The Private Equity Cash Flow Model 2020

David B. Perkins, CAIA Thomas P. Riegert, CFA The Private Equity Cash Flow Model As discussed, early in a fund’s life cycle, contributions to the fund by LPs exceed distributions as the manager makes new investments (see the below chart for a hypothetical cash flow pattern). When the manager identifies an investment, a “capital call” is sent to the LPs that have made commitments to the fund. As the fund matures and the manager exits investments, the fund makes distributions to investors. In this case, distributions to LPs overtake contributions in Year 4, and LPs recoup all called capital between Year 6 and Year 7. Distributions in Year 7 through Year 10 are all profits to the LPs.

hypothetical private equity fund j-curve*

$1M $1M

■ Contributions 750K 750K ■ Distributions Cumulative Net Cash Flows 500K 500K Cash Flow

250K 250K Cash Flow

0 0

–250K –250K

–500K –500K Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

Source: Hatteras Investment Partners. The chart shown above is for illustrative purposes and does not represent past or future performance for an actual product. There is no guarantee performance will match this illustration.

the private equity cash flow model / hatteras investment partners 2 hypothetical private equity fund cash flows: assumes $1m committed, 2.0x return on capital

in-the- portfolio year called distributed unrealized ground allocation multiple capital capital gains exposure %

1 $200,000 $— $— $180,000 3.60 0.90

2 275,000 50,000 40,000 425,000 8.50 1.00

3 200,000 75,000 80,000 610,000 12.20 1.09

4 150,000 200,000 120,000 660,000 13.20 1.19

5 125,000 300,000 225,000 690,000 13.80 1.38

6 50,000 300,000 280,000 700,000 14.00 1.63

7 — 400,000 170,000 450,000 9.00 1.78

8 — 300,000 145,000 275,000 5.50 1.90

9 — 275,000 100,000 80,000 1.60 1.98

10 — 100,000 40,000 — 0.00 2.00

total $1,000,000 $2,000,000 2.00x

Source: Hatteras Investment Partners; This is a hypothetical example not meant to predict cash flows of any specific security. The example illustrates a $1M commitment resulting in a 2x return on committed capital over a 10 year period. The example further illustrates the J-curve effect in which contributions in the early years exceed distributions. In the later years as portfolio companies mature and exits occur, distributions may exceed contributions. Not all private equity funds will be profitable given the inherent risks of investing in private equity, including the performance of underlying portfolio companies. The illustration does not represent performance of any Hatteras Investment Partners security and there can be no assurance that any Hatteras Investment Partners security will achieve the performance of the hypothetical example. For performance of the Hatteras Investment Partners, please call 866.388.6292.

Private Equity Exposure Private Equity Exposure is Often Hard to Obtain is Hard to Maintain If the private equity target allocation is 20% of a $5,000,000 As private equity funds create value, they distribute cash portfolio, or a $1,000,000 private equity allocation, this expo- proceeds back to investors. Therefore, the investors’ exposure sure is very difficult to obtain. Private equity funds call capital to private equity declines as cash distributions are returned over a period of three to six years. A commitment of $1,000,00 to the investor. As demonstrated in the Private Equity Cash to a single fund or single vintage year may only result in Flow Model, the maximum In-the-Ground Exposure peaks $200,000 being called during the first 12 months. After the at 14.00% in Year 6, and is reduced each year as realizations management fee of 2% on the total committed capital of are distributed, and by the end of year 10, it reaches zero. $1,000,000 or $20,000, the net “In-the-Ground Exposure” Making the investment self-liquidating. This is very much in is only $180,000 or 3.6%. As you can see from the cash flow contrast to an investment in a mutual fund which allows for model above, after three years, the In-the-Ground Exposure the reinvestment of gains and dividends. As the mutual fund is only 12.20%. increases in value, it retains the gains at the fund level and thus, an investor’s exposure to the investment increases.

the private equity cash flow model / hatteras investment partners 3 private equity program: a self-funding solution

A private equity program is a long-term model that continu- As the private equity industry has matured, innovative ally commits to new private funds each vintage year to structuring has helped investors manage cashflows and auto- maintain consistent exposure to the asset class. Such a pro- matically reinvest their distributions. These so-called “ever- gram has the ability to become “self-funding”, as the older green” private equity funds—which can invest in primary vintages start harvesting and distributing capital. These distri- funds, secondary funds, or directly into co-investments and butions can provide funding for the new vintage funds’ capital direct investments—enable investors to maintain their target calls. At some point the capital calls are being fully funded allocations and not find themselves in a self-liquidating, by distributions and can generate significant excess cashflow. traditional private equity investment. The potential advantage We believe a private equity program is the “secret sauce” for to a new investor is control over the amount and timing of private equity investing. capital deployed, and they can gain their private equity target allocation with a single investment. Private equity programs have been commonly implemented by larger institutional investors and family offices for decades. Investors new to private equity face many barriers to entry including operational complexity, size of required capital commitment, and the time and patience needed to establish the model.

Private Equity Program Evergreen Private Equity Fund • Requires time and patience to fully establish • Ability to immediately gain and maintain target allocation • Long-term model • Control over the amount and timing of capital deployed • Annual commitment strategy • Self-funding • Self-funding • Ability to reinvest distributions • Ability to gain and maintain target allocation • Ability to continuously invest across vintages

the private equity cash flow model / hatteras investment partners 4 1 Handbook of Alternative Investments, Second Edition; Anson, Mark J.P. 2006 ii Guynn, Jessica (June 17, 2008). “LinkedIn networks way to $53-million investment.” The Los Angeles Times. http://www.latimes.com/ business/ la-fi-linkedin18-2008jun18,0,6631759.story. Retrieved April 11, 2012 http://finance.yahoo.com/q?s=LNKD. Retrieved April 11, 2012 Weidig, Tom and Pierre-Yves Mathonet, The Risk Profiles of Private Equity: Private equity is a risky asset, but private equity investments are not necessarily so, January 2004

Please carefully consider the investment objectives, risks, and charges and expenses of the Funds before investing. Please read the Prospectus carefully before investing as it contains important information on the investment objectives, composition, fees, charges and expenses, risks, suitability, and tax obligations of investing in the Funds. Copies of the Prospectus and performance data current to the most recent month-end may be obtained online at hatterasfunds.com or by contacting Hatteras at 866.388.6292. Past performance does not guarantee future results. Safe Harbor and Forward-Looking Statements Disclosure: The opinions expressed are subject to change without notice. This material has been prepared or is distributed solely for informational purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. The opinions discussed are solely those of Hatteras and may contain certain forward-looking statements about the factors that may affect the performance of the illustrative examples in the future. These statements are based on Hatteras’ predictions and expectations concerning certain future events and their expected impact, such as performance of the economy as a whole and of specific industry sectors, changes in the levels of interest rates, the impact of developing world events, and other factors that may influence the future performance of the illustrative examples. Hatteras believes these forward-looking statements to be reasonable, although they are inherently uncertain and difficult to predict. Actual events may cause adjustments in portfolio management strategies from those currently expected to be employed. It is intended solely for the use of the person to whom it is given and may not be reproduced or distributed to any other person. The information and statistics in this report are from sources believed to be reliable, but are not warranted by Hatteras to be accurate or complete. Private equity funds are speculative investments and are not suitable for all investors, nor do they represent a complete investment program. Private equity funds invest substantially all of its assets in investments that are generally not registered as investment companies under the 1940 Act and, therefore, do not have the benefit of various protections provided under the 1940 Act with respect to an investment in such privateequity investments. Investments in private equity funds involve a high degree of risk, including the complete loss of capital. Private equity funds provide limited liquidity. General Risks, Special Risks and Investment-Related Risks of the private equity funds include, but are not limited to, Limited Liquidity, Reporting Requirements, Non-Listed Status of Units, Non-Diversified Status, Legal, Tax and Regulatory Risks, Underlying Portfolio Funds Not Registered, Portfolio Funds Generally Non-Diversified, Valuation of Portfolio Funds, Multiple Levels of Fees and Expenses, Portfolio Fund Managers Invest Independently, Portfolio Fund Operations Not Transparent, Concentration of Investments, Derivative Instruments, Distressed Investments, Valuation of Illiquid Securities and Derivative Positions, Unspecified Investments, Leverage, Risks of Capital Call Failures, and Limited Selectivity of Investments. The success of a private equity fund is highly dependent on the financial and managerial expertise of its principals and key personnel of the fund’s investment managers. Although the investment managers for the fund expect to receive detailed information from each private equity investment on a regular basis regarding its valuation, investment performance, and strategy, in most cases the investment managers have little or no means of independently verifying this information. The underlying private equity investments are not required to provide transpar- ency with respect to their respective investments. By investing in the private equity investments indirectly through fund of funds, investors will be subject to a dual layer of fees, both at the fund and the underlying private equity fund levels. Hatteras Investment Partners are offered by Hatteras Capital Distributors, LLC, member of FINRA/ SIPC.

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