Both private equity and venture capital are known for their industry-specific jargon, which can be confusing for newcomers. Understanding these terms is essential for effective communication and analysis within the industry. Here’s a breakdown of the most important terms you need to know.
11.1 Private Equity Jargon
1. Leveraged Buyout (LBO)
An LBO occurs when a company is acquired using a significant amount of borrowed money (leverage). The assets of the company being acquired typically serve as collateral for the loans. LBOs are a common strategy in private equity to acquire companies with minimal equity investment.
Example: When KKR bought RJR Nabisco in 1989, it was one of the most famous LBOs in history, involving over $25 billion in financing, mostly through debt.
2. Carried Interest
Carried interest (or “carry”) is the share of profits that a private equity or venture capital firm receives as compensation. Typically, carry is around 20% of the profits, but it’s only paid after the investors (limited partners) have received their initial investment back plus a preferred return.
Example: If a private equity fund generates $100 million in profit and the carry is 20%, the fund managers would earn $20 million in carried interest after returning the initial investment to the LPs.
3. Enterprise Value (EV)
Enterprise value is the total value of a company, including its equity and debt, minus any cash on hand. It provides a more comprehensive valuation than just market capitalization, as it includes both the company’s assets and its liabilities.
Formula:
EV=Market Cap+Debt−Cash\text{EV} = \text{Market Cap} + \text{Debt} – \text{Cash}EV=Market Cap+Debt−Cash
Example: If a company has a market capitalization of $500 million, $200 million in debt, and $50 million in cash, its enterprise value would be $650 million.
4. Multiple of Invested Capital (MOIC)
MOIC is a performance metric used in private equity to measure how much money the investment has returned relative to the initial investment. It’s calculated by dividing the total value realized from the investment by the amount of capital invested.
Formula:
MOIC=Total Value RealizedInvested Capital\text{MOIC} = \frac{\text{Total Value Realized}}{\text{Invested Capital}}MOIC=Invested CapitalTotal Value Realized
Example: If a private equity firm invested $10 million in a company and later sold it for $30 million, the MOIC would be 3.0x.
5. Limited Partner (LP)
A Limited Partner is an investor in a private equity or venture capital fund. LPs provide the capital but have no day-to-day management responsibilities. They typically include pension funds, endowments, and family offices.
Example: A university endowment fund might invest in a private equity firm as a limited partner, contributing capital but not participating in the management of the firm’s investments.
6. General Partner (GP)
A General Partner is the entity that manages the private equity fund. The GPs are responsible for making investment decisions, managing the portfolio, and executing the exit strategy. They also typically invest their own capital into the fund alongside the LPs.
Example: In a private equity firm, the general partners are the individuals who manage the fund and receive carried interest in addition to management fees.
7. Management Fee
The management fee is the annual fee that private equity and venture capital firms charge their investors (LPs) to cover operational expenses. It is usually a percentage of the total committed capital (typically 1-2%).
Example: If a private equity fund has $1 billion in assets under management and charges a 2% management fee, the firm earns $20 million annually in management fees.
8. Deal Flow
Deal flow refers to the rate at which investment opportunities are presented to private equity or venture capital firms. A strong deal flow is critical for maintaining a pipeline of potential investments.
Example: A private equity firm with good relationships in the healthcare industry might see a strong deal flow in healthcare acquisitions, allowing them to cherry-pick the best opportunities.
11.2 Venture Capital Jargon
1. Series A, B, C Funding
Series A, B, C refer to the different rounds of funding that startups go through as they scale. Each round corresponds to a different stage of the company’s development and typically involves increasing amounts of capital.
- Series A: The first major round of financing after seed funding, typically used to scale operations.
- Series B: Focuses on expanding market reach, often after the company has proven its business model.
- Series C and beyond: These rounds are for scaling further, potentially preparing for an IPO or acquisition.
Example: A startup might raise a Series A round of $10 million to scale its user base, followed by a Series B round of $30 million to enter new markets.
2. Term Sheet
A term sheet is a non-binding agreement that outlines the key terms and conditions of an investment. It is often the first step in a venture capital deal and includes details about valuation, equity stakes, board structure, and voting rights.
Example: A venture capital firm might issue a term sheet offering $5 million in funding at a $25 million pre-money valuation, meaning the investors would own 20% of the company post-investment.
3. Convertible Note
A convertible note is a form of short-term debt that converts into equity at a later stage, usually during a future funding round. It allows startups to raise capital quickly without having to determine the company’s valuation upfront.
Example: A startup might issue $1 million in convertible notes, which convert into equity at a 20% discount when the company raises its next round of funding.
4. Pre-Money and Post-Money Valuation
- Pre-Money Valuation: The valuation of a company before it raises new capital.
- Post-Money Valuation: The valuation of a company after it has raised capital, which includes the new investment.
Formula:
Post-Money Valuation=Pre-Money Valuation+New Investment\text{Post-Money Valuation} = \text{Pre-Money Valuation} + \text{New Investment}Post-Money Valuation=Pre-Money Valuation+New Investment
Example: If a startup has a pre-money valuation of $10 million and raises $5 million in new capital, its post-money valuation is $15 million.
5. Cap Table
The cap table (or capitalization table) is a spreadsheet that shows the ownership stakes, equity dilution, and securities of a company, including common shares, preferred shares, and convertible securities. It helps investors track how equity is distributed and how future investments will impact ownership.
Example: A startup’s cap table might show that founders own 60% of the company, while investors own 40% after a Series A funding round.
6. Exit
An exit refers to the point at which investors realize a return on their investment, typically through an acquisition or initial public offering (IPO). The goal of most venture capital investments is to exit at a higher valuation than the initial investment.
Example: Instagram’s exit occurred when it was acquired by Facebook for $1 billion, providing a substantial return to its early investors.
7. Unicorn
A unicorn is a privately held startup valued at over $1 billion. These companies are rare and highly sought after by venture capital firms due to their high growth potential.
Example: Uber, Airbnb, and Stripe are examples of unicorns that reached billion-dollar valuations while still privately held.
8. Seed Funding
Seed funding is the initial capital raised by a startup to develop its product and market its idea. It typically comes from angel investors, friends and family, or early-stage venture capital firms.
Example: A tech startup might raise $500,000 in seed funding to build its prototype and hire its first few employees.
9. Burn Rate
Burn rate refers to the rate at which a startup is spending its capital before generating positive cash flow. It’s typically measured in terms of cash spent per month. A high burn rate can be dangerous if the company is not generating enough revenue to sustain its operations.
Example: If a startup spends $200,000 a month and has $1 million in the bank, it has a burn rate of $200,000 and a runway of 5 months.
10. Pivot
A pivot is when a startup changes its business model, product, or market strategy based on feedback or poor initial results. Pivots are common in the startup world as companies refine their ideas to achieve product-market fit.
