Venture Capital

lean startup

a philosophy that emphasizes speed as a way to maximize IRR

j-curve

a startup company almost always has negative profits and cash flow in its early years

alternate forms of financing

1. crowdfunding 2. small business administration loans

small business administration loans

govt organization lends $ to startups

limited parters

investors- downside is limited, less upside

lean startup: collects feedback from the market and make adjustments to the product or its marketing as necessary

keep improving the market and reintroducing improved versions

problems with crowdfunding

strangers can cause problems like intellectual property theft

dilution effects which investors the most

the earliest investors

carried interest

the money general partners take of the limited partners capital gains

Dilution

the reduction of ownership (and upside) cause by each new round of investment in a company

Difference between venture capital and private equity funds: successes vs failures

venture cap funds usually make most of their money from a small number of investments-->most investments fail private equity funds have a smaller number of failures, and a higher % of successful investments

Difference between venture capital and private equity funds: type of business invested in

venture cap invests in startup companies private equity invests in more mature businesses

Difference between venture capital and private equity funds: types of securities used

venture cap usually uses convertible preferred or convertible debt private equity usually uses common stock or convertible preferred

general partners

venture capital firm-downside is unlimited, more upside

Key factors in venture capital investing: management

1. Are they competent? 2. what is their track record? previous successful startups make it much easier to raise capital 3. do they have the right mix of skills? finance/accounting, technology, sales/marketing, leadership 4. does their strategy make sense? 5. are their goals and vision congruent with yours? are they truly committed to the company? what is their vision for the company? 6. how easy are they to work with? do they get along with eachother and the board? 7. do they need mentorship or connections that a venture capital firm or angel investor can provide

bank debt

1. almost always secure by assets 2. often requires personal guarantees 3. most restrictive form of capital 4. reduces the amount of equity dilution

causes of dilution

1. angel investors 2. venture capital investors 3. employee stock options 4. new shares sold to the public in the IPO

restrictions cause by the existing capital structure

1. anti-dilution provisions 2. valuation caps 3. debt covenants 4. secured debt

forms of debt financing

1. bank debt (term loan, revolving credit facility) 2. convertible debt

Key factors in venture capital investing: exit

1. can the business become large enough to do an IPO? how quickly? would is be attractive to public equity investors? 2. is the company something that a strategic buyer would want to buy? 3. are there any barriers to exit? regulatory approvals, strategic partners, conflicting goals between management and investors

forms of equity financing

1. common equity 2. convertible preferred 3. common stock options

mix of skills management needs

1. finance/accounting 2. technology 3. sales/marketing 4. leadership

angel capital

1. funds supplied by wealthy inviduals

form of investments made by venture capital funds

1. convertible preferred stock 2. convertible debt 3. common stock (not used as frequently)

venture capital funds

1. funds that invest in startup companies-->often specialize by type of investment (early state, growth stage) or industry (biotech, green energy, social media, etc) 2. money is raised from wealthy families, pension funds, endowments and other institutional investors 3. funds usually have a defined lifespan (10 years is the most common)-->the fund is liquidated at the end of its life 4. funds invest in a large number of companies to achieve diversification 5. venture capital funds seek a minimum return of 25-30% 6. the fund seeks to exit its investments through IPOs or sales of the businesses

Key factors in venture capital investing: market

1. how big is it? regional national or global? 2. who are the existing players? how strong are they? 3. how quickly is it growing? 4. how cyclical is it? 5. what are the barriers to entry? 6. what tare the keys to success in the market? technology, price, service, distribution, marketing, etc. 7. how regulated is it? 8. are there any near-term threats to the market? technology, regulations and laws, net entrants, changing consumer tastes

Key factors in venture capital investing: scalability

1. how quickly can the business grow? 2. can the existing management team manage the process? 3. what additional resources will be required? manufacturing capacity, capital expenditures, sales people, administrative personnell

funding stages for a startup company

1. initial capital from founders 2. angel capital 3. early stage venture capital 4. growth stage venture capital 5. exit

exit

1. initial public offering 2. sale of part or all of the company

Key factors in venture capital investing: intellectual property

1. is the intellectual property protected with patents, etc? not only in the US, but other countries 2. does it infringe on someone elses patent

lean startup: market analysis

1. is there a need for the product? 2. if the market isnt there, then dont proceed

lean startup: get a product to market as quickly as possible

1. it doesnt have to be perfect 2. gets revenues flowing as quickly as possible 3. provides a chance to get quicker feedback from the market and from customers 4. holds down product development costs and the need for capital 5. makes it tougher for new competitors to beat you to the market

lean startup: if the product is not selling and you are not growing, then pivot

1. make a significant change to the product or some other aspect of the business based on customer feedback 2. collect new feedback after the change has been made

what additional resources will be required

1. manufacturing capacity-capital expenditures 2. salespeople 3. administrative personnell

funds invest in a large number of companies to achieve diversification

1. minimum investment size per company is usually >$1 million 2. most of the funds return is made from a small nubmer of very successful investments 4. most f the funds investments fail

timeline of a venture capital funds life

1. most funds have a defined life-around 10 years 2. the first five years are spent finding opportunities sand making investments 3. the last five years are focused on exiting from investments through IPOs and sales of portfolio companies

common stock options

1. often given to employees as an incentive to join a risky startup company 2. often require the employees to stay with the company for a minimum period of time ("vesting period") until before they can be exercised

convertible preferred

1. often used by venture capital firms 2. senior to the common equity-->hedges downside risk if the company isnt as successful as hoped 3. can be converted into common (usually in conjunction with an exit event)

initial capital from founders

1. personal savings 2. credit card debt 3. often supplemented with moey from friends and family

are there any barriers to exit?

1. regulatory approvals 2. strategic partners 3. conflicting goals between management and investors

responsibilities of the venture capital firms

1. sets up the fund and decides what types of investments that it will make 2. raises the money for the fund from investors 3. analyzes potential investments and performs due diligence on them 4 performs valuation analyses on potential investments 5. leads the negotiations with regard to each investment 6. usually has at least one board seat at each of the companies in which it invests

common equity

1. simplest type 2. usually the form of the investments by the founder and their friends and family

steps to lean startup

1. start with market analysis 2. get a product to market as quickly as possible 3. collect feedback from the market and make adjustments to the product or its marketing as necessary 4. if the product is not selling and you are not growing, then pivot

what are the keys to a successful market?

1. technology 2. price 3. services 4. distribution 5. marketing

are there any near term threats to the market?

1. technology 2. regulations and laws 3. new entrants 4. changing consumer tastest

Key factors in venture capital investing

1. the existing capital structure 2. management 3. product/service offered by the startup company 4. intellectual property 5. market 6. scalability 7. exit

economics of a venture capital fund

1. the general partner receives an annual fee (1-2%) for their work 2. the general partner also receives a capital gains on the $ they have invested in the fund 3. the capital gains on the $ invested by the limited partners is split between the general partners and limited partners (general usually 15-20%; limited keep 80-85%) 4. tax treatment (annual fees are ordinary income; capital gains and carried interest are taxed as capital gains)

why negative profits in early years

1. upfront costs of equipment and initial supplies 2. operating loses incurred before revenues ramp up ("cash burn")

structure of a venture capital fund

1. usuallyset up as a partnership 2. the venture capital firm serves as general partner they have unlimited liability and also get a larger share of the upside 3. the other investors serve as limited partners-downside is limited, usually have less upside that a genral partner 4. usually has a set lifespan-around 10 years

angel investors

1. wealthy individuals who provide early-stage funding (usually more thank $1 million) 2. can be common equity, convertible preferred or convertible debt 3. often are retired successful entrepreneurs who has sold companies 4. can provide valuable connections and advice 5. often want some degree of input into the business

Key factors in venture capital investing: the existing capital structure

1. what forms of capital are already in place? 2. who owns the equity? What is their track record? Do they have board seats? are they easy to get along with? 3. how much debt and what are its terms?

Key factors in venture capital investing: product/service offered by the startup company

1. what is it? 2. does it fill a need in the market? 3. where is it in its development cycle? how much additional investment is required? are there any engineering/technological problems that need to be overcome? 4. will it disrupt an existing market? 5. how long is the product life cycle? short product cycles are less profitable to invest in

convertible debt

1.debt that can be converted into common equity 2. often used by angel investors and venture cap firms 3. conversion usually happens at the time of an exit event (IPO or sale of the company)

crowdfunding

1.money raised from strangers through a website 2. people providing the money arent permitted to get equity-->usually get some other benefit instead (free products, etc)

Difference between venture capital and private equity funds: timing

venture capital funds often hold for at least 3-5 years private equity funds usually try to exit their investments within 1-3 years

Difference between venture capital and private equity funds: minimum IRR

venture capital funds usually want a larger IRR form their investments than private equity funds do-->venture capital funds are investing in riskier businesses