These terms are explained from a general financial point of view, but also with a more particular relationship to the private equity fund industry.
A bridge investment is, from the funds point of view, not in its final form with regards to its financing and it is short term by nature, typically 6-12 months. The bridge investment may for example be financed by equity only when it is meant to be leveraged. It may also be an investment which is outside the mandate of the fund and therefore subject to be sold. In both these examples, committed capital has been called from the Limited Partners but is not employed in accordance with the strategy of the fund and will be returned upon a sale or by leveraging the investment, without having been put to work in accordance with the funds investment mandate. The terms and conditions of the fund typically allow the fund manager to invest such early returned funds a second time.
Carve-out follows from a corporate reorganisation which triggers a partial divestiture of a business unit or segment. When undertaking a carve-out the company is not selling the business unit outright. Instead, they may sell an equity stake in that business or spin the business off on its own while retaining an equity stake itself or sell a segment of the business, for example the service department.
A carve-out allows a company to capitalise on a business unit or segment that may not be part of its core operations.
A co-investment is the situation that occurs when two or more investors are sharing ownership of an investment.
In private equity, co-investments will often made with existing large fund investors which are given the opportunity to take a direct stake at the fund. It is typical that such investors flag an interest in co-investments which means that they can employ capital without having to pay fees to the fund manager or carried interest on high returns.
Co-investors are typically passive investors, the fund manager seek control, but as an owner the co-investor may of course seek a more active role.
Where the funds resources are limited or when for reasons of diversification the fund seek to employ a limited amount of capital on a defined number of investments, co-investors make it possible for the fund manager to make larger investments than would otherwise have been possible for the fund. At the same time it is done without dedicating too much of the fund’s capital to a single transaction or sharing the deal with competing private equity firms.
A fund which makes a number of investments have diversified the risk. While one investment may perform poorly, overall performance of the fund will only be proportionally impacted. The overall risk to the fund related to the poor performance of individual investment is therefore reduced.
A fund with a narrow industry investment mandate, will not escape the inherent market risk of the segment but may offset company risk. A fund with a mandate to invest in the oil and gas sector will be impacted by fluctuations in oil price, whereas a fund with a mandate to invest in the energy sector may diversify the risk by making bets on also other sources of energy.
Diversification therefore reduces the overall risk of a portfolio of investments by selecting assets which are exposed to different risk factors.
A fund is bound by its investment strategy and mandate which translates to a number of investment restrictions which are normally found in the Limited Partnership Agreement.
Typical investment restrictions relate to geography, investment stage and strategy, degree of control sought, industry, direct or indirect investments, primary or secondary investments and so forth.
An investment vehicle is a general term for a legal entity used in the acquisition of an investment. Deciding on an appropriate investment vehicle will typically involve a consideration of the nature and number of owners, control, operation, jurisdiction and tax.
A partnership, company or other entity in which a fund has invested is typically referred to as a portfolio company. Private equity funds tend to seek a significant level of control in portfolio companies, control necessary to implement changes and develop the companies. Private equity funds typically make 5-15 investments in portfolio funds and therefore operate with a certain level of diversification.
Fund of funds invests primarily in other funds. Each of these underlying funds is referred to as a portfolio fund. As each portfolio fund will make a number of investments in accordance with its mandate, fund of funds will typically be well diversified.
A stapled deal is a pre-arranged financial package offered to potential bidders for shares. Stapled deals are typically arranged by an investment bank, and include all details of the lending package, including the principal, fees and loan covenants.
The investors in private equity funds typically subscribe for their interest during the Fund Raising period and are committed to the fund from the time of Closing. When an existing investor in a fund sells his interests in the fund to a third-party buyer, this is called a secondary transaction. The market for such “used” shares is the secondary market.
There may be a number of reasons for selling the original shares, realignment of portfolios is an important one, others may be changes in strategy and need to release resources for use in core activities.
The secondary buyer purchases from the seller its interests in one or more funds and typically assumes all unfunded obligations of the seller.
Secondary fund investments provide investors with a reduced blind pool risk, they will have some visibility to underlying investments. The J-curve will typically be steeper but shorter as a larger portion of committed capital is applied early.
“Tag along” and “drag long” rights are used by investors to regulate conditions of exit from an investment.
A “tag along” right gives an owner of shares the right, but not an obligation, to sell his shares along with another shareholder, normally on the same terms and conditions and to the same buyer. Minority shareholders often request tag along rights, as this allows them to then exit at the same time as majority shareholders.
A “drag along” right gives the shareholder who wish to sell his shares in a company, the possibility to negotiate the transaction with the knowledge that, given certain terms, the other shareholder(s) must sell at the same time to the same buyer.
Drag along rights is not by itself an obligation to negotiate for the sale of the shares of other shareholders but combined with tag-along rights a larger portion of shares and several shareholders will often be involved in such transactions.