Introduction To Private Equity & Venture Capital #2: The Nuts And Bolts of PE & VC Funds

Summary

This video script offers an insightful introduction to private equity and venture capital, explaining the life cycle of a private equity fund, from fundraising to investment and exit strategies. It delves into the mechanics of deal sourcing, the hands-on approach of private equity investors, and the crucial role of general partners (GPs) in managing relationships with limited partners (LPs) and portfolio companies. The script also clarifies key terms and fee structures, including the '2 and 20' rule, and discusses the importance of LPs in shaping the private equity landscape.

Takeaways

• 📈 Private equity and venture capital funds are vehicles for investing in companies at different stages of maturity, with venture funds focusing on early-stage startups and private equity funds on later-stage companies.
• 🔄 Private equity funds have a finite life, typically up to 10 years with the possibility of a two-year extension, and go through a fundraising period, an investment period, and a holding period before exits occur.
• 💼 The process of deal sourcing in private equity is extensive, with firms like Bridgepoint considering hundreds of opportunities and conducting due diligence on a fraction of those to make a handful of investments each year.
• 🛠️ Private equity is a hands-on business where investors not only provide capital but also operational experience to help grow and improve the acquired companies during the holding period.
• 🤝 The relationship between general partners (GPs) and limited partners (LPs) is crucial, with GPs having a fiduciary duty to act in the best interest of LPs and aiming to generate outsized returns.
• 🏢 The private equity firm structure includes a GP responsible for deal execution and a manager or advisor for day-to-day operations, with the GP often investing in the fund to align interests with LPs.
• 📊 Successful private equity firms typically raise new funds every three to four years, with fund sizes increasing as the firm's track record and market opportunities grow.
• 📉 The cash flow for LPs in a private equity fund follows a 'J-curve' pattern, with initial negative cash flow during the investment period followed by positive cash flow as exits occur and profits are returned.
• 💰 The standard fee structure in private equity is '2 and 20,' referring to a 2% annual management fee and a 20% profit share for the GP, with the latter being the primary incentive for GPs.
• 🚫 While private equity has improved its transparency in recent years, there are still concerns about hidden fees charged to portfolio companies, which may affect the overall fee structure's clarity.
• 🤑 The distribution of profits from exits involves first returning the LPs' capital, then paying a hurdle rate, followed by a catch-up period for the GP, and finally splitting the remaining proceeds 80/20 between LPs and GPs.

Q & A

What is the primary focus of this video channel?

The video channel is focused on private equity and venture capital, aiming to educate viewers about these topics.

What is 'dry powder' in the context of private equity and venture capital?

Dry powder refers to the capital that is reserved and available for investment by private equity and venture capital firms.

What is the typical lifespan of a private equity fund?

A private equity fund typically has a lifespan of up to 10 years, with the option to extend by another two years.

What is the first phase of a private equity fund's life cycle called?

The first phase is called the fundraising period, which is when the fund is initially raised.

How many investments does an average private equity fund make per year?

On average, a private equity fund makes about five investments per year.

What is deal sourcing in private equity?

Deal sourcing is the process of identifying and finding suitable companies that fit the investment mandate of the private equity fund.

What is the role of the General Partner (GP) in a private equity firm?

The General Partner (GP) is responsible for managing the relationships with the Limited Partners (LPs) and the portfolio companies, as well as executing the deals and ensuring fiduciary duty towards the LPs.

What are Limited Partners (LPs) in the context of private equity funds?

Limited Partners (LPs) are the investors in the private equity fund whose liability is limited to the amount of capital they have committed to the fund.

What is the typical fee structure for private equity funds, often referred to as '2 and 20'?

The '2 and 20' fee structure refers to a 2% annual management fee on committed capital and a 20% profit share, known as carry, for the GP.

What is the J-curve in private equity and what does it represent?

The J-curve represents the typical cash flow pattern for LPs in a private equity fund, where initial negative cash flows (due to investments) turn positive as investments are exited and returns are realized.

How are profits distributed in a private equity fund after an exit?

Profits are first used to return the LPs' initial investment, then pay a hurdle rate (usually 8-10%), followed by catch-up for the GP, and finally splitting the remaining profits 80/20 between the LPs and the GP, respectively.