YES NO

(b) leverage in LBO – YES NO

(c) multiple expansion - YES NO

13. What is pre-mortem analysis, and how could you use it effectively to improve your approach
to private equity, and your investment committee presentation? [4 points]

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14. You have just started work at a GP. Your boss asks you to provide an executive summary of
what can be learned about future LP demand for PE from a Fall 2021 Meeting of the Oxford
Private Equity Research Consortium. She provides you the following graph that was included
in a presentation, and asks you to address the following questions: [18 points]

a) Explain the vertical axis, the horizontal axis and why it ends in 2016, even though presentation
is in 2021, and why there are two different lines [6 points]

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b) What conclusions are LPs likely to draw from these graphs for their future allocation to PE
(relative to other assets)? [6 points]

c) Could these graphs be used to justify both an increase and a decrease in the allocation to
private equity. Explain your answer. [6 points]

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