Advanced Topics in Finance: (Venture Capital, Private Equity, and

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Advanced Topics in Finance: (Venture Capital, Private Equity, and

  1. 1. Recent Trends in Finance (GSM-687) PROFESSOR: Manohar Singh OFFICE: AGSM 307 PHONE: 503-370-6225 OFFICE HOURS: 1.30 PM to 3.30 PM Tuesdays and Thursdays MEETING HOURS: 6.30 PM to 9.10 PM Tuesdays MEETING VENUE: Room 301 TEXTS AND COURSE MATERIALS A. Required Text: The Venture Capital Cycle, 2nd edition, Paul Gompers and Josh Lerner, MIT Press, 2004, ISBN 0-262-07255-6. B. A course packet containing a set of case studies and supplemental readings will be used in this course. The course packet will be made available by the instructor. C. An excellent source of information on venture capital and private equity industry is www.altassets.net. In addition, the official site of the National Venture Capital Association-- www.nvca.org --provides a wealth of information on current issues and the trends in the field. COURSE DESCRIPTION The course is aimed at providing an overview of the workings of private equity--including venture capital—organizations and entrepreneurial ventures. From the perspective of private equity organizations, the course considers topics like organizing a venture capital partnership and raising capital; structuring deal flow; evaluating investment opportunities; valuing, structuring, and negotiating investments; monitoring performance and governance systems of ventures financed; and exit strategies. From the perspective of entrepreneurial ventures seeking private funding, the main emphasis would be on the project valuation, capital budgeting, and capital raising strategy and management of the relationship with investors. COURSE OBJECTIVE The goal of the course is to equip students with conceptual knowledge and relevant analytical tools for them to be able to make investment decisions in highly uncertain private equity markets and to structure the terms of investments within venture capital industry settings. The aim of the course is for the students to develop an understanding of the issues like, how private equity funds are raised, structured, and financed; contracting in private equity markets; valuation of private equity interests; sources of capital for private companies and entrepreneurial ventures; strategies for value creation; and venture exit strategies.
  2. 2. CAREER TRACK The course is aimed at students, who plan to follow career options involving private equity/venture capital industry, and investment management or become successful entrepreneurs through start-up of their own. COURSE STRUCTURE The course is structured as a series of 4 modules. Each module contains a set of readings covering theoretical and conceptual frameworks and one or more cases exercises. The first module provides “Venture Capitalist’s Perspective” and examines how private equity funds are raised and their finances and organizational forms structured, and implications thereof for the entrepreneurial firms. The second module provides “Entrepreneur’s Perspective” and examines development of business propositions to seek private funding and the interactions between private equity investors and venture capitalists on the one hand and the entrepreneurs they finance on the other. The third module studies various options and the process through which venture capitalists exit their investments. The fourth and final module provides a re-cap of the course and covers special topics involving study of angel investing, publicly traded investment companies, international private equity, and trends in the industry. LEARNING OUTCOMES At the completion of the course the students will have developed a capability to accomplish the following; • Develop a comprehensive analytical framework for planning a business for capitalization: o Explain the structure and mechanisms of private equity industry and markets. o Evaluate the objectives, motivations, and limitations facing venture capitalists. o Quantify value implications of various financing alternatives. o Conduct financial analysis of private equity transactions from the private equity investor as well as entrepreneurial perspective. • Explain how venture capital funds are managed, evaluated, and funded: o Evaluate portfolio management strategies and understand fund operations. o Analyze different approaches to fund evaluation by investors. o Explain the process of fund formation and capital raising. o Evaluate structure and terms of venture capital limited partnerships. • Be able to conduct valuation of the business ventures: o Use venture due diligence process as a guide to planning a venture.
  3. 3. o Apply various valuation methodologies to privately held companies. o Conduct comparative evaluation and valuation of business plans and models. o Apply well accepted finance concepts like risk-return trade-off, cost of capital, capital structure, equity risk premium, and CAPM framework to evaluate project proposals. • Be able to structure investment transactions: o To be able to utilize forecasting tools to quantify capital needs. o Structure and evaluate sequential investment rounds. o Demonstrate knowledge of the term sheet negotiation process and term sheet documentation. o Conceptualize, explain, and evaluate investment instruments and financing structures. • From the entrepreneurial perspective be able to negotiate with investors pre- and post-deal structuring: o Apply fundamentals of investor compensation in high-risk ventures. o Identify and resolve conflicting issues in the entrepreneur/investor relationship. • Analyze various exit strategies and their implications for investors and entrepreneurs: o Identify variety of exit modes -especially IPO process and buyout options. o Review implications of exit modes and strategies for investors as well as for entrepreneurs. • Identify alternative sources of capital, namely, angel financing, small business investment companies, and alliances. • Explain the global and domestic trends in, and the role of, corporate venture capital, especially in comparisons to venture capital limited partnerships. STUDENT RESPONSIBILITIES Each student should come to class prepared to discuss the assigned material. I strongly recommend that the students read the relevant text/material prior to every lecture. I will expect students to actively participate in the class proceedings. Part of your final assessment will be based on participation in the class discussions. You should also be conversant with current venture industry news from The Wall Street Journal as they relate to course topics and be prepared to discuss them in the class. I strongly recommend regular attendance in the class. Part of the participation grade will reflect how regularly a student has been attending the classes. Academic dishonesty will be dealt with in accordance with the Willamette University provisions. Headphone and cell phone use in the classroom is prohibited.
  4. 4. GRADING 1. Midterm Exam (Take Home) 25% 2. Group Presentations (Project-2) 40% (20% Each) 3. Final Exam (Take Home) 25% 4. Class Participation 10% GRADE DISTRIBUTION (%): > 90.5 A 87.5 - 90.49 A- 84.5 - 87.49 B+ 81.5 - 84.49 B 78.5 - 81.49 B- 70.5 - 78.49 C <70.49 F
  5. 5. Course Time line: Class 1-(8/30): Overview of the Course General Overview of the course: a. Course objectives b. Classroom processes c. Grading scheme d. Introductions by students Class 2-(9/6): Functioning of Venture Capital Industry and its Role in the Economy Readings: 1. “A Note on the Venture Capital Industry”-Kenney 2. “The Economics of the Private Equity Market”- Federal Reserve 3. “Chapter 1: The Venture Capital Cycle” - Text 4. “Venture Impact 2004: Venture Capital Benefits to the U.S. Economy” – Global Insight Class 3-(9/13): Raising and Structuring VC Funds-1 Readings: 1. “Chapters 2 and 3: The Venture Capital Cycle” -Text 2. “Note on Private Equity Partnership Agreements,” -Lerner et al Case: “JAFCO American Ventures, Inc.: Building a Venture Capital Firm,” - Kuemmerle et al Class 4-(9/20): Raising and Structuring VC Funds-2 Readings: “Chapters 4 and 5: The Venture Capital Cycle” -Text Case: “Yale University Investment Office-2003,” -Lerner et al Class 5-(9/27): Valuation and Investing Readings: 1. “Note on Valuation in Private Equity Settings,” - Lerner et al 2. “Chapters 7 and 8: The Venture Capital Cycle” -Text Class 6-(10/4): Venture Capital Investing Readings: 1. “Note on Private Equity Securities,” -Lerner et al 2. “Chapters 9 and 11: The Venture Capital Cycle” - Text Case: “Adams Capital Management: March 2002” -Hardymon et al Class 7-(10/11): Evaluation of a Business Model and Due Diligence
  6. 6. Reading: “A Note on Due Diligence in Venture Capital,” -Tuck School of Business Cases: 1. “How Venture Capitalists Evaluate Potential Venture Opportunities,” Roberts et al 2. “Valhalla Partners: Due Diligence,”- Sahlman et al Class 8-(10/18): Transaction Structuring and Term Sheet Negotiations Readings: 1. “Anatomy of a Term Sheet: Venture Capital: An Overview of Trends, Strategies, and Structural Issues,” - Andrew J. Sherman 2. “Note on Anti-dilution Provisions: Typology and a Numerical Example,”- Kuemmerle et al Case: “Term Sheet Negotiations for Trendsetter, Inc.,” Kuemmerle et al Class 9-(10/25): Contracts, Negotiations, and VC Monitoring Reading: 1. “Chapters 10: The Venture Capital Cycle” -Text 2. “Venture Capital Contracts: A Survey of the Recent Literature,” -Andrea Schertler Case: “Venture Capital Negotiations: VC vs. Entrepreneur,” -Robinson et al Class 10-(11/1): Student Project Presentations-1 (Entrepreneurial Perspective) Class 11-(11/8): Exit Strategies-1 Readings: 1. “Chapters 14 and 15: The Venture Capital Cycle” -Text 2. “A Note on IPO Process,” -Lerner Case: “United Parcel Service’s IPO,” - Healey et al Class 12-(11/15): Exit Strategies-2 Readings: “Chapters 18 and 19: The Venture Capital Cycle” -Text Case: “The Exxel Group: March 2001,” -Lerner et al Class 13-(11/22): Special Topics-1: Readings: “A Note on Corporate Venture Capital,” -Lerner et al Case: “Intel 64 Fund,” -Hardymon et al Class 14-(11/29): Special Topics-2:
  7. 7. Readings: “A Note on Angel Investing,” -Roberts et al Class 15-12/6: Student Project Presentations-2 (VC –Perspective) Groups Exercises: The class will be grouped into small teams to conduct role-play exercises. The goal of the group exercises is for the students to learn to prepare and present business proposition (as entrepreneur) and to be able to evaluate a business investment opportunity (as VC). All students will be assigned to either an entrepreneurial team or a venture capital group. In the first group project, entrepreneurial groups’ students will prepare and defend a business proposal and term sheet to seek funding from venture capitalist students’ group. Students in the Venture capitalist groups will critically evaluate that business proposal and decide on investing in that business. In the second project, the groups will switch roles so that the students gain dual -- VC and Entrepreneurial -- perspective and skills. The details of the business scenarios and the logistics of the process will be provided during the first session.
  8. 8. Description of the Cases Included in the Course JAFCO American Ventures: Building a Venture Capital Firm: (HBS: 9-899-099) Description: The case describes the second attempt at entry of JAFCO, a large Japanese venture capital firm, into the U.S. venture capital market. The U.S. subsidiary, JAFCO America Ventures, is in the midst of a challenging turnaround. Going forward, the U.S. subsidiary's leadership needs to make a number of important decisions regarding investment focus, deal flow generation, compensation, and cooperation with the Japanese parent company. Aim: Introduction to venture capital operations, strategy and focus of venture capital firms, and managing global private equity firms. Subjects Covered: Asia, Compensation, Entrepreneurial finance, Entrepreneurship, Foreign investment, Incentives, International business, International entrepreneurial finance, International finance, International operations, Japan, Motivation, Venture capital. Yale University Investments Office: June 2003: (HBS: 9-204-055) Description: The Yale Investments Office must decide whether to continue to allocate the bulk of the university's endowment to illiquid investments--hedge funds, private equity, real estate, and so forth. The case considers the risks and benefits of a different asset allocation strategy. It highlights the choice between different subclasses, e.g., between venture capital and leveraged buyout funds. Aim: To introduce students to asset allocation, as well as, the perspective of limited partners. Subjects Covered: Asset allocation, Asset management, Assets, Balance sheets, Business education, Colleges & universities, Corporate strategy, Entrepreneurial finance, Finance, Financial accounting, Financial management, Financial strategy, Higher education, Leveraged buyouts, Mergers & acquisitions, Portfolio management, Venture capital. Adams Capital Management: March 2002: (HBS: 9-803-143) Description: In March 2002, the five partners of Adams Capital Management (ACM), a venture capital firm investing in information technology telecommunications with $700 million under management, gathered to discuss whether they should change their strategy in view of the prolonged downturn in both the economy and their targeted investment sectors. Since its founding in 1993, ACM had followed a distinct strategy of targeting particular markets of interest, investing within these, and managing the portfolio companies through a defined process to liquidity. ACM's first fund had performed extremely well; its second was looking good; and the third, albeit only a year into its life, it was not performing as well. ACM is considering three options: investing in companies producing more fundamental products, hiring more associates or investing in more markets, or taking bigger positions in companies in its traditional sectors. Each has its own possibilities and drawbacks.
  9. 9. Subjects Covered: Assets, Corporate strategy, Entrepreneurial finance, Entrepreneurship, Finance, Fund raising, Investments, Nonprofit marketing, Strategic planning, and Venture capital. How Venture Capitalists Evaluate Potential Venture Opportunities: (HBS 9-805-019) Description: The case presents interviews with four venture capitalists from leading Silicon Valley firms about the frameworks they use to evaluate potential venture opportunities. Questions include: "How do you evaluate potential venture opportunities?" "How do you evaluate the venture's prospective business model?" "What due diligence do you conduct?" "What is the process through which funding decisions are made?" "What financial analyses do you perform?" "What role does risk play in your evaluation?" and "How do you think about a potential exit route?" Interviews feature Russell Siegelman, partner at Kleiner Perkins Caufield & Byers; Sonja Hoel, managing director at Menlo Ventures; Fred Wang, general partner at Trinity Ventures; and Robert Simon, director at Alta Partners. Aim: To highlight frameworks that individual capitalists use to evaluate potential venture opportunities. Subjects Covered: Accounting, Business models, California Research Center, Competitive strategy, Entrepreneurial finance, Entrepreneurship, Financial analysis, Financial management, Risk assessment, Venture capital. Valhalla Partners: Due Diligence: (HBS-9-805-033) Description: The case discusses a new approach to the due diligence process introduced by the Valhalla Partners venture capital firm. It features an extended excerpt from an internal due diligence report prepared by Valhalla. The report analyzes Telco Exchange, a startup company in the IT software space. The case examines the trade-offs involved in the new due diligence process and whether Valhalla should invest in Telco Exchange. Aim: To give students real-world insight into the process of due diligence and the way it is used to manage risk. Subjects Covered: Assets, Business plans, Communications industry, Entrepreneurial finance, Entrepreneurship, Finance, Investment management, Investments, Risk management, Telecommunications, Telecommunications industry, Venture capital. Term Sheet Negotiations for Trendsetter, Inc. (HBS: 9-801-358) Description: The case describes two aspiring entrepreneurs who have just received offering documents for venture funding (known as term sheets) from two venture capital firms. With neither of the entrepreneurs having experience in raising capital, they are wondering how to compare the two proposals and which one they should choose. They need to make a decision fast. The case contains two complete term sheets. The term sheets are similar in structure but differ in important ways. Both term sheets have advantages and disadvantages for the
  10. 10. entrepreneurs. Choosing one over the other requires a careful analysis as well as a certain set of assumptions about the growth of Trendsetter, Inc. Aim: Most entrepreneurs must compare different sources of equity financing at some point in the course of starting a venture, especially if they seek to raise venture capital. Term sheets are widely used by venture capitalists and increasingly by business angels. This case intends to teach students about the elements and characteristics of term sheets. Also seeks to sharpen students' understanding of how to compare term sheets and how to select the best term sheet given the likely evolution of a venture. Subjects Covered: Assets, Corporate law, Entrepreneurial finance, Entrepreneurship, Equity financing, Financial instruments, Information technology, International entrepreneurial finance, International finance, Legal aspects of business, Securities, Software, Software industry, Venture capital. Venture Capital Negotiations: VC vs. Entrepreneur: (HBS: 9-800-170) Description: The case introduces students to the challenging negotiations between venture capitalists and entrepreneurs. The case explores interests, sources of negotiating power, barriers to reaching agreement, and common contractual terms. In addition, it describes how the parties try to reduce information asymmetries, align incentives, control decision making, and protect financial downside. Subjects Covered: Compensation, Entrepreneurial finance, Entrepreneurs, Entrepreneurship, Incentives, Leadership, Motivation, Negotiations, Power & influence, Venture capital. United Parcel Service’s IPO: (HBS: 9-103-015) Description: The case examines the valuation of United Parcel Service (UPS) at the time of its IPO in mid-1999. It offers students the opportunity to assess UPS's current performance relative to its major competitor, Federal Express (FedEx), and to judge whether that performance is sustainable. Students then make projections of UPS's future earnings performance, estimate on IPO price, and assess the reasonableness of their estimate compared to the valuation of FedEx and best-in-class leaders. Subjects Covered: Accounting, Entrepreneurial finance, Finance, Financial analysis, Financial management, IPO, Shipping industry, Transportation industry, Valuation. The Exxel Group: March 2001: (HBS: 9-202-053) Description: The Exxel Group, a leading Latin American buyout fund, faces a challenge when deciding whether and how to exit its largest investment. The capital markets are very weak, precluding an initial public offering. Undertaking a trade sale of the firm, however, proves to be challenging. Aim: To illustrate the structuring of leveraged buyouts, as well as how private equity investments can be exited. Subjects Covered: Corporate strategy, Entrepreneurial finance, Finance, Financial strategy, Leveraged buyouts, Mergers & acquisitions, Venture capital.
  11. 11. Intel 64 Fund: (HBS: 9-800-351) Description: Laila Partridge of Intel's Corporate Business Development group has been charged to create a special investment fund to speed the adoption of new chip architecture. The last architecture upgrade, from 16 to 32 bits, had needed almost a decade to become fully adopted. How can this fund speed the adoption process? How can Laila structure it to avoid the common tension in corporate venture capital between financial return and strategic goal? Aim: To explore the mission of corporate venture capital, discuss when corporate money is well invested, and evaluate whether Intel's new structure will work. Subjects Covered: Computer industry, Electronics, Entrepreneurial finance, High technology, Manufacturing industry, Semiconductors, Silicon Valley, Venture capital. Angel Investing: (HBS: 9-800-273) Description: The case introduces angel investing as a concept and discusses recent developments in the industry. The case focuses on the new generation of angel investors and the steps taken on both sides of the investing equation to mitigate the risks inherent in the relationship. Subjects Covered: Angel financing, Entrepreneurial finance, Entrepreneurship, General management, Innovation, Venture capital.

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