Are you preparing for PE fund Accounting interview_.pdf
1.
2. The basic operating model of the Private Equity (PE) industry.
PE firms are institutions that manage money on behalf of investors.
Examples include KKR, The Carlyle Group, New Mountain Capital,
etc.
Sometimes terms like PE firms/fund or GPs are used
interchangeably. However, GPs or General Partners are separate
legal entities that sit on a specific fund
LPs or Limited Partners are institutions that provide money to PE
firms or GPs to invest on their behalf. Examples include Sovereign
Wealth Funds, Pension Funds, Endowment Funds, etc.
3. A PE firm manages different funds (each will have a separate
management team). LPs allocate money to different funds in the
form of commitments.
After fundraising from LPs, GPs invest money in different
companies (post-investment they are referred to as portfolio
companies) as per the mandate of the fund from which the
investment is being made.
GPs usually take active ownership of the company. Active
ownership includes creating value in the company by increasing
revenue, reducing costs, optimizing capital & tax structure, and
digital transformation, amongst others.
Once the targeted value has been generated, PE firms position the
companies for exit and sell these companies at a significant
multiple of the cost at which they originally acquired these.
Post-exit, the money is returned to LPs along with profits. PE firms
charge a cut out of these profits in the form of carried interest.
5. After the committed capital is fully invested, the fees are
paid only on the funds remaining in the investment
vehicle. As investments are exited, capital is paid back to
the investors, and they no longer pay fees on that portion
of their investment.
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6. General partner
In a limited partnership setup, the managing firm that runs
the business/portfolio and ultimately bears
unlimited liability for the business’s debts and obligations.
For a hedge fund, the management firm typically receives
both a management fee based on the value of the portfolio
and an incentive fee based on fund returns.
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8. A hedge fund is usually set up as a limited partnership, with the investors
as the limited partners, and the management firm as the general partner.
A hedge fund partnership may be limited to just a prescribed number of
investors, who must possess adequate wealth, sufficient liquidity, and an
acceptable degree of investment sophistication.
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9.
10. What is unique to private equity is this notion of committed capital. This
is the amount that the LPs have agreed to provide to the private equity
fund. The committed capital remains with the LPs until the private equity
fund draws from it for investment opportunities that it has identified.
Before the committed capital is fully drawn down, a process which
typically takes 3 to 5 years, the management fee is based on committed
capital, not invested capital.
Like hedge funds, private equity funds are typically
structured as limited partnerships where outside
investors are limited Partners and the private equity
firm, which may manage a number of funds, is
the general Partner. Most private equity firms
charge both a management fee and an incentive
fee. The management fees generally range from 1 to
3 percent, while the incentive fee is typically 20%.
11. Generally means investing in privately owned companies, or in public companies with
the intent to take them private. Private equity are usually categorised according to
their investment strategy. They include: leveraged buyouts, venture
capital, development capital, and distressed investing.
See also: Limited partnership, Private equity fee structure
12. Backfill bias
Backfill bias can be introduced when new
funds are added to a benchmark index. Since
funds that are newly added to an index tend be
those that have performed better than average,
including their returns for prior years tends to
bias the index returns upward.
15. Management fee
A fee based on assets under
management or committed capital,
as applicable. May be calculated on
either the beginning-of-period or
end- of-period values.
16. Brownfield & Greenfield investments
Investing in existing investable infrastructure.
There are 3 broad approaches that the experts use to value a property.
17. Comparable sales approach
The comparable sales approach bases valuation on recent sales of
similar properties. Obviously, no 2 properties are exactly the same, so
adjustments are made for differences in characteristics, such as age,
location, condition, and size.
Real estate valuation
19. Cost approach
The cost approach calculates the replacement cost of a
property by estimating the value of the land and the
costs of rebuilding it using current construction costs.
Such costs include building materials, labor to build,
and various “soft” costs like architectural, engineering,
legal, and environmental assessment costs.
20. Capitalisation
When a cost is capitalised, it is recorded initially in the balance sheet as an asset.
This cost is depreciated or amortised over the asset’s useful life.
In general, capitalise only if there is a future economic benefit.
21. Current value of some future cash flow or series of cash flows
PV = FV / (1 + r)N
FV: future value
r: discount rate
N: number of periods
A type of private equity fund that makes minority equity investments
in
more mature companies that are seeking capital to expand or
restructure operations, enter new markets, or finance major
acquisitions.
Development capital
22. A type of private equity fund that buys the debt of
mature companies in financial difficulty. Distressed
debt investors often take an active role in the
management and direction of the company or in
the reorganisation of the company. The return on
investment is a function of the ability of the
investor to restructure the company back to
profitability.
Distressed investing
23.
24.
25. Hedge fund strategies
Hedge funds can be classified according to the strategies that
the fund manager employs. According to Hedge
Fund Research, there are four main classifications of hedge
fund strategies: event-driven strategies, relative value
strategies, macro strategies, and equity hedge
strategies.
26. The rate of return that must be met before the incentive fee can be paid out. A hurdle rate can be set either as an
absolute percentage, or a rate relative to a benchmark, like the LIBOR rate.
A hurdle rate can be either specified as a hard hurdle, or a soft hurdle. Hard hurdle: incentive fees are earned only
on returns in excess of
the hurdle
Soft hurdle: incentive fees are paid on all profits, but only if the
hurdle rate is met.
Hurdle rate
27. High water mark
The highest value, net of fees, that a fund has reached in history. This
is a feature which ensures that investors will not be charged incentive
fees twice on the same gains in their portfolio values.
This is achieved by limiting the incentive fees to apply to the extent
that the current value of an investor’s account is above the highest
value previously recorded. Clients are not charged an incentive fee if
the latest cumulative return does not exceed the prior high water
mark.
28. Fees paid to the general partner from the limited partners based
on realised net profits.
Profits can be:
Incentive fee
29. any gains in value,
any gains in value in excess of the management fee,
or gains in excess of a hurdle rate.
High water mark is a feature which ensures that investors will not be
charged incentive fees twice on the same gains in their portfolio
values.
A type of private equity fund which acquire established private
companies or publicly listed companies with a significant
percentage of the purchase price financed through debt. If the
target is a publicly- listed company, it is taken private after the
buyout.
Two types of LBOs are management buyouts and management
buy-ins.
Leveraged buyout (LBO)
30. Lockup period
The minimum holding period before investors
are allowed to make withdrawals or redeem
shares from a fund.
31. Managed futures funds
Actively managed funds which can be focused on specific
sectors, or diversified across a number of sectors. Some are
structured as limited partnerships with fees like those of hedge
funds and restrictions on the number, net worth, and liquidity of
the investors. Others are structured like mutual funds with
shares that are publicly traded so that retail investors can also
benefit from professional management. The mutual
funds structures tends to allows a lower minimum investment,
lower fees, and greater liquidity compared to a limited
partnership structure.
32. Master Limited Partnerships (MLP)
A type infrastructure investment which trade
on exchanges and are pass-through entities
similar to REITs, where most of the free cash
flow is allocated to the investors. Typically,
the general partner manages the partnership,
receives a fee, and holds a small partnership
interest. Limited partners own the remaining
partnership interest.
33. Mezzanine financing
Debt or preferred shares that carry warrants or conversion features
that give investors participation in equity value increases. Warrants
give the lender the right to purchase new stocks at a certain price,
while the convertibility allows the lender to convert the debt
into common stock.
Mezzanine financing is one method of debt
financing in a leveraged buyout transaction.
34. Brokers provide many services including custodial services,
administrative services, money lending, securities lending for
short sales, and trading services.
Hedge fund managers primarily trade through prime brokers
Prime brokers
35. REIT valuation
REITs are composed of a portfolio of
properties and as a result, its valuation
depends on the characteristics of the
entire portfolio. Value estimates for
a REIT can be income-based or asset-
based.
36. Asset-based Approach
Income-based Approach
The net asset value of the REIT is estimated by
subtracting total liabilities from the total value of
the real estate assets, and dividing by the number
of shares outstanding.
The income-based approach is similar to
the direct capitalisation approach
(see real estate valuation) for a specific
property and uses some measure of cash
flow (e.g. FFO) and a cap rate.
37. Survivorship bias
The bias resulting from a test design that fails to
account for companies that have been delisted,
funds that are closed, accounts that are terminated,
etc. Tends to be an upward bias because
terminated accounts/portfolios/stocks tend to have
poorer performance.
38. Venture capital (VC)
A type of private equity fund that invest in companies in the early
stages of their development. The investment often is in the form of
equity but can be in convertible preferred shares or convertible debt.
Categorisation of venture capital investments is based on the
company’s stage of development. Terminology used to identify
firm investment at different stages of the company’s life includes the
following:
The formative stage refers to investments made during a firm’s
earliest period and comprises three distinct phases.
Angel investing is capital provided at the idea stage. Funds
may be used to transform the idea into a business plan and to
assess market potential.
Seed stage financing refers to investments made for product
development, marketing, and market research.
Early stage financing is provided to companies moving toward
operation but before commercial production and sales have
occurred.
Later stage refers to the stage where a company already has
production and sales and is operating as a commercial entity.
Investment funds provided at this stage are typically used for
expansion of production and increasing sales through an expanded
marketing campaign.