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When it comes to understanding private equity, financiers love their jargon. We have put together a list of some frequently used terms to help you navigate your way through:
Alternative Investments
"Alternative investments" is a broad term that captures everything not in traditional markets i.e. not listed equity, bonds, or cash. Real estate, infrastructure, commodities, bitcoin and even private equity (which includes venture capital), are all alternative investments. Alternative investments can be regulated differently than traditional markets and are generally less liquid and held longer (although that is not always the case).
Capital Call
Fund managers usually have a particular strategy when constructing a fund. For example, the fund manager may focus on buying certain technology companies. However, it is unlikely on day one of the fund the fund manager will know all the companies it will ultimately buy. Therefore, when seeking funds from investors, a fund manager does not need all the capital at once. A capital call describes the trigger point at which a fund manager requires investors to pay a portion of, or in some cases all of, the money they committed to paying to the fund manager. This is to allow the fund manager to complete an investment purchase (i.e. buy a property or company, depending on the investment thesis of a fund). The capital of investors can be "called upon" in this fashion because not all investments will need to have the committed capital (see below for the definition of committed capital) supplied upfront. A capital call may also be referred to as a "draw down".
Committed Capital
The "Committed Capital" is the amount of funds that an investor has promised to invest in a particular fund.
Distributions
Distributions are basically what investor get paid for being an investors in a fund. The distribution will depend on the investment but are often the capital gains from a sale, dividend income, interest, and principal. Some assets will have minimum or mandatory distributions at certain time periods or lump sum cash distributions.
Internal Rate of Return (IRR)
The IRR describes the annualised growth rate that is expected to be generated by an investment. It is a useful tool for comparing different investments' annual rates of return over time.
Investment Period
Some funds will have a defined time frame of open and close dates and do not accept new investors outside this investment period. The investment period usually aligns with the availability of assets in the underlying investment and is set to ensure investor capital is available to deploy into assets as they become available.
J-Curve
The J-curve is the term used to describe the expected performance pattern of a (typically) new private equity fund. As shown in the graph, the letter 'J' neatly reflects the pathway that the value of a private equity fund is expected to trace over time: as capital deployment occurs, the fund's value lowers largely reflecting upfront expenses that are incurred at the start of a fund's life and the absence of returns from realised investments (red); until the investments start to generate returns (orange); followed by a break-even (blue) and dramatic gain as the fund's net asset value grows and investments are realised (green).
Joint Venture (Limited Partners / General Partners)
JV - Private equity is typically capitalised via a Joint Venture (JV) entity (two or more parties will agree to pool their resources to accomplish a specific task).
GP / LP - The two types of members of the JV agreement are a General Partner (GP), typically a fund manager, and the Limited Partner(s) i.e. investors who commit their money. Limited partners are commonly superannuation funds, institutional investors, and High Net Worth Individuals (HNWIs).
Graphic courtesy of streetofwalls.com
Liquidity
The ease or efficiency with which an asset, investment, or security can be converted into ready cash without affecting its market price. Cash is the most liquid asset. Tangible items, such as houses, art and cars, are less so. Market liquidity relates to the ease of sale of an asset (is there a market for the goods).
Loss Rate (Loss Ratio)
Loss Rate is a risk measure that describes the percentage of invested capital lost over total invested amount net of any recovered proceeds.
Say a fund makes five $20 investments from a total of $100 into five companies (see the image above). If "Company 1" went broke and the other four companies have no losses, then the portfolio has a loss rate of 20%.
Low Correlation
Correlation is the strength of the relationship between two variables. Low correlation indicates that the variables are weakly related, meaning that the change in value of one variable does not give you much information on how the value of the other variable may change. A negative / positive correlation indicates that when the value of one variable changes, the other variable will move in the opposite / same direction. Alternative investments often have low correlation or negative correlation with traditional listed assets, and adding investments to an investment portfolio will generally improve its diversification.
Multiple on Invested Capital (MOIC)
MOIC is a simple measure of return. It reflects the current value of an investment compared to the initial amount invested. For example, an investment of $1 that is now worth $10 has a MOIC of 10. Unlike IRR, MOIC does not factor in the time that has passed to generate the growth of the investment.
Private Debt (private credit)
Is the investment of capital to acquire the debt of private companies as opposed to an equity stake. So, rather than becoming a company's owner (by taking equity) investors provide credit. Companies typically borrow from private debt investors to grow their businesses as more traditional sources of debt funding (i.e. banks), are unwilling to lend them money. Investors who provide private debt take the view that by providing the capital, they enable that growth and, all things being equal, will receive a return on their investment of the debt capital.
Private Equity
Is a type of alternative investment that describes investing capital into a private company not listed on a public exchange. Private equity investors may also buy out public companies and delist them, thus removing open public access to investment. Private equity is offered to investors by these companies to make acquisitions, fund innovation, expand working capital, and improve a target's balance sheet.
Private Market
Describes the unlisted investment activity of investors that purchase or sell equity and/or debt of privately-owned companies. The private market is not openly available or centrally exchanged, and private equity and private debt arrangements are often made directly between the owners of the asset and those who wish to invest.
Secondary Market
When dealing in alternative investments, the secondary market is where investors can buy and sell their interests in an alternative investments fund within the community of existing owners and buyers of alternative investments. As alternative investments are not listed they cannot be bought and sold like securities on a stock exchange. Such transactions are typically executed at a material discount to the net asset value of the fund. There exists secondary funds, whose strategy is to benefit from purchasing interests in alternative investment funds at a discount.
Tenure (sometimes Maturity)
Tenure is used to describe the amount of time designated to a particular investment for it to achieve its goals.
TVPI / DPI / RVPI
The total value to paid in ratio (TVPI) is a measurement of the fund's performance. The TVPI describes the total of both the fund's residual value to paid-in ratio (RVPI) and its distributed to paid-in ratio (DPI). Therefore, TVPI = RVPI + DPI. Let's break these down to understand better.
o The PI or "paid-in" describes how much capital called into a fund for investment and to cover fees at any given time.
o The D "distributed" is the capital that has been returned to fund's investors following the sale of a fund's stake in a portfolio assets/companies.
o The RV "residual value" is the fair value of its portfolio of assets/companies. This is measured by the net asset value (NAV).
This means:
RVPI is the fair value of a fund's investments (NAV) divided by its capital calls on the valuation date. RVPI is the unrealised portion of a fund's value and will be higher at the beginning, when the majority of fund value resides in active portfolio investments. RVPI will decrease to zero with time, and assets are exited.
RVPI = NAV / LP Capital called
o DPI is the total capital returned to investors divided by the capital calls at the valuation. DPI is the realised, cash-on cash returns generated by the investments. DPI is zero until the fund starts exiting investments and will be highest towards the end of its life.
DPI = sum of proceeds to fund LPs / LP capital called
In simple terms, TVPI is (Distributions + Net Asset Value) divided by Paid-In capital
Undrawn Capital
This is the amount of 'committed capital' (see definition above) that has not been called / drawn.
Venture Capital
A subset of private equity, where financing is provided to small businesses (startups) believed to have significant growth potential. Venture Capital investment relies on the investor learning about the particular aspirations of a business and making an assessment of its capability to achieve the investor's targeted return on investment.
For more information about our available private equity funds, please visit our private equity funds page.
