How a fund works, in one page
- Investors commit. Limited partners promise money to a fund run by a general partner. The total is the committed capital.
- The fund calls the money. As deals appear, the general partner issues capital calls. Investors pay a management fee throughout.
- The fund invests. It buys or backs portfolio companies after due diligence, usually agreeing a term sheet first.
- The fund exits. Over years, each company is sold or listed: an exit. Cash goes back to investors as distributions.
- Profits are shared. Investors receive their capital and a preferred return; the general partner then earns carried interest, following the waterfall.
- Performance is measured. Typical measures are IRR, MOIC, DPI and TVPI, compared by vintage year; reported returns follow the J-curve.
A
Accelerator
A programme that supports early-stage companies for a fixed period, often with mentoring, workspace and a small investment in exchange for equity. An incubator is similar but usually has no fixed end date.
Related: Incubator · Seed stage
C
Cap table
A table of who owns what in a company: each shareholder, the type of shares or options held, and the resulting percentage. It is updated at each financing.
Related: Dilution · Term sheet
Capital call
A request from a fund to its limited partners to send part of the money they committed. Funds usually draw commitments down over several years as investments are made.
Related: Committed capital · Limited partner (LP)
Carried interest
The share of a fund’s profit, commonly 20%, paid to the general partner after investors have received their capital back and, usually, a preferred return. Often shortened to carry.
Related: General partner (GP) · Preferred return · Waterfall
Co-investment
A direct investment alongside a fund in one of its deals, offered to some limited partners, usually with lower or no fees.
Related: Limited partner (LP) · General partner (GP)
Committed capital
The total amount investors have promised to a fund. It is paid in over time through capital calls, so it is larger than the amount invested at any one moment.
Related: Capital call · Limited partner (LP)
Seen in: Entrepreneurship and the Commercialization of Technology · Building a Sustainable Platform for Venture Capital
Convertible note
A short-term loan to a startup that converts into shares at a later financing, usually at a discount or with a cap on the price. It lets the first investors defer setting a valuation.
Related: Seed stage · Term sheet · Valuation
D
Deal flow
The stream of investment opportunities that reaches an investor, from founders, bankers, brokers and personal networks.
Related: Due diligence
Seen in: Building a Sustainable Platform for Venture Capital
Dilution
The fall in an existing shareholder’s percentage ownership when a company issues new shares, for example in a financing round or an option pool.
DPI
Distributions to paid-in capital: cash returned to investors divided by the capital they have contributed. It counts only money actually received.
Dry powder
Capital that investors have committed to funds but that has not yet been invested.
Related: Committed capital
Due diligence
The investigation an investor carries out before committing money: the business, the market, the people, the financials and the legal position.
Related: Term sheet · Deal flow
Seen in: Johns Hopkins Venture Capital Investment Competition 2015: Become a Venture Capitalist! · Behind the Scenes of a Venture Capitalist · Launch of JHU Finance Affinity Group in DC/Baltimore | Panel Discussion on The Investment Landscape
E
EBITDA
Earnings before interest, taxes, depreciation and amortisation. A common measure of a company’s operating profit, used to compare companies and to size debt in buyouts.
Related: Leveraged buyout (LBO)
Seen in: Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports · Launch of JHU Finance Affinity Group in DC/Baltimore | Panel Discussion on The Investment Landscape
Exit
The way an investor realises a return on an investment, typically a sale to another company, a sale to another investor, or a stock market listing.
Seen in: Johns Hopkins Venture Capital Investment Competition 2015: Become a Venture Capitalist! · Private Equity Deal Making by David Warnock, Camden Partners · Building a Sustainable Platform for Venture Capital
F
Family office
A firm that manages the wealth of one or several wealthy families, and increasingly invests directly in companies and funds.
Related: Limited partner (LP)
Seen in: Investing and Nurturing Entrepreneurship in Baltimore and the Region · Opportunities in the U.S. Small-Cap Private Equity Market
Fund of funds
A fund that invests in other funds rather than directly in companies, giving investors access to a spread of managers.
Related: Limited partner (LP) · Secondaries
Seen in: Building a Sustainable Platform for Venture Capital
G
General partner (GP)
The firm that manages a fund: it finds and makes investments, and is paid through management fees and carried interest. The investors are the limited partners.
Related: Limited partner (LP) · Carried interest · Management fee
Growth equity
Investment in established, growing companies, usually as a minority stake and often without using much debt. It sits between venture capital and buyouts.
Related: Venture capital · Leveraged buyout (LBO)
Seen in: JHU Alum Inspires Carey Private Equity Enthusiasts · Opportunities in the U.S. Small-Cap Private Equity Market
I
Incubator
An organisation that gives early-stage companies space, services and a community, often without a fixed end date. Examples in the archive include City Garage in Baltimore.
Related: Accelerator
Seen in: Entrepreneurship and the Commercialization of Technology · Investing and Nurturing Entrepreneurship in Baltimore and the Region
Independent sponsor
A dealmaker who finds and leads acquisitions without a permanent pool of fund capital, raising money from investors deal by deal. Also called a fundless sponsor.
Related: Leveraged buyout (LBO) · General partner (GP)
IRR
Internal rate of return: the annualised return that makes the net present value of a set of investment cash flows equal to zero. It is sensitive to the timing of cash flows.
J
J-curve
The usual shape of a fund’s reported returns: negative in early years as fees are paid and investments are written down, rising as holdings mature.
Related: IRR · Vintage year
L
Leveraged buyout (LBO)
The purchase of a company using a large share of borrowed money, with the company’s own assets and cash flow supporting the debt. A paper LBO is a quick mental version used in interviews.
Related: EBITDA · Private equity
Seen in: Opportunities in the U.S. Small-Cap Private Equity Market
Limited partner (LP)
An investor in a fund, such as a pension, endowment, foundation, family office or wealthy individual. LPs provide the capital and do not manage investments.
Related: General partner (GP) · Committed capital
Seen in: Building a Sustainable Platform for Venture Capital · How to Become a CEO Through Search Funds
M
Management fee
A yearly fee paid by a fund to its general partner to cover running costs, commonly in the range of 1% to 2.5% of committed or invested capital depending on the fund.
Related: Carried interest · General partner (GP)
P
Paper LBO
A simplified buyout model solved by hand, without a spreadsheet, as a recruiting test. It checks whether a candidate can estimate returns from a purchase price, debt, growth and exit assumptions.
Related: Leveraged buyout (LBO) · EBITDA
Portfolio company
A company in which a fund has invested.
Related: Exit
Seen in: Building a Sustainable Platform for Venture Capital · Behind the Scenes of a Venture Capitalist · Launch of JHU Finance Affinity Group in DC/Baltimore | Panel Discussion on The Investment Landscape
Preferred return
Also called the hurdle rate: the minimum annual return, often 8%, that investors must receive before the general partner earns carried interest.
Related: Carried interest · Waterfall
Private equity
Investment in companies that are not listed on a public stock exchange, typically through funds that buy established businesses, improve them and sell them later.
Related: Leveraged buyout (LBO) · Venture capital · Growth equity
Seen in: JHU PE & VC Club Kickoff Meeting for 2015 · JHU Alum Inspires Carey Private Equity Enthusiasts · Johns Hopkins Venture Capital Investment Competition 2015: Become a Venture Capitalist!
R
REIT
Real estate investment trust: a company that owns, and usually operates, income-producing property and must distribute most of its taxable income to shareholders. Many REITs are listed on stock exchanges.
Related: Private equity
S
Search fund
A vehicle in which an MBA graduate raises capital to find, buy and run a single small company. Also called entrepreneurship through acquisition.
Related: Independent sponsor · Leveraged buyout (LBO)
Secondaries
The buying and selling of existing interests in private funds or companies, as opposed to making a new commitment. They give sellers liquidity and buyers a view of what a fund already owns.
Related: Fund of funds · Limited partner (LP)
Seen in: Building a Sustainable Platform for Venture Capital
Seed stage
The earliest formal financing of a company, usually raised to build a first product and find early customers, from angels, small funds or accelerators.
Related: Venture capital · Convertible note
Seen in: Entrepreneurship and the Commercialization of Technology · Private Equity Deal Making by David Warnock, Camden Partners · Behind the Scenes of a Venture Capitalist
T
Technology transfer
The process by which a university or lab moves research into commercial use, through licensing the technology or creating startups. Johns Hopkins Technology Ventures is the university’s office for this.
Related: Incubator
Term sheet
A short, usually non-binding document that sets out the main terms of an investment: price, amount, type of security and investor rights. The detailed legal documents follow.
Related: Due diligence · Valuation · Cap table
Seen in: Johns Hopkins Venture Capital Investment Competition 2015: Become a Venture Capitalist!
V
Valuation
An estimate of what a company is worth. In a financing, the pre-money valuation is the value before new money goes in, and the post-money valuation is pre-money plus the new investment.
Related: Dilution · Term sheet
Seen in: Johns Hopkins Venture Capital Investment Competition 2015: Become a Venture Capitalist! · Building a Sustainable Platform for Venture Capital · Behind the Scenes of a Venture Capitalist
Venture capital
Investment in young companies with high growth potential, usually in exchange for part ownership, through funds that expect a few large successes to outweigh many losses.
Related: Seed stage · Growth equity · Private equity
Seen in: JHU PE & VC Club Kickoff Meeting for 2015 · JHU Alum Inspires Carey Private Equity Enthusiasts · Johns Hopkins Venture Capital Investment Competition 2015: Become a Venture Capitalist!
Vintage year
The year a fund makes its first investment or closes its fundraising. Funds are compared with others of the same vintage year because market conditions differ from year to year.
Seen in: Opportunities in the U.S. Small-Cap Private Equity Market
W
Waterfall
The order in which a fund’s proceeds are paid out: first return of capital to investors, then a preferred return, then a catch-up and the split of the remaining profit between investors and the general partner.
Related: Carried interest · Preferred return