VENTURE CAPITAL
VENTURE CAPITAL <ul><li>Volatile:  High Success and Failure  Rates </li></ul><ul><li>Source of Innovation:  New Ideas  and...
VENTURE CAPITAL <ul><li>Adverse Selection Problem:   How can Investor know  whether Business Opportunity is Feasible?  How...
VENTURE CAPITAL <ul><li>Customary Development Paths </li></ul><ul><li>Independent Development </li></ul><ul><ul><li>Founde...
VENTURE CAPITAL <ul><li>Financing by Venture Capital Funds </li></ul><ul><li>Specialized Approach for Supplying Capital to...
VENTURE CAPITAL <ul><li>Venture Capital Partnership </li></ul><ul><li>Venture Capitalists are Specialized Financial  Inves...
Organizational Structure of Venture Capital Investment ©2000,  Entrepreneurial Finance , Smith and Kiholm Smith Chapter 14...
VENTURE CAPITAL <ul><li>Hybrid Financing Techniques by VC Funds </li></ul><ul><li>Because New Venture has No Verifiable Ca...
VENTURE CAPITAL <ul><li>Hybrid Structure: Preferred Stock convertible into Common Stock  </li></ul><ul><ul><li>Dividends a...
VENTURE CAPITAL <ul><li>Hybrid Financing used by VC Funds </li></ul><ul><li>Ultimate Source of Repayment for Investment wi...
VENTURE CAPITAL <ul><li>Myths about Venture Capital Financing </li></ul><ul><li>VCs want no less than 50% Ownership </li><...
VENTURE CAPITAL <ul><li>Myths about Venture Capital Financing </li></ul><ul><li>VCs dominate the Private Equity Market </l...
VENTURE CAPITAL <ul><li>Myths about Venture Capital Financing </li></ul><ul><li>VCs expect to Earn a 700% Rate of Return w...
VENTURE CAPITAL <ul><li>What is a VC Fund’s “Value Proposition”? </li></ul><ul><li>Provide all Financing necessary for Fir...
VENTURE CAPITAL <ul><li>Sources of Financing for New Venture pursuing Independent Development </li></ul><ul><li>Founder’s ...
VENTURE CAPITAL <ul><li>Characteristics of Firm Development when Venture Capitalist Funding Not Used </li></ul><ul><li>Rel...
VENTURE CAPITAL <ul><li>Future for Firms needing Venture Capital </li></ul><ul><li>Evolution of VC Fund Industry into (1) ...
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Venture Capital

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Venture Capital

  1. 1. VENTURE CAPITAL
  2. 2. VENTURE CAPITAL <ul><li>Volatile: High Success and Failure Rates </li></ul><ul><li>Source of Innovation: New Ideas and Ways to do Things </li></ul><ul><li>Contribute Disproportionately to New Job Formation </li></ul>American Capitalism produces New/Small Businesses that are
  3. 3. VENTURE CAPITAL <ul><li>Adverse Selection Problem: How can Investor know whether Business Opportunity is Feasible? How can Entrepreneur Objectively Communicate likelihood of Market Acceptance? </li></ul><ul><li>Moral Hazard Problem: How can Investor evaluate Entrepreneur's Ability? How can Entrepreneur communicate Capacity, Credibility and Commitment? </li></ul><ul><li>Contracting Problem: How can Parties Agree (1) about How to Control Business in Dynamic, Uncertain Environment and (2) on Incentives that Reward Different, sometimes Conflicting, Motives? </li></ul>
  4. 4. VENTURE CAPITAL <ul><li>Customary Development Paths </li></ul><ul><li>Independent Development </li></ul><ul><ul><li>Founder Equity  Profitability/Retained Earnings  External Debt  External Equity (IPO) </li></ul></ul><ul><li>Strategic Alliances </li></ul><ul><ul><li>Collaborative Relationships with Other Firms to Certify Legitimacy and Credibility. May be informal arrangements, joint venture or licensing agreements </li></ul></ul><ul><li>Merger/Acquisition </li></ul><ul><ul><li>Sale of Partial/Complete Ownership (and Control) as Consideration for Necessary Investment Capital </li></ul></ul>
  5. 5. VENTURE CAPITAL <ul><li>Financing by Venture Capital Funds </li></ul><ul><li>Specialized Approach for Supplying Capital to New Ventures with Sufficient Managerial Expertise, Scale and Product/Market Innovation </li></ul><ul><li>Addresses Financing Dilemma presented by Entrepreneurial Firms </li></ul><ul><ul><li>No Verifiable Cash Flows or Tangible Assets </li></ul></ul><ul><ul><li>How to Exert Control Necessary to Obtain Desired Investment Performance and Minimize Risk </li></ul></ul>
  6. 6. VENTURE CAPITAL <ul><li>Venture Capital Partnership </li></ul><ul><li>Venture Capitalists are Specialized Financial Investment Intermediaries </li></ul><ul><li>Organizational Form will be Limited Partnership </li></ul><ul><ul><li>Limited Partner Investors: usually Pension Funds </li></ul></ul><ul><ul><li>General Partners select Portfolio Company Investments, Negotiate Terms and Monitor </li></ul></ul>
  7. 7. Organizational Structure of Venture Capital Investment ©2000, Entrepreneurial Finance , Smith and Kiholm Smith Chapter 14 <ul><li>Portfolio Companies </li></ul><ul><li>Value creation </li></ul><ul><li>Generate deal flow </li></ul><ul><li>Screen opportunities </li></ul><ul><li>Harvest investments </li></ul><ul><li>Negotiate deals </li></ul><ul><li>Monitor and advise </li></ul>General Partners Venture Capital Fund <ul><li>Pension plan </li></ul><ul><li>Endowments </li></ul><ul><li>Life insurance companies </li></ul><ul><li>Corporations </li></ul><ul><li>Individuals </li></ul>Limited Partners Effort and 1% of capital Annual Management Fee 2-3% Carried Interest 20-30% of Gain 99% of Investment Capital Capital Appreciation 70-80% of Gain Investment Capital and Effort Financial Claims
  8. 8. VENTURE CAPITAL <ul><li>Hybrid Financing Techniques by VC Funds </li></ul><ul><li>Because New Venture has No Verifiable Cash Flow or Tangible Assets for Collateral </li></ul><ul><ul><li>Debt not Viable Option </li></ul></ul><ul><ul><li>Consideration for Investment is Transfer of Negotiated Ownership Interest (Stock Sale), which includes Measure of Control, from Entrepreneur/Founder to Venture Capitalist </li></ul></ul>
  9. 9. VENTURE CAPITAL <ul><li>Hybrid Structure: Preferred Stock convertible into Common Stock </li></ul><ul><ul><li>Dividends accrue at Debt-like Rate; Payable at Positive Cash Flow </li></ul></ul><ul><ul><li>When Milestones achieved, non-Voting Preferred Stock converts into Voting Common Stock </li></ul></ul><ul><ul><li>Venture Capitalist will have Board Membership and Control over Major Strategic Decisions </li></ul></ul>
  10. 10. VENTURE CAPITAL <ul><li>Hybrid Financing used by VC Funds </li></ul><ul><li>Ultimate Source of Repayment for Investment will be Initial Public Offering (IPO) </li></ul><ul><ul><li>Managing General Partners paid </li></ul></ul><ul><ul><ul><li>By Limited Partners/Investors for Management Services and … </li></ul></ul></ul><ul><ul><ul><li>Percentage of Capital Gain at IPO </li></ul></ul></ul><ul><ul><li>Limited Partners/Investors earn Capital Gain </li></ul></ul><ul><ul><li>Investment Time Frame: 7 to 10 years </li></ul></ul>
  11. 11. VENTURE CAPITAL <ul><li>Myths about Venture Capital Financing </li></ul><ul><li>VCs want no less than 50% Ownership </li></ul><ul><li>Fact: VC Funds customarily hold 47% to 53% Voting Interest </li></ul><ul><li>VCs have the Right to Fire the Founder/CEO </li></ul><ul><li>Fact: Customary Condition is Employment Contract authorizing Majority of Directors to fire Founder/CEO “ with or without cause .” Performance Issues vs. Company Needs: Administrator or Inspirational Leader </li></ul>
  12. 12. VENTURE CAPITAL <ul><li>Myths about Venture Capital Financing </li></ul><ul><li>VCs dominate the Private Equity Market </li></ul><ul><li>Fact: VCs account for less than 1% of the Private Equity Market </li></ul><ul><li>VCs finance a Broad Range of Industry Types on a Nationwide Basis </li></ul><ul><li>Fact: Most VC investments are in High-Technology or Bio-science Industries in California’s Silicon Valley or Boston area </li></ul>
  13. 13. VENTURE CAPITAL <ul><li>Myths about Venture Capital Financing </li></ul><ul><li>VCs expect to Earn a 700% Rate of Return within Two to Three Years </li></ul><ul><li>Fact: VCs aim to “harvest” their Investments within 7 to 10 Years (and try to earn no less than 700%) </li></ul><ul><li>Governments invest in VC Funds because they are a “Win-Win” Situation: Eye-Popping Rates of Return and High-Paying Jobs </li></ul><ul><li>Fact: Probable Returns will be around 25% with less than half of Firms surviving more than 3 years </li></ul>
  14. 14. VENTURE CAPITAL <ul><li>What is a VC Fund’s “Value Proposition”? </li></ul><ul><li>Provide all Financing necessary for Firm’s Product Life Cycle </li></ul><ul><li>Association with VC Fund brings Credibility and Legitimacy to Entrepreneur </li></ul><ul><li>Access to Strategic Services and Tactical Advice from Sole Provider with Expertise </li></ul>
  15. 15. VENTURE CAPITAL <ul><li>Sources of Financing for New Venture pursuing Independent Development </li></ul><ul><li>Founder’s Private Equity and Short-term Debt </li></ul><ul><li>The Three “Fs”: Friends, Families and Fools </li></ul><ul><li>Angels: Investors who are Risk-Sharers </li></ul><ul><li>Bootstrapping: Suppliers and Customers with Stake in Firm’s Success </li></ul><ul><li>Alliances with Resource Providers: Manufacturers, Distributors or Retailers (Beware of Hold-up Power; Evaluate Value of Current Marginal Resource Gain versus Constrained Future Flexibility) </li></ul>
  16. 16. VENTURE CAPITAL <ul><li>Characteristics of Firm Development when Venture Capitalist Funding Not Used </li></ul><ul><li>Reliance on Informal Networks for Credibility and Necessary Services and Expertise </li></ul><ul><li>Slower Growth Rate/Longer Life-Cycle Stages </li></ul><ul><li>Multiple Sources of Funds that Provide Short- Term Funding </li></ul><ul><li>Different Relationship between Control and Risk/Uncertainty </li></ul>
  17. 17. VENTURE CAPITAL <ul><li>Future for Firms needing Venture Capital </li></ul><ul><li>Evolution of VC Fund Industry into (1) Mass Market and (2) Niche Providers differentiated by Industry, Geography or Development Stage </li></ul><ul><li>For Everyone Else… Fundamentals Still and Will Always be the Rule </li></ul><ul><ul><li>Well-conceived Opportunities always get Financed </li></ul></ul><ul><ul><li>Obtaining External Financing Must Follow and Will Be Determined by Strategic Development </li></ul></ul><ul><ul><li>Risk is always Financeable; Resolving Uncertainty is Entrepreneur’s Challenge </li></ul></ul>

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