Chapter 19 – Organization, Compensation, Regulation and Limited Partners
Q1. What is a difference between the organizational structure of private equity funds
and hedge funds?
A. Private equity funds are organized as closed-end funds whereas hedge funds are
Q2. What are similarities and differences in the compensation structure for private
equity funds and hedge funds?
A. Both generally charge a 2% management fee, although with private equity funds,
the balance the 2% is calculated on may change in the later years of the fund.
Q3. What are the primary exit strategies considered by private equity firms?
A. At the end of the investment holding period, private equity firms will consider an
Q4. Discuss whether or not the tax rates applicable to private equity firms should be
changed?
A. Open ended question. Students should touch on the difference between the 20%
tax rate on carried interest and the higher ordinary income tax rates and
Q5. In the U.S., what provisions have private equity funds historically relied on to avoid
registration with the SEC? How has the Dodd-Frank Act changed regulation of
private equity funds?
A. Investment Company Act of 1940 – Section 3(c)(1) – funds held exclusively by
100 or less beneficial owners and are not offered publicly; Section 3(c)(7) – funds
held exclusively by qualified purchasers and are not offered publicly. Investment
Advisors Act of 1940 – Section 203(b)(3) – advisors with less than 15 clients (in
Q6. Why is there a secondary market for private equity funds, but not hedge funds?
A. The close-end nature of private equity funds means that limited partners
(investors) cannot withdraw their fund until the fund is terminated (hedge fund
Q7. Based on HCA buyout Exhibits in Chapter 19, calculate the value of the financial
sponsors’ equity stake in HCA, based on FASB 157’s fair value determination
requirements. Assume HCA’s EBITDA dropped by 20% from its LTM EBITDA at the
time of the transaction, no debt has been paid down, and valuation multiples have
decreased to 6.5x.
A. $4.1 billion EBITDA * (1 – 20%) = $3.28 billion EBITDA. $3.28 x 6.5 = $21.32