WELCOME TO ISSUE NO #016

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Happy Saturday! This week I’ve prepared a one big TOPIC and one freebie just for you.

TL;DR

• Structure: GPs (fund managers) raise money from LPs (investors).

• Capital: Funds are committed and drawn as needed.

• Metrics:

  • DPI: Cash returned

  • TVPI: Total value, including unrealized gains.

• Fees: "2-20" model (2% management fee, 20% profit share above 8%).

• Profit Sharing: Full catch-up means GPs get 20% of total returns above the hurdle.

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How do PE VC Funds work?

How does a Private Equity / Venture Capital fund work? What are PE VC Funds?

In this issue we decode the world of PE VC funds, and the key terminologies associated with them.

First up – Why PE / VC funds are needed?

Ultra rich investors, having already invested in listed Equities and Debt markets, are looking for diversification and higher return potential.

So they turn to early stage #investing (unlisted equity)

How does the PE VC Fund work?

A PE / VC fund manager raises money, to invest in unlisted ventures (usually). They could define themes, like consumer funds, or tech funds, or could be sector agnostic

Who are General Partners / Limited Partners in PE VC Funds?

In simple terms, the Fund Manager is the General Partner (GP), and the investors are Limited Partners (LP).

Committed Capital?

The amount committed by the investor (Paid-in Capital).

Drawdown

The GP (Fund Manager) may draw capital at different points, rather than all at the beginning. This way, capital is called only when it is to be invested.

DPI and TVPI

As the exits from some of the unlisted investments happen in PE VC Funds, the GP distributes the money to LPs.

Terms like DPI (Distributions to Paid in Capital) and TVPI (Total Value to Paid in Capital) become key metrics.

Say the investor puts in $100 million. This is invested in 10 companies (INR 10 mn each).

If the first company is exited at $60 million (and this is distributed), and the value of the other 9 investments is $120 mn (these are yet to be exited)

DPI here would be 60/100 = 0.6

And TVPI would be (120+60)/100 = 1.8

What is the fee structure like for PE VC Funds?

Usually most PE VC funds operate on a 2-20 structure, with a Hurdle rate.

2-20?

So the management fee is 2%. Then there is a carry (profit sharing) of 20%, above a certain hurdle return – say 8%

If the fund return > 8%, then 20% is shared with the Fund Manager (FM).

But what is Catch Up?

20% above 8% is the profit sharing, but what about upto 8%. This is what Catch up defines.

If a fund has Full Catchup – it means that if the return crosses 8%, then the FM gets 20% on the entire return.

For example, if the fund generates 15%, then in full catch-up, the carried interest would be 20% of the entire 15%.

But in a No Catchup scenario, it would be 20% of the return above the hurdle (15%-8%)

What is a Distribution Waterfall?

This defines how the funds will be distributed. Think of a simple 1 year fund.

Suppose you invest 100 in this fund.

Till the fund value crosses 108 (8% of the Paid in capital), there is no profit sharing.

But above 108, profit sharing begins. The next 2% goes to the FM, so that by the time the return reaches 10% (up to Fund Value 110), 20% of the entire return is shared with the FM.

Returns above this are shared 80:20.

Venture Capital is a booming segment in USA. Knowing these concepts helps everyone: a founder, a financial management team as well as an investor.

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