Glossary

An angel investor provides first-seed funding for new businesses, typically in exchange for ownership shares in the company. They frequently invest in early-stage enterprises with a high chance of failure. The goal is to help with the establishment of new firms and offer mentorship and guidance to entrepreneurs.

Angel investors are not typically involved in the loan industry. They are investing in an idea that they value, with the expectation of obtaining a reward when the startup succeeds.

Examples of Angel Investors:

1. Peter Thiel – Facebook
2. Ratan Tata – Urban Clap, Xiaomi, Moglix, and Snapdeal

Alternative investment funds are investment vehicles that raise capital from both domestic and international investors. These funds subsequently invest the capital according to a predetermined investment policy.

It is a financial asset that does not fit into any of the traditional investment categories like equities, bonds, or cash. Alternative investment funds may include private equity or venture capital, hedge funds, managed futures, art and antiques, commodities, or derivatives contracts. They aim to obtain returns uncorrelated with traditional financial markets, thereby offering diversification and decreasing risk.

As per the SEBI (Alternative Investment Funds) Regulations, 2012, there can be three types of AIFs:

1. Category I: Invests primarily in new businesses, small and medium-sized businesses, and other industries deemed socially and economically feasible by the government.
2. Category II: Includes private equity or debt funds, for which no explicit incentives or concessions are offered by the government or any other regulator.
3. Category III: Includes hedge funds or funds that trade for short-term profits. These funds aren’t given explicit incentives or concessions by the government or any other authority.

Accrued interest is the amount of interest accumulated, in the form of revenue or expense, on a loan or other financial obligation. This accrual occurred as of a specific date but has yet to be paid out.

Accrued interest is crucial for accurately valuing, reporting, and managing fixed-income assets. It is an important component in financial transactions, used to assure fairness in bond pricing and interest income recognition.

Example: Imagine an investor buying a $10,000 bond with a 5% annual interest rate. If the interest is compounded monthly and the investor retains the bond for three months, the accrued interest is $125 ([$10,000 * 0.05] / 12 * 3).

Amortisation is the process of decreasing the value of intangible assets over time. Unlike material assets, which decrease in value due to regular use, intangible assets such as patents, copyrights, and trademarks lose value through amortisation as their usefulness declines over time.

Amortisation is important in private investing because it reflects the constant loss of intangible asset value over time. It enables investors to accurately measure the underlying economic performance of their investments. Hence helps to make sound judgements about asset management and financial reporting.

Example: You own a 10-year patent on a machine. You spent ₹1,00,000 designing and building the machine (the original patent cost). You should record ₹10,000 per year as a patent amortisation expenditure (₹1,00,000 divided by 10 years).

Asset allocation is the process that helps investors split their portfolios among various assets, such as stocks, bonds, and cash and its equivalents. Each asset class has unique risks and return possibilities, thus they will perform differently over time.

An investor’s asset allocation is anything but fixed – it changes in response to the market conditions. During bull markets, investors choose growth-oriented assets like equities. During downturns, they opt for conservative investments.

Asset-based lending (ABL) in private investing is a financing strategy in which a borrower receives a loan using their assets as collateral. The lender checks the borrower’s assets to determine how much they are ready to lend.

ABL in the private sector is an effective way to get finance for expansion, working capital, or restructuring. It is a method used when traditional funding sources like capital markets and traditional unsecured or mortgage-secured banks are unavailable.

Example: Assume that a company wants to expand its operations and seeks ₹5,00,000. Given its strong liquidity, it has a sufficient number of marketable securities to serve as collateral. The lender grants 85% of the securities’ face value. Thus, if the securities are worth ₹5,00,000, the loan will be worth ₹4,25,000.

A buyout is an investment transaction in which an investor buys more than 50% of a company’s equity, resulting in a change of control. Investors typically target underperforming or undervalued companies to take them private and gain more control over their operations.

Buyouts are of two types:

Management Buyout: A transaction in which a company’s management team acquires the assets and operations of the firm they run.

Leveraged Buyout: A financial transaction in which a company or business unit is acquired with a considerable amount of borrowed capital or debt.

Example: In 2013, Dell’s founder teamed up with Silver Lake Partners, a private equity group, to pay $25 billion for the company he created. Michael Dell went private to gain more control over the company’s activities. It is a textbook case of a management buyout.

In private investing, a benchmark is a standard or reference point with which the performance of an investment portfolio is compared. It allows investors to check the efficiency of their investment strategy and asset allocation.

Benchmarks help investors choose the optimal combination of equities, fixed-income securities, alternative investments and other asset types for effective risk management.

For example, if an investor’s portfolio constantly underperforms the benchmark, it might indicate that their investing strategy isn’t producing enough returns or that asset allocation changes are required.

A company’s beta is an estimate of a security’s uncertainty, or systematic risk, in relation to the general market. A company’s beta measures how much its equity market value changes in response to movements in the general market. The capital asset pricing model (CAPM) uses it to estimate an asset’s return.

As a risk indicator, beta can be thought of as follows: the greater a company’s beta, the higher the projected return that should be generated to offset the excess risk brought on by volatility.

Private market investors utilise beta to estimate the risk and possible rewards of investing in a certain company, allowing them to make more educated decisions based on the asset’s sensitivity to market swings.

For example, let’s consider a company in the IT sector. If the market beta is 1.2 and the company’s beta is 1.5, it means that the firm is projected to be more volatile than the general market.

If the market rises by 10%, the company’s returns are expected to climb by 15%, reflecting its greater beta. During a market downturn, the company may have a 15% decline rather than the market’s 10% decrease.

In the private market, bridge financing is a short-term loan or financial arrangement made available to a business or individual until a more permanent or longer-term financing option can be found. It serves as a “bridge” to meet sudden financial demands or gaps in funding.

It bridges the gap between when a company’s money is about to run out and when it can expect to receive a cash infusion later on. Bridge financing often has higher interest rates and costs than regular financing choices due to its short duration and increased risk.

Example: A mining business may raise ₹10 million in capital to establish a new mine that is predicted to generate greater profit than the loan amount. A venture capital firm may provide the cash for the business. Due to the risks involved in this business, the venture capital firm charges a 20% annual fee and wants repayment within one year.

A capital call is a demand by a company for a portion of the funds promised to it by investors. When an investor commits to a private fund, they agree to invest a set amount over time but often do not provide all the funds upfront.

Instead, the fund manager will request that the investor transfer a portion of this commitment when the fund is ready to invest or needs to meet expenditures. This enables the fund manager to just hold the amount of capital required at any given time, rather than managing and investing vast sums of idle money.

For example, you agreed to contribute $100,000 to the fund. Currently, you are only compelled to pay a fraction of that amount, possibly $25k, as ordered by the fund manager (also known as the general partner or GP). You may keep the remaining $75,000 for the time being. The GP will eventually “call” for the remaining funds. This process is known as a capital call.

As the name implies, capital commitments are financial commitments made by investors or organisations to invest a certain amount of money in a business venture. The investment made by the investor or the firm is determined by the projected return on investment (ROI). It could take the form of equity, debt, or both. This commitment specifies the amount of money that the investor is required to contribute over a given period or as needed.

Capital appreciation is the growth in the market price of an asset or investment over time. It is calculated by the difference between the sale and purchase prices when an investment is sold.

Investors’ goal is to increase the value of their investments. Capital appreciation is utilised as a financial plan to help people reach their financial goals. Equity stocks, mutual funds, real estate, gold, and other commodities or tradable securities have the potential to appreciate.

For example, When an investor purchases private equity shares of a company at ₹500 per share and the equity price increases to ₹700, the investor gains ₹200 in capital gains. When the investor sells the private equity, the ₹200 received will be considered as a capital gain.

When an investment is sold, the difference between the sale and acquisition prices is used to determine capital appreciation.

These are closed-ended hybrid mutual fund schemes with the primary objective of safeguarding investors’ capital in the event of market downturns. Capital protection funds build portfolios by combining equity and debt investments, with a strong emphasis on debt instruments. Typically, they invest a significant portion, often 80%, of their total investment amount in highly secure debt instruments. The remaining 20% is invested in higher-risk areas, such as equity.

Example: Assume the capital protection fund has a ₹10,000 investment corpus. It invests around ₹8,000 (80%) on debt instruments with a 12% yield for two years. This assures that the debt investment has a maturity value of ₹10,000. The remaining amount ₹2,000 (20%) is invested in equity.

Upon completion of the term, the initial money is retained and grows incrementally through debt instruments. Further benefits are realised through the appreciation of the stock investment, which contributes to the total favourable performance of the portfolio.

Carried interest is a portion of the profits produced by general partners in private equity, venture capital, and hedge funds. Carried interest is due to general partners only if the investment achieves a minimum return known as the hurdle rate. 

It represents the share of profits that fund managers or general partners receive from successful investments made on behalf of the fund’s limited partners (investors). The investments can be made through initial public offerings (IPOs), mergers and acquisitions (M&A), or secondary sales of portfolio firms.

Example: 

Total investment: ₹10,00,000

Hurdle rate: 8%

Final value after all assets have been liquidated:₹14,00,000

GP performance fee: 20%

Since the final fund value exceeds the 8% hurdle rate, the GP is entitled to receive the carried interest.

Total fund profits = Final Value – Total investment

= ₹14,00,000 – ₹10,00,000

= ₹4,00,000

Carried interest   = Total profit * Performance fee

= 4,00,000 * 20%

= ₹80,000

The remaining profits of ₹3,20,000 go to the LPs.

Recovering money that has previously been given to an employee as a result of misconduct or poor work is known as a clawback.

A clawback in the context of private equity enables limited partners to reclaim the general partners’ investment if they get further remuneration. This usually happens when the general partners make excess profits, but then they end up losing money.

It serves as insurance coverage in the event of misconduct or fraud, a decline in business earnings, or subpar work output from employees. Due to its ability to help investors and the general public regain trust in a company or industry, clawbacks are seen as a crucial component of the business model.

Co-investment is the process of individuals pooling their cash to invest in a certain opportunity. This method is frequently used in a variety of private investment sectors, including venture capital, private equity, real estate, and infrastructure. The Limited Partners and the private equity funds invest alongside each other but as separate entities. It allows investors to access investment opportunities that they would not have had otherwise.

Example: Real estate investment trusts (REITs) and institutional investors may collaborate on large-scale real estate projects, such as commercial developments or multifamily residences.

Convertible notes are a type of debt financing. It enables investors to turn their loans into equity in the case of a priced funding round or liquidation event. As it’s a loan, you must repay it upon receiving the funds from the venture capital company or sooner if you choose to do so.

The processes of a convertible note vary according to whether or not the corporation suffers a conversion event. In the absence of a conversion event, the convertible note works as a regular debt instrument, which includes an interest rate and a maturity date.

If the company experiences a conversion event, the original principal amount on the note, plus any interest paid to date, will be included in the total amount converted into equity.

In the private market, a core fund is often a private equity or real estate investment fund. It focuses on purchasing and managing low-risk, stable, income-generating assets with predictable cash flows. It targets investments with moderate but steady expected returns, with capital preservation as a top priority. Such investments often carry a low to moderate amount of risk.

Core money is also defined as the funds that a company requires to continue its operations and essential activities. This type of funding is necessary to cover day-to-day expenses such as employee pay, rent, utilities, and other operational costs.

Core finance offers the financial stability required for a company to continue its daily operations while pursuing its strategic goals. It enables the organisation to manage the complexities of the competitive market, retain a strong presence, and focus on long-term objectives. This strategy eliminates the ongoing concern about short-term financial limits.

Diversification is a strategy that involves combining a wide range of investments in a portfolio to minimise risk. Diversification doesn’t only mean investing in lots of stocks, it can also refer to investing in various asset classes such as commodities, bonds, and alternatives like private equity or investments in different countries.

By obtaining the right mix of assets, investors can theoretically achieve the perfect balance between risk and reward, which means the highest possible return for the least possible risk.

Defensive asset allocation is a financial management strategy that prioritises capital preservation while reducing risk. Many portfolio managers employ defensive investment strategies for risk-averse clients, such as seniors without a steady income.

This strategy often involves allocating a significant portion of the portfolio to assets that are considered more stable or less volatile, such as bonds, cash, or other low-risk investments. The goal of defensive asset allocation is to provide some protection against market downturns and economic hazards while also increasing returns on investment.

Examples are government bonds, gold, dividend-paying stocks, etc.

A down round in the private market is a financing round in which a company raises funds at a lower valuation than the previous funding round. This suggests that the company’s valuation dropped between the two fundraising rounds.

Down rounds often occur when a company encounters obstacles or losses, such as poor performance, market volatility, or shifts in investor perception. Down rounds may result in lower ownership percentages, loss of market trust, and a negative influence on the firm’s morale.

Dry powder refers to cash or marketable securities that are low-risk, highly liquid, and convertible into cash. Dry powder funds are stored in reserve and can be deployed in an emergency.

When a company refers to its dry powder, it means the amount of cash and current assets that can be used to meet working capital requirements. The word is commonly used by venture capitalists, who use dry powder to invest in opportunities as they emerge.

Example: Apollo Global Management is a top global alternative investment manager, with over $455 billion in assets under management. When the pandemic struck in 2020, the market fell, and many businesses struggled to survive, Apollo rapidly deployed its dry powder to invest in distressed companies.

Investors conduct due diligence to assess the risks, prospects, and overall profitability of an investment opportunity. It is a process of examining various aspects of a target company or asset to verify its financial, legal, operational, and strategic attributes before making an investment decision.

Due diligence includes reviewing a company’s finances, analysing them over time, and measuring them against competitors.

An earnout is a condition in a contract that says the seller of a firm will get paid in the future if the company meets specific financial targets.

Since the buyer only pays a fraction of the sale price upfront and the remaining amount is dependent upon future performance, the earnout removes any uncertainty for the buyer. The advantages of future expansion are taken advantage of by the seller.

Example: The seller and acquirer can agree on an initial price of ₹100 million for a business valued at ₹200 million, with the remaining ₹100 million potentially being part of the earnout.

The term “emerging markets” describes economies that are currently experiencing significant economic growth. Although they share some features with developed economies, they are not yet fully developed.

These markets belong to developing nations that are gradually becoming more integrated with global markets as they grow. As a result, they have the potential to increase liquidity in local debt and stock markets, trade volume, and foreign direct investment.

However, emerging market economies are marked by the gradual adoption of reforms and institutions similar to those seen in modern industrialised countries. This boosts economic growth.

Example: Brazil, Russia, India, China, and South Africa have long been among the world’s fastest-growing developing market economies. The BRICS nations’ GDP amounts to 29% of world GDP.

Enterprise Value (EV) is a financial term used in private markets to assess a company’s total value, including stock and debt components. It shows a company’s hypothetical takeover price, indicating what it would cost to purchase the complete organisation, including its financial commitments, if relevant.

EV allows investors and purchasers to negotiate transaction conditions, calculate valuation multiples, and assess the feasibility and attractiveness of potential acquisitions or investments.

Example: If a private equity firm buys a manufacturing company for ₹100 crores and it has ₹20 crores in debt and ₹5 crores in cash.

The Enterprise Value is ₹100 crore + ₹20 crores – ₹5 crore = ₹110 crore.

An exit strategy is a plan developed by the private market fund to sell the investment and realise the profits at the right time. It allows investors to withdraw their capital and it allows the private market funds to complete the investment lifecycle.

Typical exit strategies in the alternative investment space can include secondary sales, mergers and acquisitions, or even IPOs.

The face value, also known as par value or nominal value, indicates the monetary value of a security as declared by the issuer. It denotes the predetermined price at which a company’s stock is initially offered during an Initial Public Offering (IPO), which enables investors to purchase a portion of the company.

Face value is mainly used by investors to calculate financial metrics like earnings per share (EPS), price-to-earnings (P/E) ratio and return on equity. Please note that a security’s face value is not the same as its market value. The latter is determined by the supply and demand in the open market.

Knowing the face value is important to calculate yield and for stock splits and dividends.

Example: Assume you hold 100 shares of stock with a face value of ₹20. If the dividend percentage is 2%, the yearly preferred stock dividend is ₹0.40 per share (2/100 * 20).

A gatekeeper is a person or organisation that controls access to specific investment opportunities or transactions. They already have contacts with several institutional investors.

A key defining characteristic of private markets is that access is frequently limited. Investors must meet certain criteria or have certain links to participate in these transactions.

This is where gatekeepers come in. They act as advisors and help businesses with their investment decisions.

A general partner is one of two or more investors who jointly own a business that is structured as a partnership and who assume a day-to-day role in managing it. The general partner is in charge of managing the fund’s investments and overseeing the whole functioning of the fund. They also have the authority to negotiate transactions and decide on exit strategies for portfolio companies.

It is crucial to point out that, while general partners have more power over the company, they also carry higher personal risk due to their limitless liability. This means that the general partner’s assets can be utilised to pay the partnership’s debts.

Example: Consider a modest legal firm partnership made up of two general partners, A and B. The company has taken out a business loan to expand its office space and buy new equipment. Unfortunately, the firm’s revenue drops unexpectedly due to the economic downturn, and it struggles to make loan payments. If the partnership’s assets are insufficient to fulfil loan payments, the lender may seek repayment from the general partners’ assets.

A hurdle rate is set by a general partner with their offering documents. The hurdle rate is simply the minimal rate of return that a fund must achieve before its general partners (the fund’s managers) can begin to partake in the profits. It serves as a benchmark that must be met before profits are distributed to fund management.

Investors and businesses use hurdle rates to assess an investment or project’s viability. If the predicted rate of return exceeds the hurdle rate, the investment is considered sound. If the rate of return falls below the hurdle rate, management may decide not to proceed.

Example: For example, if an investor’s cost of capital is 8% and the risk premium for a certain investment is 4%, the hurdle rate is 8% + 4% = 12%.

In this situation, the investment fund would need to provide a return of 12% or more to meet the hurdle rate. If the investment offered only a 6% return, the alternative investment fund would not be able to charge any performance fee.

Impact investing is an investment approach that seeks to achieve specific positive social or environmental consequences in addition to financial returns. The aim is to use money and financial resources for positive social outcomes.

Impact investors assess a company’s commitment to corporate social responsibility, or the duty to benefit society as a whole.

Impact investment takes a more comprehensive approach to measuring than typical investing. There are various methods and tools for assessing impact like the United Nations’ Sustainable Development Goals, the Impact Management Project’s five dimensions of impact, and the Global Impact Investing Network’s Impact Reporting and Investment Standards.

Indexing in private markets involves creating benchmark indexes that accurately represent the performance of a specific segment or the entire private market. These indexes can be designed to determine the returns on different types of private market investments, providing investors with a standard to compare their portfolio performance against.

The index reflects the overall performance of the underlying private equity investments. Which includes evaluating the internal rate of return (IRR) or other performance measures for the constituent funds and companies.

Equities, fixed income, real estate, commodities, currencies, and alternative investments like private equity and hedge funds can all be included in an index. However, creating and sustaining indices in private markets may be challenging due to a lack of transparency and standardised reporting when compared to public markets.

The Internal Rate of Return (IRR) is an essential measurement used in private equity to assess the profitability of an investment. It takes into account the time value of money and the cash flow generated by an investment.

The IRR assists investors in determining the minimum acceptable rate of return, known as the hurdle rate, to maximise their returns. It is frequently used to compare various investment options in private markets. It helps to evaluate the performance of individual funds or compare the performance of multiple funds in a portfolio.

A significant issue in the IRR criteria is the assumption that any reinvestments made from positive cash flow must be made at the same internal rate of return.

Internal Rate of Return (IRR) = (Future Value ÷ Present Value)^(1 ÷ Number of Periods) – 1

An institutional investor refers to a firm or organisation that invests money on behalf of its members or clients. These investors are considered more knowledgeable and experienced than retail investors and are often subject to less regulatory oversight. The purchase and sale of large amounts of assets by institutional investors can create supply and demand imbalances and lead to significant changes in asset prices.

There are certain key differences between institutional and retail investors. First is the nature of investment. Institutional investors invest large amounts in a variety of asset classes. Retail investors have limited access to capital and stick to more conventional asset classes.

Second is the method of investment. Retail investors mostly invest through public exchanges. Institutional investors, on the other hand, delve into unlisted assets as well and invest through advisors and wealth managers.

Initial Public Offering (IPO) is the process through which privately held companies sell shares to the general public to raise equity capital from these investors. To make their shares available to the public, private corporations collaborate with investment banks, through extensive marketing, regulatory compliance, and due diligence.

It is challenging to buy shares in an initial public offering (IPO) because big investors, such as banks and hedge funds, typically have priority. Soon after the IPO, common investors can buy shares of a newly public firm.

The term “jobber” refers to individuals or corporations who specialise in buying and selling assets in large quantities to profit from short-term price swings. Jobbers act as intermediaries in the market, providing greater liquidity and facilitating smooth trading.

Jobbers have been prominent in a variety of regions (UK, USA, Netherlands, Japan and France) and time eras, helping to shape and operate global financial markets. Their role as market makers and intermediaries has been critical in maintaining liquidity and efficiency in trading activity.

In private markets, they may participate in secondary transactions involving privately owned securities like venture-backed startup shares or private equity investments. They provide liquidity for investors who wish to buy or sell these securities outside of public markets.

Financial leverage means using borrowed funds to increase assets and generate returns on risk capital. Leverage essentially increases investors’ purchasing power, while companies use it to finance future investments instead of issuing stock.

However, leveraging also increases the risk factor because, if the investment fails, the investor may still be required to repay the borrowed funds.

It’s important to note that leverage use in private markets can be riskier than in public markets because private asset appraisal can be more challenging, and liquidity may be limited.

Example: Assume a corporation invests ₹20,00,000 in cash and takes a ₹1,80,00,000 loan to purchase a new factory worth ₹2 crores. If this new plant makes ₹30,00,000 in annual profit, it employs financial leverage to create that profit on an initial investment of ₹20,00,000.

A limited partner also known as a “silent partner” spends money in exchange for shares in a partnership but has limited voting authority over company activities. They pledge to contribute capital to the fund for a set period. A limited partner is an investor who does not control a firm or its assets in a partnership.

In other words, limited partners provide the capital while general partners decide where to deploy the capital. They have limited liability in the fund, which means their financial risk is often limited to the amount of capital they have agreed to put in the fund. They are not personally liable for the fund’s debts or liabilities other than their capital contributions.

If a legal judgement is entered against the limited partnership, the limited partners lose just the amount of their investment, while general partners are entirely liable for resolving the judgement. Simply put, if the limited partnership cannot meet its obligations, the general partners’ personal assets may be used to do so.

Merchant banks are non-depository financial institutions that focus on offering specialised financial services to private customers or companies.

These banks are unlike any other – they offer private businesses financial services such as private equity, fundraising, advisory services, and business loans. The services offered by merchant banks are limited to businesses and major corporations, not the general public.

Example: Company ABC, established in India, wishes to acquire Company CBA, headquartered in the United States. ABC would hire a merchant bank to help with the procedure. That bank would advise Company ABC on how to structure the transaction and also help ABC with financing.

Mezzanine financing is a type of hybrid financing that combines elements of both equity and debt. It gives the lender the option to convert the debt into equity shares in case of default.

Mezzanine debt is subordinate to senior debt, which means that senior debt holders receive payment first in case of bankruptcy or liquidation. Due to its subordinated status and hybrid nature, mezzanine debt is considered riskier than standard senior debt.

It is commonly used to fund mergers and acquisitions, especially when the acquirer wants to reduce the use of equity capital.

Example: Let’s assume a private equity firm in India plans to acquire a company for ₹700 crores. Instead of using its cash reserve of ₹140 crores, the firm prefers to find a mezzanine investor to contribute ₹105 crores. The lender will provide up to 80% of the funding, or ₹560 crores.

This way, the private equity firm only has to contribute ₹35 crores from its capital to cover the entire acquisition cost.

Net present value (NPV) is an approach to capital budgeting that subtracts the present value of cash inflows from the current value of cash outflows. The net present value (NPV) of a currency unit compares its present value to its future value after taking into account inflation and returns.

The inflation and risk in the NPV calculation are critical for determining the profitability and viability of an investment. Inflation is calculated using a real discount rate, while risk is determined by the project’s riskiness, often based on the required rate of return or cost of capital. In addition, NPV takes into account the time value of money and its associated risks.

A positive NPV indicates an investment’s potential for profitability, while a negative NPV suggests insufficient cash flow to cover the initial investment and desired rate of return. A zero NPV indicates just enough cash flow to meet the initial investment and desired rate of return.

New issues, whether stocks or bonds are a method of raising capital for a business. An IPO is a standard technique of issuing new shares, allowing investors to buy into a previously private company for the first time.

Issuing new shares allows the company to give away shares to employees as part of their remuneration packages. Issuing new shares can also be used to fund acquisitions or strategic alliances.

Example: A startup company looking to expand its operations or create new products may seek funding from venture capital firms. In exchange for investing, the venture capital firm usually receives newly issued shares of the company’s stock.

Operating expenses are the day-to-day costs of running a firm. It comprises the direct costs of goods sold (COGS) and other operating expenses, also known as selling, general, and administrative (SG&A). This includes rent, wages, and other overhead costs, as well as raw materials and maintenance charges. Operating costs do not include financing-related charges such as interest, investments, or foreign currency translation.

Managers will frequently use cost-cutting methods to minimise operational expenses and increase revenue. However, too much cost-cutting can harm a company’s productivity and, as a result, profits. It is very important to maintain a balance and ensure the company’s growth is not being hampered.

Open-ended funds are those in which investors can enter and exit as they see fit. The units can be purchased and sold once the original offering period has ended, and they are valued at the fund’s most recent NAV (Net Asset Value).

Open-ended funds allow continual subscriptions and redemptions. This permits capital to move more freely into and out of the fund, rather than merely at the beginning and end of its life. Often, these funds have no set lifespan and will exist indefinitely. Most mutual funds and hedge funds are open-ended funds.

A pitchbook is a sales document published by an investment bank or corporation. It summarises the firm’s key characteristics and is used by its sales staff to promote products and services and attract new clients.

The main pitchbook gives a general summary of the firm. An investment bank might display statistics such as the number of analysts, previous IPO success, and the number of deals completed each year. For an investment firm, it would include information about the company’s financial strength as well as the numerous resources and services it provides to its clients.

Example: An investment bank is ready to pitch a client interested in renewable energy. The pitchbook’s market research reports and industry analysis help tailor pitches for renewable energy clients.

The Price to Earnings Ratio (P/E Ratio) is a popular ratio that measures the relationship between a company’s stock price and earnings per share (EPS). It helps investors comprehend the value of a firm by reflecting market expectations. The P/E ratio is the price you must pay per unit of current earnings (or future earnings, as the case may be).

A company’s price-to-earnings ratio can be benchmarked against other stocks in the same industry or against the overall market. Investors can use this ratio to determine if a company’s stock price is overvalued or undervalued.

Private placement is the process of selling securities to a small group of investors, usually institutions, accredited investors, or high-net-worth individuals, without making a public offering. It allows businesses to raise funds for expansion without requiring regulatory compliance or public demand, unlike IPOs.

Private placements provide organisations with greater flexibility in defining the offering’s terms, such as pricing, timing, size, and security structure. Companies can tailor the offering to match investors’ requirements and preferences.

Example: ​​ABC Company, a rapidly growing firm that specialises in AI solutions for businesses. They intend to perform a private placement to obtain more funding to fund expansion goals and accelerate product development. For this, they can approach institutional investors and high-net-worth individuals to raise their funds.

Recapitalisation refers to the redesigning of a company’s debt and equity ratios. It is essentially the exchange of one type of funding for another, either debt for equity or equity for debt. The goal of it is to stabilise a company’s capital structure.

A corporation may contemplate recapitalisation for various reasons, including a reduction in its share price, defending against a hostile takeover, or declaring bankruptcy.

Example: In the COVID-19 economic slowdown, United Airlines used a recapitalisation strategy to increase liquidity and survive the crisis. This involved accumulating billions of dollars through commercial debt offerings, equity funding, and government assistance under the CARES Act. This funding line helped United Airlines improve its finances and weather the pandemic’s challenges.

The term risk tolerance means the extent or ability of an investor to bear or sustain a certain level of loss while investing. Those people who have stable or assured income can take risks in high amounts. Hence those people investing in any of the assets, including bonds, must consider the risk tolerance factor at first.

Every investment includes a risk factor, and a person should estimate the level of risk they can take to prepare an investment portfolio accordingly. Generally, the risk is divided into three categories: aggressive, moderate, and conservative, which are assigned to investors depending on the risk tolerance level. Risk tolerance is also dependent on several factors including investors’ time horizon.

An investor’s risk tolerance is influenced by various factors, including their time horizon. For long-term financial goals, higher-risk assets such as equities may be considered for higher returns. On the other hand, cash investments with lower risk may be more appropriate for short-term financial objectives.

Return on Investment (ROI) is a crucial financial performance metric that helps to assess the effectiveness of an investment and compare it to other investments. It is one of the most fundamental concepts in finance and business, which tells investors how much money they can expect to earn in the future if they invest now.

ROI compares the profit or loss of an investment to its initial cost, and it calculates the relative success or failure of an investment.

ROI = Net income / Cost of investment x 100

During the investment realisation phase, the primary focus is on ensuring that the expected benefits and outcomes of the investment are realised. This phase involves monitoring and reporting business performance, as well as ensuring that the investment meets the expectations of investors.

If you decide to sell an investment, such as stocks, bonds, real estate, or other assets, the difference between the selling and buying prices (adjusted for any transaction fees) is known as the realised gain or loss.

Seed capital is the initial sum of money given to an entrepreneur or startup company to assist them in turning an idea, service, or product into a profitable venture. These fundings are provided by private investors usually in exchange for equity.

Because it gives entrepreneurs the financial tools they need to transform their ideas into successful businesses, seed funding is essential to the startup ecosystem.

Sovereign wealth funds in private markets are investments made by government-owned funds in privately held businesses or assets. These funds are typically established by countries with substantial foreign currency reserves or other valuable assets. They invest resources in a variety of ventures, including private equity, venture capital, real estate, infrastructure, and other alternatives.

Example: The Abu Dhabi Investment Authority, one of the world’s largest sovereign wealth funds, handles Abu Dhabi’s surplus oil reserves. ADIA invests in a variety of asset classes, including equity, fixed income, real estate, infrastructure, and private equity. Its substantial assets under control offer it tremendous clout in global financial markets, particularly real estate and infrastructure projects.

SWFs, like all other types of investment funds, have their objectives, risk tolerances, liability matches, and liquidity problems. Certain funds may prioritise profits over liquidity, and the other way around. According to the assets and goals, sovereign wealth funds’ risk management may vary from exceedingly conservative to highly risk-tolerant.

The concept of the time value of money is a crucial financial principle that states that receiving money now is more valuable than getting the same amount of money later. This is because the money you have now can be invested and earn a return, resulting in a larger sum of money in the future.

Companies assess the time value of money when deciding whether to engage in new product development, acquire new business equipment or facilities, or arrange credit terms for product or service sales.

Present Value = Future value/(1+ interest rate )n
Future value = Present value (1 + interest rate)n

Example: You are offered ₹10,000 now or ₹11,000 one year from now. To decide which option is better, evaluate if you can earn more than a 10% return on the money invested over the next year. If yes, take the ₹10,000 now. If not and you trust the payer, take the future payment of ₹11,000.

Underlying assets are the genuine financial assets on which the price of a derivative is based. Thus, the price of the derivative is determined by the underlying price. Any changes in the underlying price will be reflected in the price of its corresponding derivative.

Unlike stock options, which are financial derivatives based on the value of publicly traded stocks, real estate properties represent tangible assets with intrinsic value. Private investors often invest in real estate to diversify their portfolios and potentially earn attractive returns over the long term.

A value-added fund is an investment fund that aims to increase the value of its investments by using tactics other than just buying and holding assets. These funds are typically used for long-term investments that can slowly rise over time. Therefore, investing in a value fund requires diligence and patience.

The theory behind value investing is that the market has inherent inefficiencies that allow certain companies to be sold at prices lower than their true worth. Value fund managers can identify inefficiencies in these markets. As the market corrects these inefficiencies, the value investor benefits from a rise in share price.

Venture capital (VC) is a type of private equity finance that is typically offered to start-ups and early-stage firms. VC is frequently offered to enterprises with strong development potential and revenue creation, resulting in potentially high returns.

This financing is typically funded by affluent investors, investment banks, and specialised venture capital funds. The investment does not have to be financial, it can also take the form of technical or management skills. One disadvantage for the fledgling company is that investors frequently get shares in the company and hence a say in business choices.

The venture capital investment life cycle begins with seed funding for early-stage firms to develop their products or services. As the firm expands, it may attract additional capital through Series A, B, and C rounds. Eventually, investors seek an exit to recoup their investment, which can involve IPOs or acquisitions by larger companies. These exits provide liquidity and return to investors.

Example: Cred, a Bangalore-based finance business, raised $215 million in Series D fundraising in 2021, led by Falcon Edge Capital and Insight Partners. The company provides users with a credit card payment platform as well as a rewards programme.

A warrant is an agreement that grants the right, but not the obligation, to purchase or sell a security, typically equity, before it expires at a specific price. To encourage investors to purchase the security, companies frequently include warrants in share offers.

Private equity investors and the company may be able to create value together through warrants. If the company’s stock price exceeds the exercise price, an investor can profit from the fall in the price of their warrants.

Example: ABC intends to raise money by issuing fresh stock, along with warrants that entitle investors to buy more shares in three years at a fixed price of ₹1,500 each. During the offering, you buy 500 warrants and 1,000 shares. The stock price has increased to ₹2,000 per share after two years. You purchase 500 more shares at the set price when you exercise their warrants, making a profit of ₹500 on the freshly issued shares.

Working capital is used to determine a company’s efficiency in the short term. It is calculated by subtracting current liabilities from current assets and is shown on the balance sheet.

The purpose of having working capital is to fund operations, meet short-term obligations, and maintain enough capital to continue functioning. Even when faced with cash flow issues, a company must still pay its employees and suppliers to meet its other commitments such as taxes and interest payments.

It is crucial because it enables businesses to remain solvent. Even if a business is profitable, it can fail. After all, a business cannot rely on paper profits to pay its debts; those bills must be paid in cash on hand.

Example: A company has accrued ₹5 crore in retained earnings from past years. If the company invests all ₹5 crore at once, it may find itself with inadequate current assets to cover its current liabilities.

Yield is an investor’s cash flow from an investment. It is generally computed annually, quarterly, or monthly. It calculates the amount of income earned from the purchase price using a percentage.

Yield is a straightforward indicator for evaluating an investment’s success over time. It enables investors to examine several investment options and determine which ones produce the highest returns.

Example: If an investor purchases a bond for ₹1,000 and earns ₹50 in interest over the first year, their yield is 5%.

There are different types of yield such as:

• Current Yield: A bond’s current yield is an investment’s annual income, containing interest and dividend payments, divided by the security’s present price.
• Annual Yield: It is the annual return that an investor anticipates to receive throughout the bond’s period to maturity.
• Yield to Maturity: The total expected return on a bond if it is kept until its maturity date is known as yield to maturity.

Zero-coupon bonds are debt securities that do not pay interest but trade at a deep discount, yielding a profit at maturity. The difference between the purchase price of a zero-coupon bond and its par value represents the investor’s return.

Example: A ₹10,000 face value zero-coupon bond might be issued for ₹8,000.

Since no interest payments are made, the yield reflects the annualised rate of return if held until maturity. The price of a zero-coupon bond is impacted by current interest rates, time to maturity, and credit risk.