Private Equity Investing: If you’re interested in private equity investing or are just getting started, you’ve likely come across some terminology, or heard it bandied about, that you don’t understand. Well, if your aim is to one day join a fund, or at least learn enough parlance to become conversant, you must espouse the lingo – if you want to be taken seriously. Nearly every field has its own nomenclature, and PE is no different. So that you can understand, and be understood, let’s look at some terms you’ll encounter in private equity investing.
What is Private Equity?
Let’s start there. Private equity is a type of investment that occurs outside the public stock market. Through PE, investors gain an ownership stake in private organizations.
Basic Private Equity Terms
Private equity has its own vocabulary because the field can be somewhat complex. While some of the terms below are exclusive to PE, others you may be familiar with, but perhaps in a different context.
While this is not an exhaustive list, it contains a few of the most common terms in PE:
- General partner. Known as a GP, a general partner is the firm that manages a PE fund.
- Limited partner. Known as an LP, a limited partner is a third-party investor in a private equity fund.
- Committed capital. This is basically the amount an investor has pledged to an investment fund.
- Drawdown. A drawdown, also known as a capital call, is a firm’s legal demand for a portion of the LP’s committed capital to pay for a new investment or expense.
- Vintage year. This is the initial year that the fund “calls” committed capital.
- Preferred return. Also known as hurdle rate, preferred return is essentially the minimum annual return to which the limited partners are entitled before the GPs may start getting carried interest.
- Carried interest. This is a share of any profits received by general partners as pay, regardless of whether the GPs contributed any initial funds.
- Cumulative distribution. This is the amount of cash and stock that limited partners have received. It’s used when considering a fund’s investment track record.
- Residual value. Basically, residual value in private equity is the value of the fund’s investments in addition to other fund assets, minus fund liabilities.
- Private equity ratios. This is essentially a valuation ratio that compares the price of a security to earnings per share. Investors use it to determine the relative value of an organization’s shares in an apples-to-apples size up.
- Investment multiple. Also known as the total value to paid-in multiple (TVPI), investment multiple is a calculation that is performed by adding the reported value and distributions received. Then dividing that amount by the amount of capital distributed.
- Realization multiple. Also known as the distributions to paid-in (DPI) multiple, this is a calculation that divides the cumulative distributions by paid-in capital.
- RVPI multiple. Technically speaking, this is the current market value of unrealized investments, expressed as a percentage of “called” capital. It shows what portion of the fund’s return is unrealized and reliant upon the fund’s investments’ market value.
- PIC multiple. This is a calculation made by dividing paid-in capital by committed capital and reveals the share of a fund’s committed capital that’s been drawn down.
- Global investment performance standards. These are voluntary, ethical standards used for calculating and demonstrating investment performance. It’s based on the pillars of fair representation and full disclosure.
Now that you know and understand some of the terminology you’ll likely encounter in private equity investing, you’re ready to enter the field in earnest. Or maybe you’re just ready to learn more — now that you have a foundation.
The fact is that while PE was once outside the purview of mainstream investors, that’s no longer the case. So, it’s smart to embrace the verbiage that you, too, will come to use.