L2. VC

10

average life of VC funds

harvesting

finally, the GP is responsible for harvesting the investment to provide a return to the LPs.

due diligence

investor verifies entrepreneur's claims. tedious process including intense technology evaluation, contacting of customers, suppliers, competitors and competitors' customers.

1mio-1bn

size of VC funds

managing and operation

small fraction of invested capital is used each year to cover managing and operation costs.

management buy-out

stage: - enables a business to acquire existing products and or services from another public or private company

management fee

waterfall of payment: 1. payment of _____ _____ to GP

portion

waterfall of payment: 4. carried interest _______ corresponding to the preferential return of LPs is paid to GP

Hardyman & Lerner (1999)

(people) features in VC financing: - preferred stock - covenants and superiority agreements - vesting of founder, management, and key employee shares (non-forfeitable rights over employer- provides stock incentives)

Hellman & Puri (2002)

(people) investigated the role that VCs play in building new companies. they use a combination of survey data, interview data, commercial databases, and publicly available data. They found that VCs provide support function by: - formulating human resources policies - adopting stock option plans - hiring of vice presidents of sales and marketing - replacing founder with an outsider in the position of the CEO

limited partners

-pension plans, life insurance companies, endowments, corporations, individuals. 99% of the capital. Get 70-80% capital appreciation

general partner

1.5-3% of limited committed capital plus a share of profits after limited partners have recovered their initial investment

closing

= a legal process in which the commitments are used to define an ownership group. Each investor's commitment is conditional on the fund generating sufficient commitments from other investors to reach minimum total for ______

letter of intent

= an interim step between initial negotiations and formal financing agreements. They are not always used. The are rarely legally binding in total, bust should not be taken lightly! Seek advice before signing anything, some clauses are legally binding! such as prohibiting MGMT form seeking financing elsewhere for a period of time.

covenant

= contractual agreement between investor and venture. Describes conditions which must be met prior to closing

superiority agreement

= corporate amendment requiring large majority (67-90%) of shareholders to approve important changes, such as a merger

term sheet

= funding offer from the VC firm to the entrepreneur. It specifies the terms and conditions of the offer to fund, often in great detail, It typically encompasses: - allocation of CF rights - board rights - voting rights - liquidation right - other control right

conversion rights

= right to convert preferred stock to common stock at any time. Procedure and schedule can vary

affirmative covenants

= specify what the entrepreneur MUST do. - producing audited reports - holding regular board meetings - payment of taxes

negative covenants

= specify what the entrepreneur cannot do: - disposal of assets - increase risk profile - preferential treatment of friends.

anti-dilution provisions

= such as a right to retain ownership share or a full/partial ratchet provision, and conditions under which the provision would not apply, such as conversion of the preferred stock.

vesting

= the entrepreneur gains full ownership of shares - only after working with firm for a period of time - after some value accretion event occurs - time period: proportionally over specified time period (quarterly) - motivation: reward for perfomrance and protection of employee morale (golden handcuffs)

vintage year

= the year the first capital call/first investment is made. usually takes 2-3 years before fund is fully invested.

terminal values, simplification, implied

CONS of VC method: - relies on ____ ____ derived fro other methods - over ______ by using very high discount rate - derives ______ pre- and post-investment valuations rather than actual valuation.

minimum total

Each investor's commitment is conditional on the fund generating sufficient commitments from other investors to reach ______ ______ for closing

negotiates

GP ________ the terms for investing. Sometimes commits human capital to portfolio firms.

portfolio investment

GP makes capital calls only when there are immediately attractive _____ ______ opportunities. Several capital calls are made through the fund's life.

99

LPs provide __% of the fund's capital

simple, professionals

PROS of VC method: ______ and quick to use, used by VC ________

risk equity

VC can be defined broadly as the investment b professional investors of long-term, _____ ______ finance where the primary reward is an eventual gain rather than interest income or dividend yield.

private equity

VC is a popular form of _____ _______, i.e. an investment in equity that is nit traded on an organised exchange.

private investments

VC limited partnership agreement: BY GENERAL PARTNER: AGENCY ISSUES

future raising

VC limited partnership agreement: ____ ____ of capital by GP: terms and conditions

dissolve the partnership

VC limited partnership agreement: ability to _____ ___ _____ e.g. in case of poor performance

exit

VC limited partnership agreement: acquisition, IPO

management fee

VC limited partnership agreement: annual fee of 1.5-3%

addition of GPs

VC limited partnership agreement: approval of majority of LPs

re-investment of profits

VC limited partnership agreement: avoiding distribution.

allocation of profit and loss

VC limited partnership agreement: between general partner and LPa

maximum investment

VC limited partnership agreement: in a single company

payment of subscription

VC limited partnership agreement: investors must provide a specified amount of capital at the time of closing.

purpose

VC limited partnership agreement: it defines the fund's investment guidelines

use of debt

VC limited partnership agreement: limitation in leverage.

involvement of LP

VC limited partnership agreement: representation of the fund's advisory board

minimum for closing

VC limited partnership agreement: specifies dollar commitment that must be received before initial closing.

term

VC limited partnership agreement: usually 10 years, with options to extend under certain conditions which permit orderly liquidation of investments.

multiple

VC method step 1: estimate firm's value in some future year. calculate terminal value using some _______.

terminal value

VC method step 2 calculate discounted _____ ______

final ownership

VC method step 3: calculate required _____ percent _______ = Investment/DTV

current ownership

VC method step 4: calculate required ______ % _____ = RFPO/Retention ratio.

confidentiality

VCs almost never sign ______ agreements, if you don't trust them, don't start the process.

syndication

______ of investment = when VC fund co-invetss in ventures. Typically for any given venture, one fund is lead investor and the others are co-investors. Lead: highest level of direct involvement, likely to serve on the board of directors. Is a reciprocal, ongoing , informal relationship in which VC funds tend to collaborate by taking turns serving as lead investors or co-investors, pool HR

common shares

are almost never issues to VCs as the outset: they offer no rights or control and could create a taxable event for employees if shares were later issued to them at a cost lower than the per share price paid by the VC firm.

convertible debentures

are sometimes favoured in high risk transactions: - the investor can receive additional protection as a creditor - it also gives the company a tax deduction for interest paid.

individual investors

con of LP: In US, most _____ ______ are foreclosed to invest directly in VC partnership by SEC rules

subscription agreement

each LP's commitment is formalised in a _____ _______. actual investments are not made until the fund's closing

limited partnerships

funds usually are _____ _______: - general partner: 1.5-3% - lmdt partners

screens opportunities

general partner ____ ______ based on quality and compatibility with his capabilities and with timing of the fund's capital flows.

screens

general partner: _____ opportunities

harvests

general partner: ________ investments

deal flow

general partner: generates ____ _____

deals

general partner: negotiates ______

preferred shares

generally offer the greatest protection to investors, especially if anti-dilutionrights are included

portfolio companies

get investment capital & effort, give back the financial claims. value creation

2-3

harvesting usually takes __-__ years. the long window allows DP to time the exit in light of market conditions and company-specific factors.

initial investments

if and when these investments are harvested, the returns are distributed to LPs, first to repay their _____ ______, with the capital gain being shared between LPs and GP. (70/30, 80/20)

administering

in addition to identifying the few ventures that have some potential for success, the investor must be able to add enough value to the deals to cover the extra costs of ________ the fund's investment portfolio, including the return on the VC's commitment of effort

reputation

is everything

general partner

is the fund organiser and is responsible for raising investment capital from the limited partners, and deploying the capital raised by investing in portfolio companies.

venture capital

is the investment by professional investors in long-term, risk equity finance where the primary reward is an eventual gain rather than interest income or dividend yield.

financial claims

most of the capital is invested in portfolio companies in exchange for _____ _____ on the companies.

several funds

one VC may oversee _____ ______ Optimal fund size depends on both economic and social factors.

market discipline

pro of LP: the limited partnership structure solves many of the managerial problems that can arise. Because investors can participate in multiple funds and can diversify otherwise, the GP is free to concentrate on opportunities in which the partner's expertise adds the most value. the finite life of a VS fund subjects the GP to ongoing ______ ________

40%

professional managers replace more than half of founding entrepreneurs. In ___% founder retains a position in the company

marketing

raising the capital for a VC fund is a costly endeavour. The GP commits a substantial amount of time _______ the fund to prospective investors and to managing relations with existing investors. Reporting, valuations, status reports are often required by institutional investors.

waterfall

returns to LPs and GP follow a progression: 1. payment of MGMT fee 2. return of LP's investment 3. sometimes a preferential return, e.g. 4% to LPs. 4. carried interest portion to the GP corresponding to the LP's preferential return 5. remaining portion of capital gain due to the LPs. 6. GP's remaining carried interest

management buy-in

stage: - enables a manager or group of managers from outside the company to buy-in to the company

expansion (development stage)

stage: - established - requires capital for growth - may or may not have made profits - rapid growth - usually requires several rounds of capital to meet milestones of the business plan

startup (early growth)

stage: -currently being set up - may have been in business for a short time - usually, products have not yet been sold commercially - has little or no track record

effort, 1

the GP's primary contribution to the fund is ______. Also normally commits __% of the fund's capital.

negotiation

the initial term sheet is an offer subject to ______

asset by asset

the waterfall distributions are often handled ____ __ _____ (otherwise investors have to wait 10 years)

2-3

usually takes __-__ years before fund is fully invested.

seed stage

ver early stage. - in the process of being organised - needs capital for R&D usually funded by an entrepreneur

investment

waterfall of payment: 2. return of LP ________

preferential return

waterfall of payment: 3. sometimes _____ _______ of e.g. 4% to the LPs

capital gain

waterfall of payment: 5. Remaining portion of _____ ____ due to the LPs

carried interests

waterfall of payment: 6. GP gets remaining _____ ______

capital call

when the closing occurs, the GP can make an initial _____ _____ on the investors, and then the investors have short time (30d) to deliver the funds.

debt securities

with warrants offer similar advantages to convertible debt.