Free CFA Level III: Private Markets GP & Investor Perspectives Practice Questions

C is correct. In a management buyout, the existing management team acquires the company (or a controlling interest) from the PE fund, often using leverage or financing from banks, mezzanine lenders, or other PE sponsors. MBOs are used when strategic or financial buyers are not available, or when management has strong conviction in the business and wants to continue operating it independently.

B is incorrect. Replacing management is an operational initiative, not an exit route. An MBO involves the current management becoming owners, not being replaced.

A is incorrect. An MBO involves a genuine change of ownership — the management team becomes equity owners. Bonus payments without ownership transfer would be a management incentive plan, not a buyout.

A is correct. The GP catch-up is a waterfall provision that directs distributions to the GP at an accelerated rate after LPs have received their preferred return, until the GP's cumulative share equals their carried interest percentage of total profits. For example, with a 100% catch-up, the GP receives 100% of distributions after the preferred return is paid until the GP has received 20% of cumulative profits. This ensures the GP eventually receives their full 20% share of all profits, not just profits above the preferred return.

B is incorrect. There is no standard provision requiring GPs to invest additional capital based on performance. The GP's commitment is fixed at the time of fundraising.

C is incorrect. The catch-up applies to the GP's share, not to accelerating LP preferred returns. The preferred return flows to LPs first as a standard waterfall step.

A is correct. This combination provides the strongest alignment: (1) A 5% GP commitment puts substantial GP capital at risk alongside LPs. (2) A European waterfall ensures carry is earned only on whole-fund performance. (3) A 30% clawback escrow provides security that excess carry can be recovered if the fund's final performance does not justify it. (4) A key-person provision protects LPs if senior investment professionals leave the firm.

B is incorrect. This combination provides the weakest alignment: a minimal GP commitment, deal-by-deal carry that can front-load GP compensation, no clawback security, and no key-person protection. LPs bear significantly more agency risk.

B is incorrect. While a 3% GP commitment is reasonable, an American waterfall with a 100% catch-up and no clawback allows the GP to receive carry on profitable deals even if the fund overall underperforms, with no mechanism to recover excess carry from loss-making deals.