Private Equity

• A. By trading publicly listed stocks on daily market fluctuations
• B. By acquiring companies, improving their operations and value, and then selling them at a profit ✓
• C. By lending money to consumers at fixed interest rates
• D. By investing exclusively in government bonds and treasury securities

Why: Private equity firms buy controlling stakes in companies, work to increase their operational efficiency, growth, and profitability, and then exit through a sale or public offering, aiming to generate returns above what public markets offer.

• A. Retail investors buying shares on public exchanges
• B. Institutional investors such as pension funds, endowments, and sovereign wealth funds ✓
• C. Only the general partners of the fund
• D. Individual day traders using margin accounts

Why: Private equity funds are typically financed by large institutional investors, often called limited partners, who commit capital for long periods because of the high minimum investments and illiquid nature of the asset class.

• A. A purchase of a company funded mostly by debt, with the acquired company's assets and cash flows often used to support repayment ✓
• B. A purchase of a company funded entirely with the buyer's own cash
• C. A government bailout of a struggling corporation
• D. The sale of a company's shares to its existing employees at a discount

Why: An LBO uses a significant amount of borrowed money to finance the acquisition, with the target company's cash flows typically serving to service and repay that debt. This magnifies potential equity returns but also increases risk.

• A. A management fee charged on committed or invested capital plus a performance fee, often called carried interest ✓
• B. A flat fee paid once when the fund is launched
• C. A fixed percentage of the fund's daily trading volume
• D. No fees, as investors receive all returns directly

Why: Private equity funds commonly charge an annual management fee, often around 2 percent of committed capital, plus carried interest, typically around 20 percent of profits above a specified hurdle rate, as compensation to the general partner.

• A. The time a fund spends raising capital from investors
• B. The length of time a private equity firm owns a portfolio company before exiting the investment ✓
• C. The number of days a stock must be held before it can be sold on an exchange
• D. The period during which a company is required to file quarterly reports

Why: The holding period is the duration a private equity firm owns an investment before selling it. It typically ranges from about three to seven years, during which the firm works to enhance the company's value before exiting.

• A. To provide the majority of the capital as a passive investor
• B. To manage the fund, make investment decisions, and bear unlimited liability for the partnership's obligations
• C. To act as the fund's custodian and hold all portfolio company shares
• D. To serve as an independent auditor who verifies fund valuations

• A. Unlimited personal liability for all fund debts
• B. Liability limited to their committed capital contribution
• C. Joint and several liability alongside the General Partner
• D. Liability limited only to management fees paid

• A. The cash amount an LP must wire immediately upon signing the partnership agreement
• B. A binding promise by an LP to contribute a specified amount of capital when called by the GP over the fund's life
• C. The minimum return the GP guarantees to LPs
• D. The amount of debt the fund is permitted to take on

• A. Indefinite, with no set end date
• B. Approximately 1 month to allow quick deployment of capital
• C. Typically around 10 years, often with extension options
• D. Exactly 3 years, as required by securities regulation

• A. It allows the fund to avoid all taxes permanently
• B. It provides pass-through taxation and limits LP liability while giving the GP operational control
• C. It is required by law for all investment funds regardless of size
• D. It allows public trading of fund units on stock exchanges

• A. An acquisition of a company funded primarily with equity from the buyer
• B. An acquisition of a company funded primarily with debt, with the target's cash flows used to service that debt ✓
• C. A merger between two publicly traded companies using stock as the main currency
• D. A government-backed bailout of a distressed company

Why: An LBO uses a significant amount of borrowed money to finance the purchase price, and the acquired company's cash flows and assets are typically used to repay that debt. This leverage amplifies the equity returns if the investment performs well.

• A. To reduce the total capital required and amplify returns on the equity invested ✓
• B. To avoid paying taxes on the acquisition
• C. To guarantee a fixed return to investors regardless of performance
• D. To increase the company's credit rating before an IPO

Why: By funding a large portion of the purchase with debt, the sponsor invests less equity, so any increase in enterprise value translates into a higher percentage return on the smaller equity check. Leverage magnifies both gains and losses.

• A. Buying companies only after they have been listed on a public exchange
• B. Identifying and approaching potential acquisition targets directly, before they are widely marketed through a formal sale process ✓
• C. Sourcing deals exclusively from government auctions
• D. Purchasing shares of companies from existing shareholders on the open market

Why: Proprietary sourcing means a firm finds targets through its own research and relationships, often reaching out to owners before an investment bank runs a competitive auction. Such deals typically face less competition and can be acquired at more favorable prices.

• A. The lender providing the senior debt
• B. The company being acquired
• C. The private equity firm that organizes and controls the acquisition ✓
• D. The investment bank advising the seller

Why: The sponsor is the private equity firm that arranges the transaction, contributes the equity, and typically takes an active role in governing the acquired business. Lenders and advisors are separate parties.

• A. Because they require no capital expenditures at all
• B. Because steady cash flow can reliably service and repay the acquisition debt ✓
• C. Because they always trade at a discount to their book value
• D. Because lenders are legally required to lend to them

Why: Since LBOs rely on debt repayment from the target's cash flow, predictable and strong cash generation reduces the risk of default. Volatile or cyclical businesses are generally riskier candidates for heavy leverage.

• A. The total cash flows generated during the explicit forecast period
• B. The value of the business beyond the explicit forecast period, typically estimated using a perpetuity growth or exit multiple approach ✓
• C. The book value of the company's net assets at the end of the holding period
• D. The present value of the debt that must be repaid at exit

Why: Terminal value captures the value of all cash flows beyond the explicit forecast horizon, which is usually estimated with a Gordon growth (perpetuity) model or an exit multiple applied to a final-year metric such as EBITDA. It is typically a large share of total DCF value.

• A. Net income
• B. Revenue
• C. EBITDA ✓
• D. Free cash flow to equity

Why: EV/EBITDA divides enterprise value by EBITDA, so EBITDA is the denominator. EBITDA is a widely used proxy for operating cash earnings before financing and accounting-driven items, making it the standard basis for comparing leveraged companies.

• A. To determine the company's tax liability over the holding period
• B. To measure the sponsor's equity return on the initial investment, accounting for entry price, cash flows, and exit value ✓
• C. To calculate the accounting book value of the target at closing
• D. To estimate the working capital requirement for daily operations

Why: IRR (internal rate of return) and MOIC (multiple on invested capital) measure how much the private equity sponsor earns on its equity check, combining the entry equity investment, any interim distributions, and the exit proceeds. They are the core metrics for judging whether a deal meets fund return targets.

• A. To show how the model's outputs, such as IRR, change when key assumptions like exit multiple or revenue growth are varied ✓
• B. To list all historical financial statements of the target company
• C. To verify that the balance sheet balances in each forecast year
• D. To record the legal terms of the debt financing package

Why: Sensitivity tables flex one or two key drivers, such as exit multiple, leverage, or EBITDA growth, and show the resulting returns. They help investment committees understand risk and which assumptions most affect the deal's outcome.

• A. Because private companies always have higher revenue than public companies
• B. Because private company shares are illiquid and lack the publicly available information that public markets provide ✓
• C. Because tax authorities require a fixed discount on all private transactions
• D. Because private companies cannot generate positive free cash flow

Why: Private company equity is illiquid, meaning it cannot be quickly sold at market price, and information is typically less transparent than for public firms. These factors justify a discount for lack of marketability and sometimes lack of control, reflecting the additional risk and lower liquidity.

• A. To set the final purchase price for the target company
• B. To verify the target company's financial, legal, operational, and commercial condition before investing ✓
• C. To arrange debt financing for the acquisition
• D. To select the management team after the deal closes

Why: Due diligence is the investigative process used to verify assumptions and uncover risks in a target company before committing capital. While price is negotiated partly based on findings, its core purpose is verification across financial, legal, operational, and commercial areas.

• A. The limited partnership agreement
• B. The investment memorandum summarizing the opportunity, risks, returns, and diligence findings ✓
• C. The fund's annual audited financial statements
• D. The portfolio company's employee handbook

Why: The investment memorandum (often called the IC memo) presents the deal thesis, valuation, key risks, projected returns, and diligence results so the committee can make an informed approval decision.

• A. The personal backgrounds of the target's executives
• B. The quality of earnings, cash flow, working capital, and debt-like items of the target ✓
• C. The fund manager's personal investment history
• D. Environmental compliance of the target's facilities

Why: Financial due diligence assesses the sustainability and quality of earnings, cash conversion, working capital needs, and liabilities that function like debt, all of which affect valuation and deal structure.

• A. It is a regulatory requirement for all securities offerings
• B. It forces the deal team to clearly articulate how value will be created and what must go right ✓
• C. It determines the management fee the fund will charge
• D. It replaces the need for any further diligence

Why: A clear investment thesis states the sources of value creation, such as growth, margin expansion, or multiple arbitrage, and makes assumptions explicit so the committee can challenge them.

• A. The deal is always abandoned immediately
• B. The price may be renegotiated, protections such as escrows or indemnities may be added, or the deal may be dropped ✓
• C. The risk is ignored because the fund has already committed capital
• D. The fund automatically increases the purchase price

Why: Material findings typically lead to renegotiation of price, structural protections like escrows, specific indemnities, or representations and warranties insurance, or withdrawal from the transaction if risks cannot be adequately mitigated.

• A. To minimize the number of employees at portfolio companies
• B. To create value and improve operating performance of portfolio companies before exit
• C. To maintain the original business model without changes
• D. To avoid any interaction with company management

• A. Increasing financial leverage through additional debt
• B. Improving pricing strategy and reducing operating costs
• C. Changing the fund's management fee structure
• D. Extending the fund's investment period

• A. Acquiring several companies in the same year
• B. Selling a company at a higher valuation multiple than the one paid at entry
• C. Increasing the number of board members at a portfolio company
• D. Raising additional capital from limited partners

• A. To satisfy regulatory requirements for all investments
• B. To bring in expertise and align management with the value creation plan
• C. To reduce the firm's tax obligations
• D. To comply with limited partner reporting standards only

• A. Price-to-earnings ratio
• B. Internal rate of return (IRR) and multiple on invested capital (MOIC)
• C. Current ratio
• D. Dividend yield

• A. Initial public offering (IPO)
• B. Sale to a strategic buyer (trade sale) ✓
• C. Liquidation of all assets
• D. Management buyout financed by public debt

Why: Trade sales to strategic buyers are historically the most common exit route for PE-backed companies because they often deliver the highest valuations through synergies, while IPOs are less frequent and depend heavily on market conditions.

• A. The fund earned a 2.5% annual return
• B. The investor received $2.50 for every $1.00 invested ✓
• C. The investment took 2.5 years to exit
• D. The company's EBITDA grew by 2.5 times

Why: MOIC measures total value returned divided by total capital invested. A 2.5x MOIC means investors received $2.50 for every $1.00 invested, regardless of how long the investment took.

• A. The absolute dollar profit generated
• B. The time value of money and the timing of cash flows ✓
• C. The management fees paid to the general partner
• D. The leverage ratio used at acquisition

Why: IRR is the discount rate that sets the net present value of all cash flows to zero, so it accounts for when cash is invested and returned. Two investments with the same MOIC can have very different IRRs depending on timing.

• A. Selling the company's shares to employees at a discount
• B. Using new debt to fund a special dividend to the fund's investors before a full exit ✓
• C. Reinvesting all profits back into the portfolio company
• D. Converting preferred equity into common stock

Why: A dividend recap raises debt at the portfolio company level and distributes the proceeds to shareholders, returning capital to investors early and boosting interim IRR while the sponsor still holds the investment.

• A. The percentage of unrealized gains still held in the portfolio
• B. Cash actually returned to LPs as a multiple of capital they have contributed ✓
• C. The total management fees paid to the GP divided by committed capital
• D. The annual growth rate of portfolio company revenues

Why: DPI measures realized cash returned to limited partners relative to paid-in capital. Unlike TVPI, which includes unrealized value, DPI reflects only actual cash distributions, making it a key measure of liquidity.