Private Equity Investment

Private Equity Investment Entrepreneurship in the Credit Crunch How do Entrepreneurs Raise Funds to start a Business? • Bootstrapping – Self Financing – credit cards, savings, personal debt – Vendor Financing – inventory, payables, receivables – Bank Financing – revolvers, balance sheet, lines of credit – Family and Friends – loans, common stock, partnerships Social Networking to startups • Microfinance and Microcredit • http://www.nytimes.com/2005/12/22/busine ss/22sbiz.html?pagewanted=2&_r=1 • http://www.kiva.org/ How do Entrepreneurs Raise Funds to start a Business? • Public Sector – SBIR, SBA, DARPA, Earmarks? – Grants, loan guarantees, contracts • Venture Investors (VIs) – Angels – high net worth individuals and families – Venture Capitalists – professional investment fund managers – Corporate Capitalists – strategic investment fund managers Who are Venture Investors? • Angel Investors – Have made money doing something else – Typically invest close to home and expertise • Venture Capitalists – Paid to generate above-market returns – Typically invest with a particular stage, market, return in mind • Corporate Capitalists – Paid to generate returns and corporate synergy – Typically have a very narrow industry or technology focus Who are Venture Investors? • All three have common characteristics – Build portfolios of deals over a long period of time – Have established and use clear selection criteria – Have developed a process for sourcing, evaluating and valuing – Are subject to market pressures that affect their perception of risk/return Who are These People? • Angel Investors – Typically invest $10,000 to $250,000 – Make as many as one hundred times as many investments as VCs – Are much more likely to invest in seed and early stage deals – Are much more likely to syndicate or share deals with others • Venture Capitalists – – – – Typically invest $1MM to $10MM Are much more likely to invest in early to late stage deals Are much less likely to syndicate (Until recently) In 1999 There were approximately 600 firms in the United States • About 3800 investment professionals • With $134B under management • Making approximately 7000 new or follow-on investments Why Venture Capital? • New companies – limited operating history – too small to raise capital in the public markets – too risky/immature to secure a bank loan or complete a debt offering. • In exchange for the high risk, VCs get significant control over company decisions and a significant portion of the company's ownership and eventual value. • VCs take companies for 3-5 years and liquidate investments to reinvest in others. What Do VIs Consider? • Sourcing • Negotiating – how do I find quality – how do I negotiate opportunities? terms, valuation, control? • Evaluating • Supporting – what makes a good deal good? – what do I commit besides money? • Valuing • Harvesting – what’s it worth? – how do I make • Structuring money? – who owns what? who control what? VC History • 1400’s: Chris and Isabella • Pre 1939: angels, government, families (Rockefeller/Mellon) • The Glass-Steagall Act, also known as the Banking Act of 1933 (48 Stat. 162), was passed by Congress in 1933 and prohibits commercial banks from engaging in the investment business. – It was enacted as an emergency response to the failure of nearly 5,000 banks during the Great Depression. • 1939: Venture Capital is first used as a term at a banker convention • 1946: First VC funds launched with the vision to institutionalize risk capital and the investment process and invest in people – JH Whitney: Minute Maid – ARD, General George Doriot: Digital Equipment Corporation General George Doriot • ARD’s most successful investment – In 1960, when it gave $70,000 to a young researcher who used it to start the Digital Equipment Corporation. – Only 12 years later, the computer manufacturer had grown from three employees to 7,000. • ''Always remember that someone, somewhere, is making a product that will make your product obsolete.” • “A history of profits is much more important in the long run than a profit in any one year.” • 1956: Thermo Electron launches first “incubator” – George Hatsopoulos (MIT engineering professor) founded Thermo Electron in 1956 because he wanted to create a company that would foster innovation and allow outstanding engineers, scientists and entrepreneurs to apply technology to emerging societal needs. – strategy of spinning out one public company after another23 in all – Current strategy of Thermo Electron- buy up other companies. VC History (Continued) • 1958: SBIC act passed: loan guarantees/low interest loans Small Business Investment Companies. • 1965: less than $100M in new ventures • Late 1960’s: Bull IPO market – Pinnacle: DEC, a 1958 investment of $70K from ARD proved model can work • 77% ownership, $350M market cap in 1970, ARD owned 10% • Early 1970’s: First crash: minis and semi conductors – Largest fund: $80 million from Chicago State Street (insurance) VC History (Continued) • Mid 1970’s: No IPO’s – 7 year slump • Late 1970’s: The turnaround begins – 49% cap gains slashed to 28% – Removal of stock option taxes – Prudent man rules – prevents pension funds from investing – Small business Investment Incentive Act – pension funds as limited partners • 1980: VC’s raised and invested less than $600 million – Family money largest source VC History (Continued) • 1983: Second VC Crash – painful but shorter • Result of excesses of pc run up and too much money • But venture captial was strategically important • 1988: VC’s raised and invested $3.7 billion • Early 1990’s: A different scene, an IPO boom – Only 3.3% of funds were going into early stage deals – Pension investments = 50% of VC money VC History (Continued) • 1993: Biotech bust • Late 1990’s: VC’s raised= $26 billion – The pinnacle: 1999 new Investments: $48 billion – 41% into early stage (50% of all funded companies) Y2K The Dot Com Crash VC History (Continued) • What type of deals Post-Dot.Com: – Internet? Web 2.0 • http://www.youtube.com/watch?v=6gmP4nk0EOE – Software (games, applications)? – Applied Materials? – Healthcare? – Biotech? – Green? – Energy? Gramm-Leach-Bliley Act: 1999 • 90:8 vote in Senate with Bipartisan support • Allowance of banking, securities and insurance activities within the same holding company system. • Created a new kind of bank holding company, called a "financial holding company," with authority to engage not only in activities that are "closely related to banking" but more broadly in any activity that the Fed determines to be "financial in nature or incidental to such financial activity" or that the Fed determines is "complementary to financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally." Gramm-Leach-Bliley Act: 1999 • In defining certain activities that are "financial in nature," the Act sets out specific conditions for merchant banking or venture capital activities. Financial Holding Companies • FHC is authorized to take, through a securities affiliate equity positions in any company, provided: – the position is part of a bona fide underwriting or merchant or investment banking activity, including investment activities engaged in for the purpose of appreciation and ultimate resale or disposition of the investment. – the position is held for a period of time to enable the sale or disposition thereof on a reasonable basis consistent with the financial viability of the activities of the underwriting or merchant or investment banking activity being engaged in and – during the period such position is held, the bank holding company does not routinely manage or operate such company or entity except as may be necessary to obtain a reasonable return on investment upon resale or disposition. Gramm-Leach-Bliley Act • “at all times that a financial holding company is engaged in such activities, all of its depository institution subsidiaries must be well managed and well capitalized. In addition, as a condition to commencing any new activity, all depository institutions subsidiaries must have at least a "satisfactory" CRA rating.” Gramm-Leach-Bliley Act • “The point of Gramm-Leach-Bliley was to tear down the wall, built by Glass-Steagall, separating banks that did risky investing from those that did basic lending. (The mingling of those two helped create a cascade of bank failures during the Depression.) Thus were born Citigroup, Bank of America and J. P. Morgan Chase, behemoths that owned bank branches, bought and sold stocks and shepherded corporate mergers.” New York Times 9/28/2008 Gramm-Leach-Bliley Act and Credit Meltdown • The first fatalities were firms that didn’t change all that much in the wake of Gramm-Leach-Bliley. • Bear Stearns and Lehman Brothers were both classic investment banks. • Problems with Financial “products.” – Financial firms chopped bad mortgages into thousands of little pieces and deluded themselves into thinking that the sum of the parts was safer than the whole. – Hedge funds and insurance Commodity Futures Modernization Act 2000 • Phil Gramm also co-sponsored this legislation, passed at the end of Clinton administration • Products offered by banking institutions would not be regulated as futures contracts • Contributes to the current crisis by unleashed the derivatives market and paved the way for banks to become more aggressive about investing in mortgages. • “Enron Loophole” • Subsequent meltdown of Enron and other companies like WorldCom because of accounting fraud • The act specifically banned regulation of credit default swaps. These unregulated instruments, insurance policies against default on risky investments like mortgage backed securities Lessons of the Credit Crisis Problem- People sold these, revalued them and sold them again and again. The Employee Retirement Income Security Act (ERISA) • Applied a revised and restated version of the prudent man rule to pension and profit sharing portfolios. • ERISA requires that a fiduciary manage a portfolio 'with the care, skill, prudence, and diligence, under the circumstances then prevailing, that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.' • Safe to ask, how prudent were some of these investments? Investing in Canned Goods • Some sites referred to this as humor • Yesterday, Campbell's stock only one to go up. State of VC Market Today? • Increasing interest in Angel Investors • How risky are new concrete businesses vs. Wall Street? Sourcing and Screening Investment Model Deal Filter Due Diligence Markets Stage Management Markets Products Detail Review Deal Terms and Structure Likely Outcome: Fewer Deals Investment Model Deal Filter Due Diligence Deal Remember “If you can dream it, you can do it” -- Walt Disney Disneyland was built in 366 days.