Title LM03 Investments in Private Capital - Equity and Debt IFT Notes.pdf ✅

LM03 Investments in Private Capital - Equity and Debt 2025 Level I Notes © IFT. All rights reserved 1 LM03 Investments in Private Capital - Equity and Debt 1. Introduction ........................................................................................................................................................... 2 2. Private Equity Investment Characteristics ................................................................................................ 2 3. Private Debt Investment Characteristics .................................................................................................... 6 4. Diversification Benefits of Private Capital ................................................................................................. 7 Summary ...................................................................................................................................................................... 8 Required disclaimer: IFT is a CFA Institute Prep Provider. Only CFA Institute Prep Providers are permitted to make use of CFA Institute copyrighted materials which are the building blocks of the exam. We are also required to create / use updated materials every year and this is validated by CFA Institute. Our products and services substantially cover the relevant curriculum and exam and this is validated by CFA Institute. In our advertising, any statement about the numbers of questions in our products and services relates to unique, original, proprietary questions. CFA Institute Prep Providers are forbidden from including CFA Institute official mock exam questions or any questions other than the end of reading questions within their products and services. CFA Institute does not endorse, promote, review or warrant the accuracy or quality of the product and services offered by IFT. CFA Institute®, CFA® and “Chartered Financial Analyst®” are trademarks owned by CFA Institute. © Copyright CFA Institute Version 1.0
LM03 Investments in Private Capital - Equity and Debt 2025 Level I Notes © IFT. All rights reserved 2 1. Introduction This learning module covers:  Features and investment characteristics of private equity  Features and investment characteristics of private debt  Diversification benefits of private capital 2. Private Equity Investment Characteristics Private capital is a broad term for funding provided to companies that is not sourced from the public equity or debt markets. Capital that is provided in the form of equity investments is called private equity, whereas capital that is provided as a loan or other form of debt is called private debt. Private Equity: Description Private equity means investing in private companies or public companies with the intent to take them private. The companies in which the private equity funds invests are called portfolio companies because they will become part of the private equity fund portfolio. The three main categories of private equity are:  Leveraged buyouts: Borrowed funds are used to buy an established company.  Venture capital: Refers to investments in companies that have not been established yet.  Growth capital: Refers to minority equity investments in mature companies that require funds for growth or expansion, restructuring, entering a new territory, an acquisition, etc. Leveraged Buyouts Leveraged buyout is an acquisition of an established public or private company with borrowed funds. If the target company is a public company, then after the acquisition, the company becomes private, i.e., the target company’s equity is no longer publicly traded. The acquisition is significantly financed through debt, hence the name leveraged buyout. LBOs capital structure consists of equity, bank debt, and high-yield bonds. The firm (GP) puts in some money of its own, raises a certain amount from LPs, and a substantial amount of money is borrowed in the form of debt to invest in companies. For example, assume the GP invests in a target company that requires an investment of $100 million. In this, the GP invests $20 million of its money (equity), $70 million from bank debt, and the remaining $10 million is raised by issuing high-yield bonds. There are three changes that happen to a company as a result of a leveraged buyout:  An increase in financial leverage.
LM03 Investments in Private Capital - Equity and Debt 2025 Level I Notes © IFT. All rights reserved 3  Change in management or the way the company is run.  If the target company is previously public, after the LBO it becomes private. Why LBO?  To improve the company’s operations; to add value and eventually increase cash flows and profits.  Leverage will enhance potential returns once the restructuring/growth strategy is complete and the company turns profitable. Debt is central to an LBO structure. Buyouts are rarely done entirely using equity. There are two types of LBOs:  Management buyouts (MBO): Current management team purchases and runs the company.  Management buy-ins (MBI): Current management team is replaced and the acquirer team runs the company. Venture Capital Venture capital firms invest in private companies (portfolio companies) with significant growth potential. The time horizon is typically long-term. The distinction between VC and LBO is that the latter invests in mature companies, whereas VC invests in growing companies with a good business plan and strong prospects for future growth. Other important points related to VCs are given below:  Venture capitalists are actively involved in the companies they invest in.  The rate of return expected depends on the stage the company is in when the investment happens.  VC investing can take place at various stages Formative stage: Company is still being formed. o Angel investing: Financing provided at the idea stage. o Seed stage financing: Financing provided for product development and market research. o Early stage: Financing for companies moving towards operation, but before commercial production and sales. Fund to initiate commercial production and sales. Later stage financing: For expansion after commercial production and sales but before IPO. Mezzanine stage: Preparing to go public. The following exhibit shows the growth stages of a company and the types of financing it may receive at each stage.
LM03 Investments in Private Capital - Equity and Debt 2025 Level I Notes © IFT. All rights reserved 4 PIPE (Private Investment in public equity):  A PIPE occurs when an institutional or accredited investor purchases stock from a public company at a discount to the market price.  PIPEs save companies time and money while raising funds because they have less stringent regulatory requirements than public offerings.  However, the lower cost of PIPE shares means less capital for the company, and their issuance effectively dilutes the stake of current stockholders. Private Equity Exit Strategies The goal of private equity is to improve new or underperforming businesses and exit them at high valuations. Typically, investments (target companies) are held for an average of 5 years. The holding period may be longer or shorter. The three common exit strategies are:  Trade sale: Selling the company to a competitor or any strategic buyer. It can be done through auction or private negotiation. For instance, if a PE firm (GP) invested in a small generic pharma company, it may sell it to large pharma firm after a few years.  IPO: Company goes public, i.e., it sells all or some of its shares to public investors.  Special purpose acquisition company (SPAC): A SPAC is a shell company, often called a “blank check” company, because it exists solely for the purpose of acquiring an unspecified private company sometime in the future. SPACs raise capital through IPOs and deposit the proceeds in a trust account. They have a finite time (e.g. 24 months) to complete a deal; otherwise, the proceeds are returned back to the investors. Exhibit 3 from the curriculum lists the pros and cons of these three strategies.