Glossary

Acquisition - It is the process of taking over a controlling interest in another company. Usually the bidder ends up with 50 per cent or more of the company.

Acquisition finance - Its the external finance to fund an acquisition. This can be in the form of bank debt and/or equity, such as a share issue.

Advisory board - More prevalent among smaller companies. It is less formal than the board of directors. It usually consists of people, chosen by the company founders, whose experience and influence can benefit the business. The board will meet periodically but does not have any legal responsibilities with regard to the company.

Alternative assets - Describes non-traditional asset classes, to include private equity, venture capital, hedge funds and real estate. Alternative assets are generally more risky than traditional assets, hence are expected to generate higher returns for investors.

Asset allocation - The percentage breakdown of an investment portfolio among different asset classes. This could include shares, bonds, property, cash and overseas investments. Institutions structure their allocation to balance risk and ensure they have a diversified portfolio. Effective asset allocation maximises returns while covering liabilities.

Balanced fund - A fund that spreads its investments between various types of assets such as stocks and bonds. Investors can avoid excessive risk by balancing their investments in this manner.

Beauty parades - The means of providing companies with a choice of providers of financial and professional services. It normally involves a short-list of potential suppliers being drawn up and invited to pitch for business.

Benchmark - Generally a measure used to assess the performance of a company. Investors need to know whether or not a company is hitting certain benchmarks as this will determine the structure of the investment package.

BIMBO - 'buy-in management buy-out' - Internally, a group of managers will purchase enough share capital to 'buy out' the company from within. An external team of managers will simultaneously 'buy in' to the company management. Both parties could require financial assistance from private equity funds in order to achieve this end.

Bond - A form of IOU issued by companies or institutions. They generally have a fixed interest rate and maturity value, so they're very low risk.

Bridge loan - A form of short-term financing that enables a company to continue operating until it can arrange longer-term financing. Companies sometimes seek this because they run out of cash before they receive long-term funding alternatively they do so to strengthen their balance sheet in the run up to flotation.

Burn rate - Its the rate at which a start-up uses its venture capital funding before it begins earning any revenue.

Business angels - These are individuals who provide seed or start-up finance to entrepreneurs in return for equity. They usually contribute a lot more than pure cash - they often have industry knowledge and contacts that they can pass on to entrepreneurs.

Business plan - This is a description of the plans of a new business, or of the expansion plans of an existing business, together with financial projections.

Buy-out - This is the purchase of a company or a controlling interest of the company's shares. This often happens when a company's existing managers wish to take control of the company.

Caps, floors and collars - These are the imits on interest rates. Interest rates can either be fixed or variable. Where they are variable, it may be agreed (at a cost) that the rate is capped so it will not rise above a certain figure, or that there will be a floor below which it will not fall. A collar involves both a cap and a floor.

Capital commitment - Every investor in a private equity fund commits to investing a specified sum of money in the fund partnership over a specified period of time. The fund records this as the limited partnership's capital commitment. The sum of capital commitments is equal to the size of the fund. Limited partners and general partners must make a capital commitment to participate in the fund.

Capital distribution - These are the returns that an investor in a private equity fund receives which is income and capital realised from investments less expenses and liabilities. Once a limited partner has had their cost of investment returned, further distributions are profit. The partnership agreement generally determines the timing of distributions to the limited partner. It will also determine how profits are shared between the limited partners and general partner.

Capital gain - When an asset is sold for more than the purchase cost, the increase is known as the capital gain. The opposite is capital loss, which occurs when an asset is sold for less than the purchase price. Capital gain refers strictly to the gain achieved once an asset has been sold - an unrealised capital gain refers to an asset that could potentially produce a gain if it was sold. An investor will not necessarily receive the full value of the capital gain - capital gains are often taxed.

Capital under management - This is the amount of capital that the fund is managing for investment purposes.

Carried interest - This is the share of profits that the fund manager is entitled to once it has returned the cost of investment to investors. Carried interest is normally expressed as a percentage of the total profits of the fund. The industry norm is 20 per cent. The means the fund manager will therefore receive 20 per cent of the profits generated by the fund and distribute the remaining 80 per cent of the profits to investors.

Catch up - This is a clause that allows the general partner to take, for a limited period of time, a greater share of the carried interest than would normally be allowed. This continues until the time when the carried interest allocation, as agreed in the limited partnership, has been reached. This usually occurs when a fund has agreed a preferred return to investors.

Clawback - This is a clause that ensures that a general partner does not receive more than its agreed percentage of carried interest over the life of the For example if a general partner receives 21 percent of the partnership's profits instead of the agreed 20 per cent, limited partners can claw back the extra one per cent.

Closing - When a fund-raising firm announces it has reached first or second closing, it doesn't mean that it is not seeking further investment. When fund raising, a firm will announce a first closing to release or drawdown the money raised so far so that it can start investing. A fund may have many closings, but the usual number is around three. Only when a firm announces a final closing is it no longer open to new investors.

Co-investment - This term has a special meaning when referring to limited partners in a fund. If a limited partner in a fund has co-investment rights, it can invest directly in a company that is also backed by the private equity fund. The institution therefore ends up with two separate stakes in the company - one indirectly through the fund one directly in the company. Some private equity firms offer co-investment rights to encourage institutions to invest in their funds.

Comfort factor - Investing in a growing enterprise is always risky, but one can increase the comfort factor by checking up on various aspects of the business - the state of relationships with its customers, for instance, or whether its products are highly rated by reputable authorities. Comfort factors can often by provided by due diligence.

Company buy-back - This is a means by which a company buys back the stake held by a financial investor, such as a private equity firm. This is one exit route for private equity funds.

Consolidation - This is also called a leveraged rollup. This is an investment strategy in which an LBO firm acquires a series of companies in the same or complementary fields, with the goal of becoming a dominant regional or nationwide player in that industry. In some cases, a holding company will be created, into which the various acquisitions will be folded. In other cases, an initial acquisition may serve as the platform through which the other acquisitions will be made.

Corporate venturing - This is the process by which large companies invest in smaller companies. They usually do this for strategic reasons, for example to access companies that are developing new products.

Debt financing - This is raising funds for working capital or capital expenditure through some form of loan. This could be by arranging a bank loan or by selling bonds or notes (forms of debt) to individuals or institutional investors. In return for the loan, the individuals or institutions become creditors and receive a promise to repay principal plus interest on the debt.

Deferred consideration - This refers when part of a transaction is to be paid in the future, sometimes depending on performance targets being achieved.

Discounted cash flow - This is a means of assessing the value of an investment based on predicted cash flows that are discounted to take account of the value of money over time.

Distressed debt - This is a form of finance used to purchase the corporate bonds of companies that have either filed for bankruptcy or appear likely to do so. Private equity firms and other corporate financiers who buy distressed debt don't asset-strip and liquidate the companies they purchase. Instead, they can make good returns by restoring them to health and then prosperity. These buyers first become a major creditor of the target company. This gives them leverage to play a prominent role in the reorganisation or liquidation stage.

Distribution in kind - This can happen if an investment has resulted in an IPO. The limited partner could receive its return in the form of stock or securities instead of cash. The stock may not be liquid and limited partners can be left with shares that are worth a fraction of the amount they would have received in cash. There can also be restrictions about how soon a limited partner can sell the stock.

Dividend cover - The dividend is the amount of a company's profits paid to shareholders each year. Dividend cover is the calculation used to show how much of a company's after-tax profit is being used to finance the dividend. Dividend Cover = (Earnings per share/Dividend per share).

Drawdown - When a private equityl firm has decided where it would like to invest, it will approach its own investors in order to draw down the money. The money will already have been pledged to the fund but this is the actual act of transferring the money so that it reaches the investment target.

Due Diligence - This is the investigation of the private equity fund, to include the capabilities of the management team, performance record, deal flow, investment strategy and legals.

Early-stage finance - This is venture capital as opposed to private equity. A venture capitalist will normally invest in a company when it is in an early stage of development. This means that the company has only recently been established, or is still in the process of being established - it needs capital to develop and to become profitable. Early-stage finance is risky because it's often unclear how the market will respond to a new company. However, if the venture is successful, the return is correspondingly high.

Earn-out - A provision sometimes written into the terms of a transaction that states the sellers will receive further payments if the business they have sold achieves specified performance levels.

Equity financing - Companies seeking to raise finance may use equity financing instead of or in addition to debt financing. To raise equity finance, a company creates new ordinary shares and sells them for cash. The new share owners become part-owners of the company.

Evergreen fund - This is a fund in which the returns generated by its investments are automatically channelled back into the fund rather than being distributed back to investors. The objective is to keep a continuous supply of capital available for further investments.

Exit - Private equity fund has the focus on the exit from the moment it first sees a business plan. An exit is the means by which a fund is able to realise its investment in a company - this could be by an initial public offering, a trade sale, selling to another private equity firm or a company buy-back. If a fund manager can't see an obvious exit route in a potential investment, then it won't touch it.

First time fund - This is the first fund for a private equity team - either the fund is made up of managers who have never raised a fund before or, as in many cases, the firm is a spin-off, where managers from different, established funds have joined forces to create their own, new firm

Flip - A very short investment, where the exit is often identified pre-completion

Follow-on funding - Companies could often require several rounds of funding. If a private equity firm has invested in a particular company in the past, and then provides additional funding at a later stage, is known as 'follow-on funding'.

Fund of funds - These are funds set up to distribute investments among a selection of private equity fund managers, who in turn invest the capital directly. Fund of funds are specialist private equity investors and have existing relationships with firms. They may be able to provide investors with a route to investing in particular funds that would otherwise be closed to them.

Fund raising - This is the process by which a private equity firm looks for financial commitments from limited partners for a fund. Firms generally set a target when they begin raising the fund and ultimately announce that the fund has closed at a particular amount. This may mean that no additional capital will be accepted. But sometimes the firms will have multiple interim closings each time they have hit particular targets (first closings, second closings, etc.) and final closings. The term cap is the maximum amount of capital a firm will accept in its fund.

Gatekeeper - These are specialist advisers who assist institutional investors in their private equity allocation decisions. Institutional investors with little experience of the asset class or those with limited resources often use them to help manage their private equity allocation. Many gatekeepers also manage funds of funds.

General partner - This refers to the top-ranking partners at a private equity firm as well as the firm managing the private equity fund.

General partner contribution - The amount of capital that the fund manager contributes to its own fund. This is a means for limited partners to ensure that their interests are aligned with those of the general partner.

Golden share - These are shares with unusual rights, often allowing exiting/minority shareholders disproportionate control or rights to future capital proceeds.

Holding period - This is the length of time that an investment is held.
Incubator - This is an entity designed to nurture business ideas or new technologies to the point that they become attractive to venture capitalists. An incubator typically provides physical space and some or all of the services - legal, managerial, technical - needed for a business idea to be developed.

Institutional buy-out (IBO) - When a private equity firm takes a majority stake in a management buy-out, the deal is an institutional buy-out. This is also the term given to a deal in which a private equity firm acquires a company out right and then allocates the incumbent and/or incoming management a stake in the business.

Initial public offering (IPO) - This is the official term for 'going public'. It occurs when a privately held company - owned, for example, by its founders plus perhaps its private equity investors - lists a proportion of its shares on a stock exchange. IPOs are an exit route for private equity firms.

Internal rate of return (IRR) - This is the most relevant performance benchmark for private equity investments. In simple terms, it is a time-weighted return expressed as a percentage. IRR uses the present sum of cash drawdowns (money invested), the present value of distributions (money returned from investments) and the current value of unrealised investments and applies a discount.

Later stage finance - This is capital that private equity firms generally provide to established, medium-sized companies that are breaking even or trading profitably. The company uses the capital to finance strategic moves, such as expansion, growth, acquisitions and management buy-outs.

Lead investor - This is the firm or individual that organises a round of financing, and usually contributes the largest amount of capital to the deal.

Leveraged buy-out (LBO) - The acquisition of a company using debt and equity finance and where more debt than equity is used to finance the purchase, eg 90 per cent debt to ten per cent equity. Normally, the assets of the company being acquired are put up as collateral to secure the debt.

Limited partners - Institutions or individuals that contribute capital to a private equity fund. LPs generally include pension funds, insurance companies, asset management firms and fund of fund investors.

Limited partnership - The is the vehicle for investment in private equity funds. A limited partnership has a fixed life. The partnership's general partner makes investments, monitors them and finally exits them for a return on behalf the investors - limited partners. The GP usually invests the partnership's funds within three to five years and, for the fund's remaining life, the GP attempts to achieve the highest possible return for each of the investments by exiting. Occasionally, the limited partnership will have investments that run beyond the fund's life. In this case, partnerships can be extended to ensure that all investments are realised. When all investments are fully divested, a limited partnership can be terminated or 'wound up'.

Lock-up period - This is a clause in the agreement between an investment bank and existing shareholders that prohibits corporate insiders and private equity investors from selling at IPO.

Management buy-in (MBI) - When a team of managers buys into a company from outside, taking a majority stake, it generally needs private equity financing. An MBI is likely to happen if the internal management lacks expertise or the funding needed to 'buy out' the company from within. It can also happen if there are succession issues - in family businesses, for example, there may be nobody available to take over the management of the company. An MBI can be perceived as slightly riskier than a MBO because the new management will not be as familiar with the way the company works.

Management buy-out (MBO) - A private equity firm will often provide finance to enable current operating management to acquire or to buy at least 50 per cent of the business they manage. In return, the private equity firm usually receives a stake in the business. This is one of the least risky types of private equity investment because the company is already established and the managers running it know the business - and the market it operates in - extremely well.

Management fee - This is the annual fee paid to the general partner. It is typically a percentage of limited partner commitments to the fund and is used to cover the basic costs of running and administering a fund. Management fees tend to run in the 1.5 per cent to 2.5 per cent range, and often scale down in the later years of a partnership to reflect the GP's reduced workload. The management fee is not intended to incentivise the investment team - carried interest is the reward for performance.

Mezzanine financing - This is the term associated with the middle layer of financing in leveraged buy-outs. In its simplest form, this is a type of loan finance that sits between equity and secured debt. Because the risk with mezzanine financing is higher than with senior debt, the interest charged by the provider will be higher than that charged by traditional lenders, such as banks. Equity provision - through warrants or options - is sometimes incorporated into the deal.

Options - This refers to the right to acquire shares at a specified price or after a future date, and they can be performance-related. The release of share options will normally dilute the value of other shares in issue.

Portfolio - A private equity firm will invest in several companies, each of which is known as a portfolio company. The spread of investments into the various target companies is referred to as the portfolio.

Portfolio company - This is one of the companies backed by a private equity firm.

Placement agent - Placement agents are specialists in marketing and promoting private equity funds to institutional investors. They typically charge two per cent of any capital they help to raise for the fund.

Preferred return - This is the minimum amount of return that is distributed to the limited partners until the time when the general partner is eligible to deduct carried interest. The preferred return ensures that the general partner shares in the profits of the partnership only after investments have performed well.

Private equity - This refers to the holding of stock in unlisted companies - companies that are not quoted on a stock exchange. It includes forms of venture capital and MBO financing.

Private placement - When securities are sold without a public offering, this is referred to as a private placement. Generally, this means that the stock is placed with a select number of private investors. This term is also used specifically to denote a private investment in a company that is publicly held.
Private equity firms that invest in publicly traded companies sometimes use the acronym PIPEs to describe the activity - private investing in public equities.
Public to private - This is when a quoted company is taken into private ownership - more recently by private equity firms.

RAMBO (Rescue After an MBO) - This refers to when MBOs go wrong. Perhaps too high a price was paid, or the management team isn't up to the job. In such circumstances a RAMBO may be required.

Ratchets - This is a mechanism that determines the eventual equity allocation between groups of shareholders. A ratchet enables a management team to increase its share of equity in a company if the company is performing well. The equity allocation in a company varies, depending on the performance of the company and the rate of return that the private equity firm achieves.

Reverse takeover - This refers either to when a small company takes over a large one, or when the company being taken over is likely to be the major element in the combined business.

Ring master - Refers to an intermediary who is co-ordinating the fundraising process.

Running yield - The annual l measure on an investment, expressed as a percentage of the current value not the original value.

Secondaries - This is the term for the market for interests in venture capital and private equity limited partnerships from the original investors, who are seeking liquidity of their investment before the limited partnership terminates. An original investor might want to sell its stake in a private equity firm for a variety of reasons: it needs liquidity, it has changed investment strategy or focus or it needs to re-balance its portfolio. The main advantage for investors looking at secondaries is that they can invest in private equity funds over a shorter period than they could with primaries.

Secondary buy-out - A common exit strategy. This type of buy-out happens when an investment firm's holding in a private company is sold to another investor.

Secondary market - This is the market for secondary buy-outs. This term should not be confused with secondaries.

Second stage funding - This is the provision of capital to a company that has entered the production and growth stage although may not be making a profit yet. It is often at this stage that venture capitalists become involved in the financing.

Seed capital - This is the provision of very early stage finance to a company with a business venture or idea that has not yet been established. Capital is often provided before venture capitalists become involved. However, a small number of venture capitalists do provide seed capital.

Strategic investment - An investment that a corporation makes in a young company that can bring something of value to the corporation itself. The aim may be to gain access to a particular product or technology that the start-up company is developing, or to support young companies that could become customers for the corporation's products. In venture capital rounds, strategic investors are sometimes distinguished from venture capitalists and others who invest primarily with the aim of generating a large return on their investment. Corporate venturing is an example of strategic investing.

Syndication - The sharing of deals between two or more investors, normally with one firm serving as the lead investor. Investing together allows venture capitalists to pool resources and share the risk of an investment.

Term sheet - This is a summary sheet detailing the terms and conditions of an investment opportunity.

Tombstone - When a private equity firm has raised a fund, or it wishes to announce a significant closing, it may choose to advertise the event in the financial press - the ad is known as a tombstone. It normally provides details of how much has been raised, the date of closing and the lead investors.

Turnaround - Turnaround finance is provided to a company that is experiencing severe financial difficulties. The aim is to provide enough capital to bring a company back from the brink of collapse. Turnaround investments can offer spectacular returns to investors but there are drawbacks: the uncertainty involved means that they are high risk and they take time to implement.

Venture capital - The term given to early-stage investments.

Vintage year - This is the year in which a private equity fund makes its first investment.

Warrant - This is an option to purchase stock in a company, typically exercised over an extended period