Venture_Capital

Understanding Venture Capital•Stock Funds•Bond Funds•Hedge Funds•Private Equity•VC•LBO•OtherWhere Does VC Fit in the Financial Cosmos?•Pension Funds•Wealthy Families•University Endowments•Foundations•OthersFund of Funds•Entrepreneurs trying to start a business•Entrepreneurs trying to buy a businessPublic marketsSources of CapitalUsers of CapitalMoney ManagersWithin VC Asset ClassSeed /IncubationEarly StageLate Stage /MezzanineMulti-StageOr by …•Industry•TechnologyWhat Is The Point?•Raise money•Invest it•Give back lots more than we took in•RepeatWhy Do It?•Oh, yeah, we keep some for ourselves•Management fees –2-2.5% per year•Profits interest: 20-30%Really, Why Do It?•Spend all your time on the cutting edge•Meet very interesting people•Change the world•New challenge every day•Can be very lucrativeExactly What Do We Do?•Raise money•Make investments•Monitor investments•Exit investmentsExamples•COMPAQ•CIENA•Citrix SystemsWhat Does VC Mean to an Institutional Investor?•Illiquid•Takedown over time•Very long gestation•Series of pools, or “funds”•Part of small allocation (5-10%) to “alternative assets”Institutional Investor Perspective•VC firm is just a money manager with multiple funds•Difference:–Stock fund money manager –different funds by strategy–VC fund money manager –different funds by vintageExample: Sevin Rosen Funds•Early stage technology -constant•Multiple funds–Fund I (1981) -$25 million–Funds II (1983) through VII (1999)–Fund VIII (2000) -$600 millionWhat is a Fund?•Legally: a limited partnership•Characteristics:–Committed capital–Term–Takedown schedule–Investment restrictions–Lots moreObjective•Make ninvestments over 1styyears of the fund•Exit those investments in the 10-12 year term at a profitWhat is y?•Usually target 2-1/2 to 4 years•Less –too much time raising funds•More –LPs want chance to re-up more often than that•Sometimes miss the targetWhat is n?•Balance: diversification vs. focus and impact•Inverse of targeted $ per deal (d)•dis over the life of the deal–Typically 1stinvestment is 30-40% of expected dHow to Set Fund Size•Function of:–$ per deal (d) –physics of companies–# of GP equivalents–Companies /GP•Steady state board capacity•Turnover rateObjective Revisited –Make Money for LPs and GP•Measure success over 10-12 years•Metrics: IRR or cash-on-cash over the life of the fund•Looking to juice “returns” over public equity (15-20+% vs. 12-15%)•Spoiled in the boom with 100%+ IRRsObjective Revisited –Make Money for LPs and GP•Given 10 year life, we need to make a multiple of the fund:10 year IRR7 year IRR2x7.2%10.4%3x11.6%17.0%4x14.9%21.9%5x17.5%25.8%8x23.1%34.6%10x25.9%38.9%And That’s Not All•Layer on top of that:–Historical batting average -.500, plus or minus•So 5x the fund means 10x on the deals that work•On averageSo, What Really Happens?FUND I36.2x20.9x9.6x11.0x10.4x6.3x7.9x9.0x3.2x-10.00.010.020.030.040.050.060.0Capital Invested (in $mm)Capital Returned (in $mm)Fund I = $19.6MM Total returned$180.6MM9.2x CCTotal invested$18.3MM93.4% of CCFUND II----------------42.6x14.7x19.4x9.1x4.1x3.0x5.6x2.1x3.1x3.8x4.0x3.9x0.8x1.8x1.2x0.8x0.3x-10.00.010.020.030.040.050.060.0Capital Invested (in $mm)Capital Returned (in $mm)Fund II = $60.6MMTotal returned$223.0MM3.7x CCTotal invested$53.68MM88.6% of CCFUND III--------------------39.3x50.8x4.2x3.5x2.1x3.5x1.9x0.6x1.9x1.0x0.1x2.5x(10.00)-10.0020.0030.0040.0050.0060.0070.0080.0090.00100.00110.00120.00130.00140.00150.00Capital Invested (in $mm)Capital Returned (in $mm)Fund III = $65MMTotal returned$266.3MM4.1x CCTotal invested$69.4MM106.8% of CCFUND IV1.0x0.4x0.2x1.3x3.2x3.4x3.2x8.4x19.6x11.3x13.1x138.5x(10.00)-10.0020.0030.0040.0050.0060.0070.0080.00Capital Invested (in $mm)Capital Returned (in $mm)590.00Fund IV = $65MMTotal returned$826MM12.5x CCTotal invested$66.3MM102% of CCFund IFund IVFund IIIFund IISo, What Really Happens?•Fund I –9.2x overall–2 @20-40x; 3 @10x; .529 avg.•Fund II –3.7x overall–2 @20-40x; 2 @10-15x; .560 avg.•Fund III –4.1x overall–2 @40-50x; .409 avg.•Fund IV –12.5x overall–1 @140x; 3 @10-20x; .526 avg.Practical Impact•Capital invested matters•Valuation matters•VCs are sluggers, not looking for infield singles and walks•Focus on potential winners•Cents on dollar in bad deals not worth muchHow Do We Manage Such a Process?•Deal making –very hard because:–Usually invest before market is clear–Feedback loop very long (and expensive)–Success (and failure) has large luck component•Success in other venues no guarantee•Like sailing blindfoldedWho Are Deal Makers?•Each firm has deal makers of varying experience–General partner, managing director, etc.–Partner, principal, etc.–Associate, more or less senior–AnalystsKey Role -General Partner•Make investment decisions–Initial investment is most important•Help each company be as successful as it can be•Sometimes less is more•Help others apprenticeHerding Cats•Very different models–Cowboy confederation model–Consensus models–Joe Blow Ventures –either you’re Joe or you’re not•Lots of blends of these•Explains a lot of behaviorHow We Make Decisions•Slowly (these days)–Due diligence hell•Some never tell you no•The role of partners meetings•Type of investment matters–New investments–Follow-on investmentsHow we get paid•Depends on the model•Management fee–% of committed capital–Imagine 10 year revenue visibility•Profits interest (carry)–Helps if there are profitsWhat Breaks Down?•Management fee–Role of multiple funds•Carry–Fund by fund–Sharing philosophyWait –What Happens When Fund is Fully Invested•You raise another fund•You don’tMulti-fund Firms•Series of partnerships every 2-4 years•Generally don’t overlap portfolios•Crossover investing is big issue•Know what fund you are in, and the rules•Amplifies the management fee issueWhat Can Go Wrong –New Investments?•Unseen scar tissue•Bad chemistry•Bad hair day•Misjudge the DMU•Ego crowdingWhat Can Go Wrong –Existing Portfolio Companies?•The living dead syndrome•Chronic fatigue syndrome, VC style•No money left problem•Partner on the roof problem•With some firms, “it’s in their nature”•GP overload –drive-by board meetingsWhat Can Go Right?•Well established firm•Capital access –direct and referrals•GP –operating and domain experience•Other resources•Know your partner