Slides16_HD - Corporate Finance(ECON W4280 Lecture 16 Tri...

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Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 1 Corporate Finance (ECON W4280) Lecture 16 Tri Vi Dang Columbia University
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Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 3 Lecture 16 II.2 Private Equity and Venture Capital Finance C. Contracting Between GP and LP D. Overview of Deal Structure E. History and Investment Patterns of VC Finance F. Contracting between Fund and Portfolio Company G. Economic Analysis of VC Contracts H. Empirical Studies of VC Contracts
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Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 4 II.2.C. Contracting Between GP and LP
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Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 5 PE firm and fund - A PE firm serves as the general partner (GP) for PE funds . - A VC fund is a limited partnership with a finite lifetime (usually ten years plus optional extensions of a few years) between GP and investors (limited partners, LP)
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Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 6 Contracting: GP and LP
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Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 7 Legal Structure - PE funds are structured as limited partnership and governed by the Limited Partnership Agreement (LPA) - LPA is contract specifies key terms of the partnership
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Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 8 Key Terms Management fees An annual payment to GP for the private equity firm's investment operations (typically 1 to 2% of the committed capital per year) Example Committed capital $300M Management fee: 2% per year Total management fee = 10 * 0.02* $300M = $60M Investment capital = Committed capital – total management fee = $240M
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Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 9 Carried interest A share of the profits of the fund's investments (typically up to 20%), paid to the fund’s management company as a performance incentive The remaining 80% of the profits are paid to the fund's investors
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Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 10 Example (Carry) Limited partner provides: 100: Final Cash flow: 200 Payback to LP: 100 Profit: 100 LP: 0.8*100=80 GP: 0.2*100=20 Total payment to LP = 180 Total payment to GP = 20
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Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 11 Hurdle Rate or preferred return A minimum rate of return (e.g. 8-12%), which must be achieved before the fund manager can receive any carried interest payments.
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Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 12 Example (Preferred return) Limited partner provides: 100 Preferred return: 10% Final Cash flow: 200 Payback to LP: 110 Profit: 90 LP: 0.8*90=72 GP: 0.2*90=18 Total payment to LP = 182 Total payment to GP = 18 Remark: If final cash flow is smaller than 110, GP gets nothing.
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Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 13 Catch-up When there is a preferred return, GP can demand a catch-up before the 80:20 split of profit
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Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 14 Example (Preferred return and catch-up) Limited partner provides: 100 Preferred return: 10% Final Cash flow: 200 Payback to LP: 110 Catch-up for GP: 2.5 = 10/4 (10:2.5 = 4:1 or 80:20) Profit: 87.5 LP: 0.8*87.5=70 GP: 0.2*87.5= 17.5 Total payment to LP = 180 Total payment to GP = 20
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Slides16_HD - Corporate Finance(ECON W4280 Lecture 16 Tri...

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