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Venture Capital Yale University Investments Office Professor Sandeep Dahiya Georgetown

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Venture Capital Yale University Investments Office Professor Sandeep Dahiya Georgetown Powered By Docstoc
					Yale University Investments
          Office
    Professor Sandeep Dahiya
      Georgetown University
                      Road Map
• Last Class
  – VC Fund structure introduction (Fixed Life, GP, LP,
    compensation etc.)
  – What do VCs do
  – VC Cycle
• Today’s Class
  – View of a prominent LP
  – Role of VC investments in Broader portfolio management of LPs
  – Trends in Private Equity
• Tomorrow’s Class
  – ACCEL VII CASE HOME WORK
  – Start on VC method of Valuation
        ONSET Ventures
• What Happened?
                     Some Basics
• How is return of a fund measured?
• Consider a fund that raised 100 million – Drew down 50 million at
  start of year 1 and Year 2. Distributed 100 million at the end of year
  7 and 80 million at the end of year 10.
  0     1     2     3      4     5     6      7      8     9      10



-50     -50                                 100                   80

                  IRR=7.87%          Multiple 1.8x       What if 100 was
• What is distribution?                                  distributed at the
                                                         end of Year 5
• How does the VC get paid?                              instead of Year 7?
• What about funds that are only a few years old?
      Yale Investment Office
• Some Background Facts
  – How and why is the endowment important for
    Yale?
  – How has the Investment Office done under
    Swensen?
         A Clear Philosophy
• Focus on Equities--public or private.
• Avoiding market timing.
• Focus on inefficient markets.
• Pick investment managers rather than
  investments.
• Focus on incentives.
           Asset Allocation at Yale
                    1985                   2006

           YALE   PEERS    ALL    YALE   PEERS    ALL


Domestic   61.6   51.5     46.1   11.6   24.5     45.8
Equity

Foreign    6.3    2.0      0.8    14.6   17.4     12.7
Equity
Bonds      10.3   26.4     30.6   3.8    16.2     21.5

Cash       10.1   10.8     14.5   2.5    1.1      3.5

Real       8.5    4.8      4.2    27.8   10.7     3.9
Assets
Private    3.2    2.7      0.7    16.4   9.3      2.4
Equity
Absolute   0.0    1.8      3.1    23.3   20.7     8.7
Return
           Asset Allocation at Yale
                    1985                   2006

           YALE   PEERS    ALL    YALE   PEERS    ALL


Domestic   61.6   51.5     46.1   11.6   24.5     45.8
Equity

Foreign    6.3    2.0      0.8    14.6   17.4     12.7
Equity
Bonds      10.3   26.4     30.6   3.8    16.2     21.5

Cash       10.1   10.8     14.5   2.5    1.1      3.5

Real       8.5    4.8      4.2    27.8   10.7     3.9
Assets
Private    3.2    2.7      0.7    16.4   9.3      2.4
Equity
Absolute   0.0    1.8      3.1    23.3   20.7     8.7
Return
  Private Equity is an Important
            Element
• Investor since 1973.
• Repeated investments in partnerships
  formed by a select group of organizations.
• Emphasis on value-added strategies.
• Focus on incentives.
Spectacular Success in Private
            Equity
• 31% over 29 years--well above
  benchmarks.
• Success in venture capital, buyouts, and
  oil & gas.
• Prestige investor.
      But Worries About Future
• Recent fund influx:
  –   Private pension funds in 1980s.
  –   Public pension funds in 1990s.
  –   Private equity pool--from $4B in 1980 to
      ~$300B in 2004.
  –   ―Virtual overhang.‖
     Private Equity Fundraising
Billions of 2002 $s   Source: Venture Economics and Asset Alternatives.

    150
   125

   100                                                     Other
                                                           Buyout
    75
                                                           Venture
    50
    25
     0
    46
    51
    56
    61
    66
    71
    76
    81
    86
    91
    96
    01
  19
  19
  19
  19
  19
  19
  19
  19
  19
  19
  19
  20
               Private Equity Returns
         Source: Venture Economics

                                                                Venture Capital
125%

100%

75%
                                             Buyouts
50%

25%

 0%
       1974   1976 1978   1980 1982   1984   1986 1988   1990   1992 1994   1996 1998   2000   2002


-25%
      Implications of Fund Influx
•   Alteration in incentives.
•   Relaxation of covenants.
•   Concerns about within-fund compensation.
•   Quality of deals.
                      But ...
• Good returns during last fund influx.
• Inter-quartile spreads:
  –   3% in public equities.
  –   12% in private equity.
• Private equity small relative to potential:
  $1:$30.
                   But…. (2)
• Ways to manage risks:
  – Top down: Optimizer.
    • Drove decision to undertake major hedging effort
      in 1999.
  – Bottom up: What—in Swensen’s team’s
    judgment—are the interesting areas going
    forward?
    • Swensen: Must use both approaches!
       – Need for communication and trust with Investment
         Committee.
Challenge of Internationalization
• 10% of Yale’s private equity, mostly
  Europe.
• Poorer returns.
• Organizational worries and difficulties of
  assessment.
• Who to back?
         Swensen’s Dilemma
• Is private equity still viable for Yale?
  – If so, where?
  – If not, what other asset classes should they
    pursue?
• How far can it go in pursuit of returns?
• How dangerous is it to be different?
    Yale Investment Office 2006
•   Domestic Equity 12%, Bonds 4%!!!
•   Private Equity 17%
•   Real Assets 27%
•   Beat S&P500 in every year since 2002 by
    Wide margins!! Endowment size $18
    billion
  How Are VCs Compensated?
• Management Fee – (Little risk)
  – Like Salary
  – What are the incentives' for GP?
  – Why 2% (Usually) of ―Committed Capital‖
• Carried Interest – (Performance Based)
  – Like bonus
  – How to measure performance?
  – Can this cause problems?
• Let us look at an example
                Key Ventures
• Size is $250 million, life 10 years
• Management Fee 2% collected at start of each
  year. (2%x250 = 5 million each year)
• Investment Capital = 250-10x5= 200
• Assume 4 equal take downs (200/4=50)
• Assume gross return is 25%
• 10% of portfolio value is distributed every year
  starting in Year 4 (end of year).
• No carry till the entire 250 million is returned to
  investors
   Key Ventures
                                                                    Year 8 Cum Distribution = 231.2
                                                                    Year 9 first 18.8 (250-231.2) go to LPs
                                                                    Rest 46.1 (64.9-18.8) shared 80/20


Year                                          0       1        2        3        4       5       6        9       10
Management Fee                                5       5        5        5        5       5       5        5        0
Investment                                50.00   50.00    50.00    50.00      0.0     0.0     0.0      0.0      0.0
Estimated Portfolio Value                  50.0   112.5    190.6    288.3    360.4   405.4   456.1    649.4    730.5
Distributions                               0.0     0.0      0.0      0.0     36.0    40.5    45.6     64.9    730.5
Cumulative Distributions                    0.0     0.0      0.0      0.0     36.0    76.6   122.2    296.1   1026.7
Distribution to Key                         0.0     0.0      0.0      0.0      0.0     0.0     0.0      9.2    146.1
Cumulative Distributions to Key             0.0     0.0      0.0      0.0      0.0     0.0     0.0      9.2    155.3
Distribution to LPs                         0.0     0.0      0.0      0.0     36.0    40.5    45.6     55.7    584.4
Cumulative Distributions to LPs             0.0     0.0      0.0      0.0     36.0    76.6   122.2    286.9    871.3
Portfolio value after capital returned     50.0   112.5    190.6    288.3    324.3   364.9   410.5    584.4      0.0
Contributed Capital                        55.0   110.0    165.0    220.0    225.0   230.0   235.0    250.0    250.0
Invested Capital                           50.0   100.0    150.0    200.0    200.0   200.0   200.0    200.0    200.0
Cash Flow to Key Ventures                   5.0     5.0      5.0      5.0      5.0     5.0     5.0     14.2    146.1
NPV for Key Ventures                         82
Cash Flow to LPs                         -55.00   -55.00   -55.00   -55.00   31.04   35.54   40.61    50.71   584.43




         What effect would having a 25% carry but
         management fee only for the first 4 years have?
                 Key Ventures – Full Analysis

Year                                              0        1        2        3        4        5        6        7        8        9        10
Managem ent Fee                                   5        5        5        5        5        5        5        5        5        5         0
Investm ent                                   50.00    50.00    50.00    50.00      0.0      0.0      0.0      0.0      0.0      0.0       0.0
Estim ated Portfolio Value                    50.00   112.50   190.63   288.28   360.35   405.40   456.07   513.08   577.21   649.37    730.54
Distribution for the year                      0.00     0.00     0.00     0.00    36.04    40.54    45.61    51.31    57.72    64.94    730.54
Cum ulative Distributions                      0.00     0.00     0.00     0.00    36.04    76.57   122.18   173.49   231.21   296.15   1026.68
Distribution to Key Ventures                   0.00     0.00     0.00     0.00     0.00     0.00     0.00     0.00     0.00     9.23    146.11
Cum ulative Distributions to Key Ventures      0.00     0.00     0.00     0.00     0.00     0.00     0.00     0.00     0.00     9.23    155.34
Distribution to LPs                            0.00     0.00     0.00     0.00    36.04    40.54    45.61    51.31    57.72    55.71    584.43
Cum ulative Distributions to LPs               0.00     0.00     0.00     0.00    36.04    76.57   122.18   173.49   231.21   286.92    871.35
Portfolio value after capital returned        50.00   112.50   190.63   288.28   324.32   364.86   410.46   461.77   519.49   584.43      0.00
Contributed Capital                           55.00   110.00   165.00   220.00   225.00   230.00   235.00   240.00   245.00   250.00    250.00
Invested Capital                              50.00   100.00   150.00   200.00   200.00   200.00   200.00   200.00   200.00   200.00    200.00
Cash Flow to Key Ventures                      5.00     5.00     5.00     5.00     5.00     5.00     5.00     5.00     5.00    14.23    146.11
NPV for Key Ventures at 12% discount Rate     82.01
Cash Flow to LPs                             -55.00   -55.00   -55.00   -55.00    31.04    35.54    40.61    46.31    52.72    50.71    584.43
IRR for LPs                                 20.14%

				
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