CFM Private Equity & Venture Capital 5 — Questions and Answers
Question 1: What is the significance of a 'MOIC' (Multiple on Invested Capital) of 3.0x versus a 30% IRR in evaluating PE performance?
- A 3.0x MOIC is always preferable because it ignores time value of money
- MOIC measures total return magnitude while IRR measures return speed; both are needed for full performance assessment (Correct answer)
- IRR is the only metric LPs use for fund manager selection
- MOIC of 3.0x and IRR of 30% always imply the same holding period
Correct answer: MOIC measures total return magnitude while IRR measures return speed; both are needed for full performance assessment
MOIC captures total absolute return while IRR accounts for the time dimension; a high IRR on a short hold may produce lower MOIC than a longer hold with lower IRR.
Question 2: In venture capital term sheets, what is the difference between 'full ratchet' and 'weighted average' anti-dilution?
- Full ratchet adjusts conversion price to the lowest down-round price; weighted average considers relative size of the down round (Correct answer)
- Full ratchet applies only to Series A; weighted average applies to later rounds
- Full ratchet is more favorable to founders; weighted average benefits investors more
- There is no functional difference between the two provisions
Correct answer: Full ratchet adjusts conversion price to the lowest down-round price; weighted average considers relative size of the down round
Full ratchet provides maximum investor protection by repricing all prior shares to the down-round price, while weighted average is less punitive as it factors in round size.
Question 3: Which type of private equity strategy typically operates with the shortest holding period and highest leverage?
- Distressed debt investing (Correct answer)
- Growth equity
- Mega-cap buyout
- Venture capital
Correct answer: Distressed debt investing
Distressed debt strategies often involve acquiring debt at a discount with shorter time horizons to restructuring outcomes, frequently using high leverage to amplify returns.
Question 4: What is a 'SPAC' (Special Purpose Acquisition Company) and how does it relate to private equity exits?
- A government-sponsored entity that co-invests with PE funds in infrastructure deals
- A blank-check shell company that raises public capital to acquire a private company, providing an alternative IPO exit for PE-backed firms (Correct answer)
- A structured credit vehicle used to finance PE fund investments
- A secondary market platform for trading PE fund interests
Correct answer: A blank-check shell company that raises public capital to acquire a private company, providing an alternative IPO exit for PE-backed firms
SPACs offer PE-backed companies an alternative path to public markets by merging with a pre-funded shell company, often faster and more certain than a traditional IPO.
Question 5: In the context of LP/GP relationships, what does 'clawback' mean?
- The GP's right to call additional capital from LPs beyond original commitments
- The obligation of GPs to return excess carried interest if later fund losses reduce overall returns below the hurdle (Correct answer)
- A penalty fee charged to LPs who withdraw capital early
- The recapture of management fees if the fund underperforms its benchmark
Correct answer: The obligation of GPs to return excess carried interest if later fund losses reduce overall returns below the hurdle
Clawback provisions require GPs to return previously distributed carried interest if subsequent losses cause cumulative returns to fall below the hurdle rate.
Question 6: What is 'dry powder' in private equity, and what are the implications of excessive industry-wide dry powder?
- Uninvested committed capital; excess dry powder can drive up acquisition multiples due to competition for deals (Correct answer)
- Cash held in reserve by portfolio companies; excess signals poor capital deployment by management
- Leverage capacity in LBO structures; excess signals loose lending standards only
- Distributions returned to LPs; excess dry powder indicates strong fund performance
Correct answer: Uninvested committed capital; excess dry powder can drive up acquisition multiples due to competition for deals
Dry powder is committed but undeployed LP capital; when industry-wide levels are high, competition for quality assets intensifies, pushing valuation multiples upward.
Question 7: A VC fund has a 2% management fee on committed capital of $200M and 20% carried interest above an 8% hurdle. If the fund returns $500M total, what is the approximate carried interest earned?
- $100M
- $60M (Correct answer)
- $58.4M
- $40M
Correct answer: $60M
The hurdle requires returning committed capital plus 8% annually; roughly, carried interest is 20% of profits above the 8% hurdle, approximating to $60M on $300M profit after subtracting fees and hurdle.
CFM Private Equity & Venture Capital 5
What is the significance of a 'MOIC' (Multiple on Invested Capital) of 3.0x versus a 30% IRR in evaluating PE performance?