​Redemption rights are rights held by preferred stockholders to require a company to repurchase its stock from the preferred stockholders.  Redemption rights are sometimes referred to “put rights,” meaning the preferred stock investors have the right to “put” its shares to the company.  A “put” in finance is the right to sell a security (usually stock) to another party at a certain price.
 
Redemption rights are rare in early-stage venture capital financings, but can sometimes be found in later stage financings, down rounds or in restructurings.
 
Let’s get started.

A “dividend” is the payment of "excess cash" by a company to its shareholders (it’s a bit more complicated than that, but we’ll get to that later).  If the company pays dividends, the stockholders will receive the dividends based on their ownership in the company.
 
For privately-held companies, especially early-stage companies, dividends are generally not paid as these companies generally don’t have excess cash, and even if they did, they would use any excess cash to grow the company’s business.  But even though dividends are generally not paid by privately-held companies, it is important to understand how dividends work because preferred stock investors may negotiate dividend provisions that could result in substantial sums of money being paid to the preferred stockholders in certain situations.

​ 
When private companies hold financing rounds with venture capital and other professional investors, these investors acquire convertible preferred stock from the company.  The “convertible” or “conversion” feature of the preferred stock is fundamental to many of the rights, privileges and preferences granted to the preferred stock investors.
 
So what is the convertible feature of convertible preferred stock?  Read on.

​A “right of first offer,” also known as a “pre-emptive right,” provides an investor in a company with the right to participate in future financing rounds so that the investor can maintain its ownership percentage in the company.  Rights of first offers are referred to in shorthand as ROFOs.
 
There are many elements to ROFOs.  Let’s break them down.

This is second part of the post on dilution.  The first post discussed ownership dilution, also known as equity dilution.  The first post can be found here:  http://www.allenlatta.com/allens-blog/dilution-part-one-understanding-ownership-dilution
 
As discussed in part one, I view dilution as having two components: ownership (equity) dilution and value dilution.  These concepts are related.  Let’s now explore value dilution.

​Private equity, generally speaking, is an equity (stock) investment in a privately-held company.  My blog post “LP Corner: What is Private Equity?” provides an overview of how the term “private equity” is used.  This post is going to explore the “equity” component of “Private Equity.”  This post is a complement to my posts "LP Corner: What is Private Equity" and "LP Corner: The "Private" in Private Equity".
 
Let’s start with a basic definition of equity: Equity is the most basic form of ownership in a company.  Since virtually all private equity-backed companies in the United States are corporations, we are going to focus on equity in a corporation.

​A concept that is important for understanding company financings is that of “pre-money” and “post-money” valuation.  Pre-money valuation is the value of a company immediately prior to a financing round.  Post-Money Valuation is the value of the company immediately after the financing round.  The difference is usually the amount of money raised in the round.
 
Let’s explore this deeper.

This is one of a series of posts on fund terms.  Other posts include:

• ​GP Commitment
• Carried Interest Overview
• Carried Interest – Preferred Return and GP Catchup
• GP Clawback
• Management Fee Offsets
• Key Person Clauses
• No Fault Divorce
• For Cause Actions
• Should Venture Capital Funds have a Preferred Return Hurdle?

In private equity, the term “2 and 20” refers to the traditional compensation structure for private equity funds: 2% management fee and 20% performance fee (also known as “carried interest” or “carry”).
 
In this post, we will explore management fee.
 
Historically, management fee was intended to provide fund managers with enough money to pay modest salaries, rent modest offices and incur modest expenses.  It was said that management fee was intended to let the fund manager “keep the lights on” and that the performance fee (known as “carried interest” or “carry”) was where the fund manager made its money.  While investors in private equity funds (known as “limited partners” or “LPs”) continue to take this view, terms in fund documents (known as the "limited partnership agreement" or "LPA") relating to management fee have become more complex.
 
Let’s dig in.
 
In previous posts, we have explored committed capital and the investment period:

• LP Corner: On Committed Capital, Called Capital and Uncalled Capital
• LP Corner: the Four Phases in the Life of a Private Equity Fund
• LP Corner: Private Equity Cash Flows from the LP Perspective

 
We will look at management fee in three phases of a fund’s life: the investment period, the harvesting (or realization) period and during extensions.

To read more, please click on the "Read More" link below and to the right.

This one of a series of posts on fund performance metrics.  Other posts in this series include:

• LP Corner: Private Equity Fund Performance – An Overview
• LP Corner: Fund Performance Metrics – Multiples TVPI, DPI and RVPI
• LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part One
• LP Corner: Fund Performance Metrics – Internal Rate of Return (IRR) – Part Two
• LP Corner: Fund Performance Metrics – Public Market Equivalent (PME)
• LP Corner: Fund Performance Metrics - Private Equity Fund Performance - This blog post.
• LP Corner: Gross vs Net Returns
  

We have now discussed the three metrics that are primarily used to evaluate the performance of private equity funds: (1) the multiples TVPI, DPI and RVPI; (2) IRR; and (3) PME.  We will now discuss how to use these metrics to evaluate the performance of private equity funds.
 
Overview
There are several ways to evaluate the performance of a fund, or a portfolio of funds, with the main methods being:

• Absolute return.
• Comparative return to other similar funds (Quartile Analysis).
• Comparative return to the public markets (PME Analysis).

 
Absolute Return
Absolute return refers to a specific threshold requirement for a fund’s performance.  For example, some LPs may say that they expect a 3.0x TVPI and 30% IRR net return from early stage venture capital funds, or a 2.0x and 20% return for buyout funds.  If a fund’s return exceeds these metrics, then it “outperforms” the metrics.  If a fund’s returns are less than these metrics, then the fund “underperforms.” 
 
A note about absolute return.  Most funds experience a J-Curve, where performance declines in the first couple of years of a fund when fund expenses and investment losses exceed investment gains, but the fund’s performance improves over the next several years.  The J-Curve is more pronounced for early-stage venture capital funds.  The J-Curve looks something like this:

For more on the J-Curve, see my post: “LP Corner: The J-Curve.”
 
The point here is that using absolute returns are really only useful late in a fund’s life or after the fund is liquidated.  If one were to apply a 20% absolute return metric to the fund in the J-Curve example above, the fund would underperform all years until the last year in the graph.

To read more, please click "Read More" to the right below.

Basic Limited Partnership Structure
In a basic limited partnership, there are several passive investors (known as "Limited Partners" or "LPs") and the manager of the fund, (known as the "General Partner" or "GP").  The diagram below illustrates this basic structure.

This is one of a series of posts on fund terms.  Other posts include:

• Management Fee
• ​Carried Interest Overview
• Carried Interest – Preferred Return and GP Catchup
• GP Clawback
• Management Fee Offsets
• Key Person Clauses
• No Fault Divorce
• For Cause Actions
• Should Venture Capital Funds have a Preferred Return Hurdle?

Private equity funds (buyout, venture capital and growth equity funds) are typically structured as limited partnerships, which have two types of partners: limited partners, or LPs, which are passive investors in the fund; and a general partner, or GP, which is the manager of the fund.  As I evaluate funds, one of the fund terms that receives special attention is the amount of money the GP will commit to the fund - which is called "GP Commitment", "GP Capital Commitment" or "GP Commit."  ​

To read more, please click "Read More" to the lower right.