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1.
In the most reCommercial banks, followed by insurance companies,
cent years which savings institutions, finance companies, and credit unions
financial institution has been
the number-one
lender in the U.S.
economy?
2.
Real estate loans are secured by real property—land, buildings, and other
structures—and include short-term loans for construction
and land development and longer-term loans to finance
the purchase of farmland, homes, apartments, commercial structures, and foreign properties.
3.
Financial institu- include credit to banks, insurance companies, finance
tion loans
companies, and other financial institutions
4.
Agricultural
Loans
5.
Commercial and credit granted to businesses to help cover purchases of
Industrial Loans inventory, plant, and equipment and to meet other operating expenses like paying taxes and meeting payrolls
6.
loans to individu- include credit to finance the purchase of automobiles,
als
mobile homes, appliances, and other retail goods, to
repair and modernize homes, and to cover the cost of
medical care and other personal expenses, and are either
extended directly to individuals or indirectly through retail
dealers
7.
Miscellaneous
Loans
include all loans not listed above, including securities'
loans
8.
lease financing
receivables
where the lender buys equipment or vehicles and leases
them to its customers
9.
credit extended to farm and ranch operations to assist in
planting and harvesting crops and to care for and market
livestock
the largest in dollar volume is real estate loans, accounting for just over half of total bank loans among U.S. bank1 / 23
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Which loans
ing firms. The next largest category is loans to individuals,
have the largest followed closely by commercial and industrial (C&I) loans,
$ value?
each repre-senting about one-fifth of the total
10. Wholesale
Lenders
lending institutions that devote the bulk of their credit
portfolios to large-denomination loans extended to corporations and other relatively large business firms and
institutions
11. Retail Credit
smaller-denomination loans extended to individuals and
families as well as to smaller businesses
12. what type of
loans do small
banks usually
lend?
The smallest banks (under $100 million in total assets)
are more heavily committed to real estate and agricultural
loans than the largest banking firms (over $1 billion in
assets), which tend to be more heavily committed to
commercial loans and loans to individuals
13. What does the
loan mix at any particular lending institution depends
loan mix depend heavily upon the expected
heavily upon?
yield that each loan offers compared to the yields on all
other assets the lender could acquire
14. Legal Lending
Limit
The percentage of a banks total capital base they are
allowed to lend to any one non-related company; some
countries its 25%, in US its 15%
15. Criticized Loans Loans that are performing well but have minor weaknesses because the lender has not followed its own loan policy
or has failed to get full documentation from the borrower
16. scheduled loans - Loans that appear to contain significant weaknesses or
that represent what the examiner regards as a dangerous
concentration of credit in one borrower or in one industry
- a scheduled loan is a warning to management to monitor that credit carefully and to work toward reducing the
lender's risk exposure from it
17. Adversely Clas- When an examiner finds loans that carry an immediate
sified
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versely classified. They are further classified as substandard loans, doubtful loans, and loss loans
18. Substandard
Loans
the loans' margin of protection is inadequate due to weaknesses in collateral or in the borrower's repayment abilities
19. doubtful loans
loans which carry a strong probability of an uncollectible
loss to the lending institution
20. Loss Loans
regarded as uncollectible and not suitable to be called
bankable assets
21. CAMELS rating
Capital adequacy
Asset quality
Management
Earnings
Liquidity
Sensitivity to market risk
22. written loan poli- Policy that gives loan officers and management specifcy
ic guidelines in making individual loan decisions and in
sharpening the overall loan portfolio
23. customer profile A file that shows what services the customer is currently
using and contains other information required by management to monitor a customer's condition and financial
service needs
24. What should a
lender deal with
before any other
issue regarding a
loan?
The question that must be dealt with before any other is
whether or not the customer can service the loan —that is,
pay out the credit when due, with a comfortable margin for
error. This usually involves a detailed study of the critical
aspects of a loan application: character, capacity, cash,
collateral, control, and condition
25. character
- Customer's past payment record
- Experience of other lenders with this customer
- Purpose of loan
- Customer's track record in forecasting business or per3 / 23
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sonal income & credit rating
- Presence of cosigners or guarantors of the proposed
loan
26. capacity
The loan officer must be sure the customer has the authority to request a loan and the legal standing to sign a
binding loan agreement
27. cash
borrowing customers have only three sources to draw
upon to repay their loans: (a) cash flows generated from
sales or income, (b) the sale or liquidation of assets, or
(c) funds raised by issuing debt or equity securities
28. collateral
In assessing the collateral aspect of a loan request, the
loan officer must ask, Does the borrower possess adequate net worth or own enough quality assets to provide
adequate support for the loan
29. Control
The control element centers on such questions as
whether changes in law and regulation could adversely
affect the borrower and whether the loan request meets
the lender's and the regulatory authorities' standards for
loan quality. The control factor also considers the adequacy of the supporting documentation that accompanies
each loan and whether a proposed loan seems consistent
with current loan policy
30. Conditions
The loan officer and credit analyst must be aware of
recent trends in the borrower's line of work or industry and
how changing economic conditions might affect the loan
31. Who is the num- Commercial banks, followed by finance companies, credit
ber-one origina- unions, and savings institutions
tor of loans
to households
(consumers) in
the United
States?
32.
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how does collateral incentivize
the borrower to
repay loans?
33. perfected
If the borrower cannot pay, the pledge of collateral gives
the lender the right to seize and sell those assets designated as loan collateral, using the proceeds of the sale
to cover what the borrower did not pay back. Second,
collateralization gives the lender a psychological advantage over the borrower. Because specific assets may be
at stake (such as the customer's automobile or home), a
borrower feels more obligated to work hard to repay his
or her loan and avoid losing valuable asset
When a lender holds a claim against a borrower's assets
that stands superior to the claims of other lenders and to
the borrower's own claim, we say that lender's claim to
collateral has been perfected
34. common types of - accounts receivable
collateral
- factoring
- inventory
- real property
- personal property
- personal guarantees
35. safety zones surrounding funds
loaned to protect
a lender
1. income or cash flow
2. strength of the customer's balance sheet (liquidity and
collateral pledged)
3. personal guarantees and pledges made by the owners
of a business firm or by cosigners to a loan
36. most widely con- Risk Management Association (RMA)
sulted source of
data on business firm performance
37. promissory note - It specifies the principal amount of the loan. The face of
the note will also indicate the interest rate attached to the
principal amount and the terms under which repayment
must take place (including the dates on which any installment payments are due)
- the promissory note is a negotiable instrument
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38. loan commitment agreements
the lender promises to make credit available to the borrower over a designated future period up to a maximum
amount in return for a commitment fee (usually expressed
as a percentage—such as 0.5 percent—of the maximum
amount of credit available). This practice is common in the
extension of short-term business credit lines
39. unsecured loans these have no specific assets pledged behind them; these
loans rest largely on the reputation and estimated earning
power of the borrower
40. restrictive
covenants:
affirmative &
negative
- Affirmative covenants require the borrower to take certain actions, such as periodically filing financial statements with the lending institution, maintaining insurance
cover-age on the loan and on any collateral pledged, and
maintaining specified levels of liquidity and equity
- Negative covenants restrict the borrower from doing
certain things without lender approval, such as taking on
new debt, acquiring additional fixed assets, participating
in mergers, selling assets, or paying excessive dividends
to stockholders
41. Events of Default a section contained in most loan agreements listing what
actions or omissions by a borrower would represent a
violation of the terms of the agreement and what action
the lender is legally authorized to take in response
42. Loan Workout
the process of recovering funds from a problem loan
situation
43. Loan Review
a process of periodic investigation of all outstanding loans
to make sure each loan is paying out as planned, all
necessary documentation is present, and loan officers
are following the institution's loan policy
44. What are the
Bad loans, management error, criminal activity, and adprincipal causes verse economic conditions
of failure among
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banks and thrift
institutions?
45. self-liquidating
loans
business loans, usually to support the purchase of inventories, in which the credit is gradually repaid by the
borrowing customer as inventory is sold
46. Working capital
loans
- loans that provide businesses with short-term credit
lasting from a few days to one year and that are often
used to fund the purchase of inventories in order to put
goods on shelves or to purchase raw materials
- they carry a floating interest rate on the amounts actually
borrowed against the approved credit line
- a commitment fee is charged on the unused portion of
the credit line and sometimes on the entire amount of
funds made available
47. Compensating
Deposit
Balances
required deposits a customer must keep with a lender as
a condition for getting a loan
48. Interim Construction Loan
- secured short-term lending to support the construction
of homes, apartments, office buildings, shopping centers,
and other permanent structures
- once the construction phase is over, this short-term
loan usually is paid off with a longer-term mortgage loan
issued by another lender, such as an insurance company
or pension fund
49. Security Dealer
Financing
Dealers in securities need short-term financing to purchase new securities and carry their existing portfolios
of securities until they are sold to customers or reach
maturity
50. Retailer and
Equipment Financing
Lenders support installment purchases of automobiles,
home appliances, and other durable goods by financing
the receivables that dealers selling these goods take on
when they write installment contracts to cover customer
purchases
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51. asset-based
loans
credit secured by the shorter-term assets of a firm that
are expected to roll over into cash in the future
52. Factoring
the process of selling accounts receivable for cash
53. syndicated loan - a loan or line of credit extended to a business firm
by a group of lenders in order to reduce the credit risk
exposure to any single lending institution, and to earn fee
income (facility fees or commitment fees)
- usually traded on the secondary market and carry an
interest rate based on LIBOR
54. Term loans
- credit extended for longer than one year and designed to
fund longer-term business investments, such as the purchase of equipment or the construction of new physical
facilities
- Term loans usually look to the flow of future earnings of
a business firm to amortize and retire the credit
- Term loans normally are secured by fixed assets owned
by the borrower and may carry either a fixed or a floating
interest rate
55. revolving credit
line
- a financing arrangement that allows a business customer to borrow up to a specified limit, repay all or a
portion of the borrowing, and reborrow as necessary until
the credit line matures
- often granted without specific collateral and may be
short-term or cover a period as long as five years
- Lenders normally will charge a loan commitment fee
either on the unused portion of the credit line or, sometimes, on the entire amount of revolving credit available
for customer use
56. loan commitments : formal loan commitment & confirmed credit line
- formal loan commitment: contractual promise to lend up
to a maximum amount of money at a set interest rate
or rate markup over the prevailing base rate (prime or
LIBOR)
- confirmed credit line: the lending institution indicates its
approval of a customer's request for credit, though the
price of such a credit line may not be set in advance and
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the customer may have little intention to draw upon the
credit line, using it instead as a guarantee to back up a
loan obtained elsewhere
57. most risky busi- long-term project loans
ness loan
58. Project Loans
credit to finance the construction of fixed assets designed
to generate a flow of revenue in future periods
59. LBOs (leveraged leveraged buyouts of firms by small groups of investors,
buyouts)
often led by managers inside the firm who believe their
firm is undervalued in the marketplace. A targeted company's stock price could be driven higher, it is argued, if
its new owners can bring more aggressive management
techniques to bear, including selling off some assets in
order to generate more revenue
60. operating efficiency
how well a company uses its assets to generate revenue
61. Turnover of fixed indicates how rapidly sales revenues are being generated
assets
as a result of using up the firm's plant and equipment (net
fixed assets) to produce goods or services
62. Coverage Ratios measures of the degree of protection for long-term creditors and investors
63. Interest Coverage Ratio
EBIT/ interest expense
64. coverage of in- EBIT/(int.exp + principal repayments/1-T)
terest and principal payments
65. Coverage of all
fixed payments
EBIT and lease payments/
(Interest exp. + Lease payments)
66. Liquidity Ratios
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ability to raise cash in timely fashion at reasonable cost,
including the ability to meet loan payments when they
come due
67. net liquid assets current assets - inventory - current liabilities
68. Working Capital a measure of a firm's ability to meet its short-term debt
obligations from its holdings of current assets
69. disadvantages of - A business borrower with too many assets tied up in
excess liquidity liquid form, rather than in income-producing assets, loses
opportunities to boost returns.
- Excess liquidity invites dishonest managers and employees to "take the money and run."
70. profitability indi- The ultimate standard of performance in a market-oricators
ented economy is how much net income remains for
the owners of a business firm after all expenses (except
stockholder dividends) are charged against revenue
71. financial leverage
use of debt in the hope the borrower can generate earnings that exceed the cost of debt, thereby increasing
potential returns to a business firm's owners
72. Types of Contin- 1. Guarantees and warranties behind the business firm's
gent Liabilities products
2. Litigation or pending lawsuits against the firm
3. Unfunded pension liabilities the firm will likely owe its
employees in the future
4. Taxes owed but unpaid
5. Limiting regulations.
73. operating cash
flow (direct)
Net Sales Revenue - Cost of Goods Sold - Selling, General and Administrative Expenses - Taxes Paid in Cash +
Noncash Expenses
74. operating cash
flow (indirect)
Net Income + Non cash Expenses + Losses from the Sale
of Assets - Gains from the Sale of Assets - Increases in
Assets Associated with Operations + Increases in Current
Liabilities Associated with
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Operations - Decreases in Current Liabilities Associated
with Operations + Decreases in Current Assets Associated with Operations
75. cost-plus loan
pricing
figuring the rate of interest on a loan by adding together
all interest and non-interest costs associated with making
the loan plus margins for profit and risk
76. Loan interest
rate formula
Marginal cost of raising loanable funds to lend to
the borrower + Non funds operating costs + Estimated
margin to
compensate for default risk + Desired profit margin
77. prime rate
- prime rate is usually considered to be the lowest rate
charged the most creditworthy customers on short-term
loans
- sometimes called base or preference rate
78. longer term
loans are assigned to ------
term risk premium
79. Markup
risk premiums attached to loans are often referred to
collectively as the markup
80. LIBOR
the London Interbank Offered Rate—on short-term Eurocurrency deposits, which range in maturity from a few
days to a few months
81. below-prime
pricing
interest rates on loans set below the prevailing prime rate,
usually based on the level of key money market interest
rates (such as the current market rate on Federal funds
or Eurodollar deposits)
82. Customer Prof- refers to the allocation of revenues and costs to customer
itability Analysis segments or individual customers to calculate the prof(CPA)
itability of the segments or customers
83. investment
buying securities or other financial assets
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84. Underwriting
an arrangement under which an investment banker
agrees to purchase all shares of a public offering at an
agreed-upon price
85. Investment
Banking
- it includes raising capital (underwriting), advising on
M&A, capital markets services: fixed income, equity, currency, and commodity products
- it acts as an intermediary between investors (buyers and
sellers) or investors and issuers
86. IB revenue
mix: commissions, trading income, underwriting revenues, interests, and various kinds of
fees.
- commission: revenue from many kinds of agency transactions (when the IBs act as intermediaries) stipulated as
a percent-age of the transaction value
- trading income: realized and unrealized gains and losses when an IB "makes a market" (takes the other side of
customer trades)
- underwriting revenues: gross profits (or losses) from
underwriting security issues
- interests: the margin interests (when customers borrow
against the value of their securities to finance purchases)
or interests from investment accounts (including repurchase agreements and reverse repurchase agreements)
- asset management revenue: fees from the sale of mutual
funds and the management of portfolios
- other securities related revenues: advisory fees from
M&As but also dividends and interest from investment
accounts
87. Bulge Bracket
Banks
global full-service players providing the entire spectrum
of investment banking services
88. IPO (initial public - the first sale of a corporation's common shares to inoffering)
vestors on a public stock exchange
- generally involve a large group of banks called an underwriting syndicate to approach investors with offers to sell
these shares
- may be a primary offering, in which new shares are
sold to raise additional cash for the company. Or it may
be a secondary offering, where the existing shareholders
decide to cash in by selling part of their holdings
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89. "Wire House"
Firms
a firm operating a private wire to its own branch offices
90. internal funds
generated from sources within company (profits, sale of
(retained earn- assets, working capital reduction, accounts receivable)
ings + depreciation)
91. net equity issues - almost negative every year (this means that companies
paid out more to shareholders by repurchasing shares
than the raised by share issues)
- stock repurchases have typically been larger than new
issues of shares especially in 2006 & 2007
92. debt issues
positive in almost every year
93. debt ratios
- book debt ratio was higher than market debt ratio from
1965 - 2016
- Korea had the highest debt ratio (65%) & south Africa
the lowest (15%)
94. financial intermediaries
firms, such as banks, mutual funds, pension funds, and
insurance companies, that borrow funds from savers and
lend them to borrowers
95. common stockholders
in the United States, 39% of this common stock is held
directly by individual investors, and a similar proportion
belongs to financial intermediaries
96. pros of having a - they help to insulate management from short-term presstaggered board sure and allow the company to innovate and take risks
- Shareholder activists complain that staggered elections
serve to entrench management since dissident shareholders must wait two years before they can gain majority
representation on the board.
97. Tunneling
the exploitation of minority shareholders
98.
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reverse stock
splits
The company making the reverse split simply combines
its existing shares into a smaller, more convenient number
of new shares
99. preferred stock
stock that entitles the holder to a fixed dividend, whose
payment takes priority over that of common-stock dividends.
100. Eurobonds
Bonds sold in a foreign country but denominated in the
currency of the issuing firm
101. warrant
The owner of a warrant has the option to purchase a set
number of the company's shares at a set price before a
set date. Warrants and bonds are often sold together as
a package
102. convertible
bonds
Bonds that can be converted into common stock at the
bondholder's option
103. financial market market where securities are issued and traded
104. financial intermediary
an organization that raises money from investors and
provides financing for individuals, companies, and other
organizations. Banks, insurance companies, and investment funds are all intermediaries
105. Mutual funds
investments that reduce risk to shareholders by investing
in many different stocks
106. money market
fund
a savings-investment plan offered by investment companies, with earnings based on investments in various
short-term financial instruments
107. open vs. closed Mutual funds are open-end funds—they stand ready to
ended funds
issue new shares and to buy back
existing shares. In contrast, a closed-end fund has a fixed
number of shares that are traded on an exchange. If you
want to invest in a closed-end fund, you cannot buy new
shares from the fund; you must buy existing shares from
another stockholder in the fund
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108. exchange traded - a portfolio of stocks that can be bought or sold in a single
fund (ETF)
trade
- ETFs do not have managers with the discretion to try to
"pick winners." ETF portfolios are tied down to indexes or
fixed baskets of securities
109. hedge funds
- usually follow complex investment strategies, access is
restricted to knowledgeable investors such as pension
funds, endowment funds, and wealthy individuals
- generally established as limited partnerships
- try to attract the most talented managers by compensating them with potentially lucrative, performance-related
fees. In contrast, mutual funds usually charge a fixed
percent-age of assets under management
110. vulture funds
specialized funds that invest in distressed loans
111. defined contribu- a percentage of the employee's monthly paycheck is contion plan
tributed to a pension fund
112. pension fund
- a type of mutual fund that holds assets in order to provide
retirement income to its members
- provide professional management and diversification
- tax advantage: Contributions are tax-deductible, and
investment returns inside the plan are not taxed until cash
is finally withdrawn
113. financial institu- entities that provide financial services, such as taking detions
posits, managing investments, brokering financial transactions, or making loans
114. commercial
banks
- depository institutions that historically make short-term
loans primarily to businesses
- major sources of loans for corporations
115. how does under- investment banks underwrite stock offerings by purchaswriting work?
ing the new shares from the issuing company at a negotiated price and reselling the shares to investors. Thus, the
issuing company gets a fixed price for the new shares,
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and the investment bank takes responsibility for distributing the shares to thousands of investors
116. Insurance Com- - more important than banks for the long-term financing of
panies
business. They are massive investors in corporate stocks
and bonds, and they often make long-term loans directly
to corporations
117. venture capital
- equity investment in young private companies
- may be provided by investment institutions or by wealthy
individuals who are prepared to back an untried company
in return for a piece of the action
- Venture capitalists rarely give a young company up front
all the money it will need. At
each stage they give enough to reach the next major
checkpoint
- Most venture capital funds are organized as limited
private partnerships with a fixed life of about 10 years
- tend to specialize in young high-tech
firms that are difficult to evaluate and they monitor these
firms closely
- provide ongoing advice to the firms that they invest
in and often play a major role in recruiting the senior
management team
118. Angel Investors wealthy individuals in the business community willing to
risk investment funds on a promising business venture
119. crowdfunding
the practice of funding a project or venture by raising
many small amounts of money from a large number of
people, typically via the Internet.
120. Carried Interest
portion of profits paid to the professional venture capitalist
as incentive compensation
121. private equity in- Investors who offer funds to finance firms that do not trade
vesting
on public stock exchanges such as the NYSE or NASDAQ
122.
skyrocketed in 2000 due to the dot com bubble, been on
a steady increase since 2002
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venture capital investment
trends
123. how can VCs
cash out?
- Once the new business has established a track record,
it can be sold out to a larger firm
- go public and so provide the original backers with an
opportunity to "cash out," selling their stock and leaving
the original entrepreneurs in control
124. What is the aver- 17%, more than 15% higher than that of an equivalent
age return on VC investment in the stock market
funds?
125. road show
series of presentations to potential investors
126. Greenshoe
Option for underwriters to issue up to 15% more shares to
prevent them from having a short if shares are over-subscribed
127. Best Efforts Un- the type of underwriting in which the underwriter sells as
derwriting
much of the issue as possible, but can return any unsold
shares to the issuer without financial responsibility
128. Underwriting
Spread
difference between what the investment bank gets from
selling securities to public investors and what they pay to
the issuing firm
129. average underpricing of IPOs
16.8%
130. IPO stock price
trends
During the period 1980 to 2015 investors who bought the
stock of an IPO at the close of the first day's trading would
have lost 18.7% relative to the market over the following
three years. This suggests that the initial reaction to the
new issues was overenthusiastic
131. discriminatory
auction
every winner is required to pay the price that he or she bid
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132. Uniform Price
Auction
all winning bidders pay a price that is the lowest winning
bid.
133. general cash of- issue of securities offered for sale to the general public on
fer
a cash basis
134. foreign bonds
bonds sold in a foreign country and denominated in that
country's currency
135. global bonds
Eurobonds that trade in the national bond market of a
country other than the country that issues the currency
the bond is denominated in, and in the Eurobond market
136. market reaction Economists who have studied seasoned issues of comto stock issues mon stock have generally found that announcement of
the issue results in a decline in the stock price of 2% to
4%.43 While this may not sound overwhelming, the fall in
market value is equivalent, on average, to nearly a third
of the new money raised by the issue
137. privileged subscription, or
rights, issues
- Instead of making an issue of stock to investors at large,
companies sometimes give their existing shareholders
the right of first refusal
- are largely confined to closed-end investment companies
138. private placement
primary offerings in which shares are sold directly to a
small group of institutional or wealthy investors to avoid
costly process of registering with the SEC
139. Yield Spread
- the difference between the interest rate paid by the
consumer and the market interest rate
- the yield spread for baa bonds is higher than aaa bonds
140. Credit Default
Swap
an insurance policy on the default risk of a corporate bond
or loan
141. default put
The put's value is the value of limited liability—the value
of the stockholders' right to walk away from their firm's
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debts in exchange for handing over the firm's assets to
its creditors.
142. Bond Value
bond value assuming no chance of default - value of put
option on asset
143. increase in: val- value of company's assets - declines
ue of default put standard deviation of asset value - rises
amount of o/s debt - rises
debt maturity - rises
default free interest rate - declines
dividend payments - rises
144. investment
grade bonds
Bonds rated triple-B or higher; many banks and other
institutional investors are permitted by law to hold only
investment-grade bonds
145. Junk Bonds
(High-Yield
Bonds)
Ba & BB below
146. horizontal merg- combination of two firms in the same line of business
er
147. vertical merger
- a combination of firms at different stages in the production of a good or service
- The buyer expands
back toward the source of raw materials or forward in the
direction of the ultimate consumer
148. conglomerate
merger
a combination of two firms that are in unrelated industries
149. proxy
the right to vote another shareholder's shares
150. management
buyout (MBO)
Acquisition of the firm by its own management in a leveraged buyout
151. spin-off
a new, independent company created by detaching part
of a parent company's assets and operations. Shares in
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the new company are distributed to the parent company's
stockholders
152. Carve-outs
- similar to spin-offs, except that shares in the new company are not given to existing shareholders but are sold
in a public offering
- Most carve-outs leave the parent with majority control of
the subsidiary, usually about 80%
ownership
153. asset sale or di- - sale of a part of one firm to another. This may consist
vestiture
of an odd factory or warehouse, but sometimes whole
divisions are sold
- Announcements of asset sales are good news for investors in the selling firm and on aver-age the assets are
employed more productively after the sale
154. privatization
- a sale of a government-owned company to private investors
- Most privatizations are more like carve-outs than
spin-offs because shares are sold for
cash rather than distributed to the ultimate "shareholders"—that is, the citizens of the selling country
155. motives for privatization
- Increased efficiency. Through privatization, the enterprise is exposed to the discipline of competition and insulated from political influence on investment and operating decisions. Managers and employees can be given
stronger incentives to cut costs and add value
- Share ownership. Privatizations encourage share ownership. Many privatizations give special terms or allotments to employees or small investors.
- Revenue for the government
156. debtor in possession (DIP)
- In Chapter 11 bankruptcy proceedings, a debtor who is
allowed to continue in possession of the estate in property
(the business) and to continue business operations.
- While a reorganization plan is being drawn up, the company is likely to need additional
working capital. It has, therefore, become increasingly
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common to allow the firm to buy goods on credit and to
borrow money
157. performance
performance is the amount of capital that is returned to
the investors and the speed of returning this capital. If the
team delivers a good performance to the investors, every
three to five years it will normally be able to raise another
fund
158. role of the GP
finds investments, negotiates the deals, monitors the investments (hopefully adding some value along the way),
exits the investments, and returns the proceeds to the LP
159. features of VC
funds
- Venture capital funds are, in most cases, set up with a
10-year horizon. The portfolio is built up over the first few
years, and good exits generally take about five to seven
years or more to come to fruition. GPs generally have the
right to ask for a one-to two-year extension to the ten-year
life of the fund
- Partnerships are tax-efficient vehicles; the capital gains
are taxed when they are received by the partner rather
than within the fund. If the fund were structured as a company, gains would be taxed within the company and could
possibly be subject to double taxation when received by
the investor
- A fund brings together a coalition of investors. Each of
the investors wants to ensure that the GP is tied in closely
for the duration of the fund and that there are no conflicts
of interest
160. types of VC investors
- Pension funds. A pension fund with a relatively high ratio
of current employees to retirees is an ideal investor in a
VC fund
- Endowments. Endowments for universities and charitable institutions often have very long-term liabilities and
make particularly ideal investors in VC funds
- Balanced fund managers. In many parts of the
world there are investment managers who run balanced
funds—managing a mix of equities, bonds, cash, and
alternative assets (including venture capital).
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- Funds-of-funds. Managers of pension funds and other
pools of capital might decide not to pick particular venture capital funds themselves. Rather, they might decide
to diversify across a lot of VC funds by investing in an
intermediate vehicle called a fund-of-funds. It aggregates
commitments from a number of institutions and then does
a lot of due diligence to determine the best VC teams with
whom to invest.
- Corporations. Many large companies make commitments to independent venture capital funds. Sometimes
the investment is intended as a way of keeping an eye on
technology developments within the sectoral focus of the
VC fund
- Individuals. Wealthy individuals, sometimes through a
family office vehicle, make commitments to VC funds
161. How are VC firms The partners and staff of a venture capital company are
compensated
rewarded in two ways—through a management fee and
through carried interest.
- Partners and staff of a venture capital company receive
an annual fee—roughly 2% of the total amount of the fund
they manage each year
162. Hurdle rate.
A fund may have a hurdle rate internal rate of return
(IRR) (maybe 6% or a Treasury bill rate) before the carried
interest becomes payable. Normally, once this hurdle rate
has been reached, there is a catch-up clause so that the
gain is paid on all gains above the committed capital of
the fund—not just the gains above the hurdle rate.
163. Clawbacks
Some fund agreements allow the general partner to
earn carry when the gains from investments exceed the
amount of capital drawn. For example, if the general partner had drawn $50M from a $100M fund and had already
returned capital of $70M on the early investments, carried
interest of 20% of the $20M gain would be payable
164. Division of the
carried interest
Some funds have a straight-line division of the carried interest; others have a tiered structure with senior partners
and junior partners getting shares commensurate with
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their seniority or performance and all other staff receiving
a thin slice. Limited partners want to see an equitable split
between the long established partners and those who are
up and coming.
165. valuation of VC
investments
- companies in a venture capital portfolio should be
valued at fair value. FV being the amount for which an asset could be exchanged between knowledgeable, willing
parties in an arm's-length transaction
- When an investment is made initially, it is valued at cost.
A Series A investment of $1M in Company X in exchange
for 33% of the share capital of the company will value that
company at $3M.
166. which of the fol- 6/7
lowing is considered a good
multiple for an
individual investment in a venture
capital fund?
167. which of the fol- 2.5/3
lowing is considered a good multiple for a VC return to the LP?
168. what % return do 2% - 5% above public equities
VCs look for?
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