CFM Private Equity & Venture Capital 3 — Questions and Answers
Question 1: In venture capital, what is a 'participating preferred' structure?
- Preferred shares that convert to common stock automatically at IPO
- Preferred investors receive their liquidation preference AND then share in remaining proceeds with common shareholders (Correct answer)
- A structure where VC investors participate in board meetings only
- Preferred shares with a fixed dividend yield paid annually
Correct answer: Preferred investors receive their liquidation preference AND then share in remaining proceeds with common shareholders
Participating preferred allows VC investors to first recover their investment, then share in remaining proceeds alongside common stockholders, unlike non-participating preferred.
Question 2: Which exit strategy typically provides private equity investors with the most control over timing and pricing of their exit?
- IPO
- Strategic acquisition
- Secondary buyout (Correct answer)
- Management buyout
Correct answer: Secondary buyout
Secondary buyouts (selling to another PE firm) allow sellers to control timing and negotiate pricing directly, unlike IPOs which depend on market conditions.
Question 3: What is the primary purpose of a 'ratchet' mechanism in a private equity deal?
- To automatically adjust the fund's management fee each year
- To allow management to earn additional equity if performance targets are achieved (Correct answer)
- To increase the debt level of the acquired company
- To renegotiate terms with lenders during covenant breaches
Correct answer: To allow management to earn additional equity if performance targets are achieved
A ratchet aligns management incentives by granting them additional equity ownership when they achieve or exceed agreed financial performance targets.
Question 4: Series A, B, and C funding rounds in venture capital primarily differ by:
- The type of securities issued (debt vs. equity)
- The stage of company development and typical capital amounts raised (Correct answer)
- The geographic location of the investors participating
- Whether the company is profitable or pre-revenue
Correct answer: The stage of company development and typical capital amounts raised
Later series represent more mature stages of development with larger capital raises and typically higher valuations, reflecting reduced early-stage risk.
Question 5: In a private equity LBO model, 'financial engineering' refers to:
- Developing new financial products for the acquired company to sell
- Using leverage and capital structure optimization to enhance equity returns (Correct answer)
- Engineering cost reductions in the portfolio company's finance department
- Creating complex derivatives linked to the acquired company's performance
Correct answer: Using leverage and capital structure optimization to enhance equity returns
Financial engineering in LBOs involves optimizing the debt-equity mix and debt repayment to amplify equity returns beyond what operational improvements alone would generate.
Question 6: A venture capital firm holds a 20% stake in a startup valued at $50M (post-money). The pre-money valuation was:
- $40M (Correct answer)
- $50M
- $10M
- $60M
Correct answer: $40M
If the VC holds 20% and the post-money valuation is $50M, the VC invested $10M, making the pre-money valuation $40M.
Question 7: What distinguishes 'growth equity' from both venture capital and traditional buyout investing?
- Growth equity always requires a controlling stake in the company
- It targets established, profitable companies seeking capital for expansion without the use of significant leverage (Correct answer)
- Growth equity firms never take board seats or governance rights
- It exclusively focuses on technology sector companies
Correct answer: It targets established, profitable companies seeking capital for expansion without the use of significant leverage
Growth equity bridges VC and buyout by investing in proven businesses with established revenue that need capital to scale, typically using minimal leverage and acquiring minority stakes.
CFM Private Equity & Venture Capital 3
In venture capital, what is a 'participating preferred' structure?