​In the prior post “Preferred Stock Financings: Rights of First Refusal” we discussed the right that the company and stockholders have to acquire the shares of stock being offered for sale by an existing stockholder.
 
A related right is the Co-Sale right, also known as “tag-along” right or “take me along” right.  A Co-Sale applies when an existing preferred stockholder in a privately-held company has received an offer from a potential buyer (known as a “third party”) to buy its stock.  The Co-sale right enables existing stockholders to sell their stock alongside the selling stockholder in this transaction.
 
Let’s explore the mechanics of a Co-Sale right.

Have you heard the term “ROFR” (pronounced “Roafer”)?  This term is well known by professional investors.
 
ROFR means Right of First Refusal.  We will do a deep dive on ROFRs in this post.

​This post is a continuation of the post “Preferred Stock Financings: Registration Rights Part 1.”
 
In the prior post, we discussed the registration process, which enables the company and/or existing stockholders to sell shares to the public on a stock exchange, such as the New York Stock Exchange (“NYSE”) or NASDAQ.  We discussed S-1 registration statements and S-3 registration statements, which are the primary ways for the company to sell stock to the public.
 
In this post, we explore “demand” registration rights and “piggyback” registration rights, which are rights held by the preferred stockholders in order to be able to register their shares so they can be sold in the public markets.

​There are two key events that occur for an investor in a private company:  The purchase of the stock and the exit (an “exit” is the sale or exchange of the stock for cash or publicly traded stock).  The primary exits are when a company is sold and the investor receives cash for its stock, and when the investor sells their shares into the public market as part of a registered offering, such as an IPO.
 
“Registration rights” are the rights that preferred stock investors obtain to allow them to sell their stock in a registered offering. 

​There’s a lot to discuss here, so buckle up and let’s get going.

When you buy stock of a publicly-traded company, there's lots of information available about the company's business and finances.  This is because publicly-traded companies are required by law to publish their financials and other company information.  

The world is very different when investing in private companies.  Absent an agreement, private companies have very few requirements to provide investors with information on the company’s business and finances.  That’s where information rights come in.
 
This post explores information rights typically obtained by preferred stockholders in private companies.

​Here’s a scenario inspired by real events that I have experienced:  a startup telecom company was all the rage and the company’s Series A preferred stock financing was heavily oversubscribed.  As a result, the deal was “take it or leave it” for investors and the Series A preferred stockholders invested without obtaining many of the normal provisions protecting their investment.  The company raised significantly more money than they needed at that stage.  With all this cash burning a hole in the company’s pocket, the company decided to buy some land and build itself a new headquarters building.  The company also gave management huge raises and bonuses and lavishly spent on marketing (sponsoring a race car and hiring a celebrity spokesperson), office décor, company retreats and parties.  Not surprisingly, the company blew through all of its cash very rapidly, with little progress to show for it.  The company then tried to raise another round of financing but couldn’t agree with investors on valuation (the investors wanted a very low valuation) and the company went out of business.
 
Moral of the story: If the investors in the financing described above had obtained protective provisions, this financial debacle may not have occurred.
 
This blog post is about protective provisions.

​Boards of directors for early-stage companies are very important and serve a number of critical functions.  The board hires the company’s CEO and other senior management (and sometimes fires them), and decides other major events for the company, such as whether and when to raise additional capital, enter into important contracts, sell the company, go public or to wind the company down.  In addition, the board often has committees, including an audit committee (to review the financials of the company) and a compensation committee (to establish officer compensation) that meet separately from the board.
 
Members of the board of directors are elected by the stockholders, and represent the stockholders’ interests.  In preferred stock financings, the lead investor will usually obtain the right to appoint a director to the board.  If the lead investor doesn’t obtain a board appointment right, then the investor may obtain the right to be a “board observer.”  Board observer rights are sometimes granted in addition to board appointment rights.
 
This blog discusses an investor’s rights to appoint a member of the board and/or a board observer.

​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.

​In a convertible preferred stock financing, one of the most heavily negotiated terms is the liquidation preference. 
 
A liquidation preference is a priority payment right given to preferred stockholders when a company has a “liquidation” event – which means a sale of the company or the bankruptcy/winding down of the company.  In the event of a liquidation, the liquidation preference determines how the liquidation proceeds are prioritized and paid to the preferred stockholders and the common stockholders.  These payments are called a “liquidation waterfall.”
 
Liquidation preferences can be pretty complex, so let’s break this down into components.

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.

​Anti-dilution provisions protect existing stockholders from value dilution and/or ownership dilution. They are powerful investor protections and they come in different flavors.  
 
In a prior post, we discussed Rights of First Offer (also known as Pre-Emptive Rights) which offer protection against ownership dilution.
 
This post will explore anti-dilution protections that protect against value dilution.

​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.

​The word “dilution” is used often private equity, particularly in venture capital financings.  One can hear venture capitalists and founders say they don’t want to be diluted.  But what are they talking about when they say this?  That’s the topic of this post.
 
I view dilution as having two components: ownership dilution and value dilution.  These concepts are related.  In this post, we’ll take a look at ownership dilution.  We’ll look at value dilution in a later post.

​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.

My firm Campton Private Equity Advisors today hosted a webinar "Private Equity Investing 101: An Overview for New Investors" which provided an overview of investing in Private Equity.  Topics covered in the webinar included:

• What is Private Equity?
• Introduction to Venture Capital and Buyouts
• Why invest in Private Equity?
• Private Equity investment strategies: direct investing, fund investing and fund-of-funds investing

Click the button below to go to a reply of the webinar on YouTube:

If the button doesn't work, here's a link to the webinar on YouTube at: ​​https://youtu.be/zsFgajgoE2E

The presentation is available for download below:

​Overview
Private equity funds-of-funds (“FOFs”) ​are funds that invest in other private equity funds, which then invest directly into privately-held companies.  By investing in a FOF, a limited partner (“LP”) obtains a diversified portfolio of private equity fund investments as well as a larger portfolio of indirect investments in underlying private companies.  I have worked for two private equity fund-of-fund managers and understand well the pros and cons of these vehicles.  This post provides an overview of FOFs.
 
Structure
FOFs invest in a portfolio of private equity funds (known as “portfolio funds”), which in turn invest in privately-held companies (known as “underlying portfolio companies”).  A FOF will invest in a portfolio of private equity funds and each portfolio fund will invest in a portfolio of private companies.  As a result, an LP’s single investment in a FOF can provide the LP with exposure to many funds and potentially hundreds of underlying portfolio companies.  The simplified diagram below illustrates this.

Just as wines have “vintage years”, private equity funds also have "vintage years."  But what is a vintage year?  For wine, it’s universally recognized as the year the grapes were harvested.  However, it’s not that simple for private equity, as various industry participants define “vintage year” differently.

Consider the following hypothetical:  In 2011, two private equity professionals decide to raise a fund.  That year they form a legal entity for the fund and launch their fundraising efforts.  In late 2012 the fund has its initial closing of commitments from limited partners, and makes its first capital call, where limited partners make their first cash contribution to the fund.  In 2013, the fund makes its first investment.  In 2014, the fund has its final closing.  As of September 30, 2018, the fund has a net IRR of 18.5%.  What should the vintage year be for this fund - 2011, 2012, 2013 or 2014?

​To read more, please click on "Read More" below.

Why is it that mutual funds take an investor’s capital on day 1, while PE funds take an investor’s capital over time?  That’s the topic of this post.

When an investor makes an investment in a mutual fund, the investor invests the entire amount of the investment on day 1.  The mutual fund manager will quickly use this money to increase existing positions in the fund or make new investments.  It’s easy for the mutual fund manager to put the money to work by buying publicly-traded securities.
 
Investments in private equity funds are different.  Private equity funds operate on a “called capital” model.  By way of background, when an investor (known as a “limited partner” or “LP”) makes a legal commitment to a private equity fund, the LP commits to providing the fund with a certain maximum investment amount, which is known as the “LP commitment.”  For example, if an LP agrees to invest a total of $10 million in a private equity fund, that $10 million is the LP commitment.  For more background, please see the following posts:

• LP Corner: On Committed Capital, Called Capital and Uncalled Capital
• LP Corner: US Private Equity Fund Structure – The Limited Partnership

 
​To read more, please click “Read More” below.

Sit right back and you’ll hear a tale…
 
In this fictional account, Able Bentley Capital is a $500 million private equity fund (“ABC”).  ABC is formed as a Delaware limited partnership, and the general partner (“GP”) is ABC Partners.  (For a discussion of limited partnerships, see my post “LP Corner: US Private Equity Fund Structure - The Limited Partnership.”)  ABC makes a number of international investments.  Bill Smith is one of managing partners of the management company and a member of the GP.  Bill sources and leads several international investments.  It is common in international investments to have the fund’s investment flow through one or more intermediate (known as “blocker”) shell companies in order to shield the fund from negative tax consequences.  Using a complicated blocker structure, Bill was able to defraud ABC out of several million dollars.  The fraud was eventually discovered and after several years Bill was convicted of fraud and embezzlement.
 
Situations where a GP (or a principal of the GP or management company) behave truly badly are rare, but they do occur.  The question becomes, what should happen when really bad behavior occurs?  Read on to find out!
 
To read more, please click “Read More” below.

Divorce, Private Equity style...

Private equity funds have long lives.  Private equity limited partnership agreements (LPAs) typically provide for an initial 10-year term, plus two one-year extensions at the discretion of the general partner of the fund (GP).  However, fund terms often stretch out for much longer, sometimes 15 to 18 to 20 or more years.  This is truly a long-term commitment, for both the limited partners (LPs) and for the GP.  For an overview of LPs, GPs and limited partnerships, please see my prior post "LP Corner: US Private Equity Fund Structure - The Limited Partnership."
 
Because funds stay around for a long time, things will change.  Partners may leave the fund’s management company; the investment strategy might drift away from the initial strategy; the investment performance may be terrible to the point that the LPs want to stop the GP from investing; the fund or management firm may be embroiled in a scandal; or in rare cases, the GP may behave badly (not illegally or in violation of the LPA, but in ways that may place their personal interests above the best interests of the LPs).  There are many other changes that can occur during the life of a fund.

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

Thousands of private equity funds are being raised right now.[1]  For a fund in the market, that’s a massive amount of competition.  Limited partners (or LPs), the investors in private equity funds, are constantly meeting with general partners (GPs), the fund managers, to select the very best funds in which to invest.

This means GPs have little room for mistakes on the fund-raising trail.  A compelling roadshow is a key element to fundraising success.

Having met with hundreds of managers over the years, and after seeing the good, the bad and the ugly of roadshow presentations, I offer the following thoughts for GPs on how to have a successful roadshow meeting with an LP.
This article is geared to funds that will be institutional – $100 million or more marketing to institutions including pension funds, funds of funds, foundations, endowments and family offices. But most of the tips presented will also be relevant for sub-$100 million funds.​