L2. VC
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.
10
average life of VC funds
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
harvesting
finally, the GP is responsible for harvesting the investment to provide a return to the LPs.
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
due diligence
investor verifies entrepreneur's claims. tedious process including intense technology evaluation, contacting of customers, suppliers, competitors and competitors' customers.
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
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 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
management fee
waterfall of payment: 1. payment of _____ _____ to GP
investment
waterfall of payment: 2. return of LP ________
preferential return
waterfall of payment: 3. sometimes _____ _______ of e.g. 4% to the LPs
portion
waterfall of payment: 4. carried interest _______ corresponding to the preferential return of LPs is paid to GP
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.