CFM Private Equity & Venture Capital 4 — Questions and Answers
Question 1: In private equity, what is a 'portfolio company add-on acquisition' (also called a 'bolt-on')?
- Acquiring a PE fund's limited partner stake from another investor
- The initial platform acquisition that forms the foundation of a PE investment thesis
- A smaller acquisition made by an existing portfolio company to expand its capabilities or market share (Correct answer)
- Adding new debt tranches to an existing LBO capital structure
Correct answer: A smaller acquisition made by an existing portfolio company to expand its capabilities or market share
Add-on acquisitions are smaller companies purchased by an existing PE portfolio company to build scale, enter new markets, or add capabilities under the 'buy-and-build' strategy.
Question 2: What is a 'subscription line of credit' (also called a 'capital call facility') used for in private equity funds?
- To provide permanent financing for portfolio company acquisitions
- To allow the fund to borrow against LP commitments before calling capital, improving IRR metrics (Correct answer)
- To fund management fees during the investment period
- To refinance portfolio company debt at lower interest rates
Correct answer: To allow the fund to borrow against LP commitments before calling capital, improving IRR metrics
Subscription lines allow PE funds to borrow short-term against LP commitments, delaying capital calls and artificially inflating IRR by shortening the time capital is deployed.
Question 3: Which of the following best describes a 'continuation fund' in private equity?
- A fund that automatically rolls over into a new vintage upon expiration
- A vehicle that allows a GP to transfer select portfolio assets into a new fund when the original fund term ends (Correct answer)
- A successor fund raised by the same GP team
- An evergreen structure with no defined end date
Correct answer: A vehicle that allows a GP to transfer select portfolio assets into a new fund when the original fund term ends
Continuation funds allow GPs to extend ownership of high-performing assets beyond the original fund's term by moving them into a new vehicle, offering LPs the choice to exit or roll over.
Question 4: The 'Rule of 72' is applied in private equity primarily to:
- Calculate management fee obligations over 10 years
- Quickly estimate the number of years required to double an investment at a given annual return rate (Correct answer)
- Determine the maximum leverage ratio for an LBO
- Set the threshold for carried interest distribution
Correct answer: Quickly estimate the number of years required to double an investment at a given annual return rate
Dividing 72 by the annual return rate gives an approximate number of years for an investment to double, useful for quick mental valuation checks.
Question 5: What is 'deal sourcing' in the context of private equity, and why is it a key competitive differentiator?
- The process of arranging debt financing for acquisitions
- Identifying and accessing investment opportunities, often before they reach competitive auction processes (Correct answer)
- Screening existing portfolio companies for follow-on investment
- Matching portfolio companies with strategic acquirers for exit
Correct answer: Identifying and accessing investment opportunities, often before they reach competitive auction processes
Proprietary deal sourcing allows PE firms to negotiate directly with sellers before competitive auctions, often resulting in better pricing and more favorable deal terms.
Question 6: In venture capital, what does 'pro-rata rights' entitle an existing investor to do?
- Veto any new investor from participating in future rounds
- Maintain their ownership percentage by investing in future funding rounds (Correct answer)
- Convert their preferred shares to common at any time of their choosing
- Receive a proportional share of any dividends declared by the company
Correct answer: Maintain their ownership percentage by investing in future funding rounds
Pro-rata rights allow existing investors to participate in future funding rounds at their proportional ownership level, preventing dilution of their stake.
Question 7: A PE-backed company has $100M in debt and generates $15M in free cash flow annually. After 5 years of cash flow sweep, what is the remaining debt balance assuming all FCF goes to debt repayment?
- $75M
- $25M (Correct answer)
- $50M
- $0M
Correct answer: $25M
Five years at $15M annual repayment totals $75M in debt paydown, leaving $100M - $75M = $25M remaining.
CFM Private Equity & Venture Capital 4
In private equity, what is a 'portfolio company add-on acquisition' (also called a 'bolt-on')?