Understanding Venture Capital
Where Does VC Fit in the Financial Cosmos? <ul><li>Stock Funds </li></ul><ul><li>Bond Funds </li></ul><ul><li>Hedge Funds ...
Within VC Asset Class Seed / Incubation Early Stage Late Stage / Mezzanine Multi-Stage <ul><li>Or by … </li></ul><ul><li>I...
What Is The Point? <ul><li>Raise money </li></ul><ul><li>Invest it </li></ul><ul><li>Give back lots more than we took in <...
Why Do It? <ul><li>Oh, yeah, we keep some for ourselves </li></ul><ul><li>Management fees – 2-2.5% per year </li></ul><ul>...
Really, Why Do It? <ul><li>Spend all your time on the cutting edge </li></ul><ul><li>Meet very interesting people </li></u...
Exactly What Do We Do? <ul><li>Raise money </li></ul><ul><li>Make investments </li></ul><ul><li>Monitor investments </li><...
Examples <ul><li>COMPAQ </li></ul><ul><li>CIENA </li></ul><ul><li>Citrix Systems </li></ul>
 
What Does VC Mean to an Institutional Investor? <ul><li>Illiquid </li></ul><ul><li>Takedown over time </li></ul><ul><li>Ve...
Institutional Investor Perspective <ul><li>VC firm is just a money manager with multiple funds </li></ul><ul><li>Differenc...
Example: Sevin Rosen Funds <ul><li>Early stage technology - constant </li></ul><ul><li>Multiple funds </li></ul><ul><ul><l...
What is a Fund? <ul><li>Legally: a limited partnership </li></ul><ul><li>Characteristics: </li></ul><ul><ul><li>Committed ...
Objective <ul><li>Make  n  investments over 1 st   y  years of the fund </li></ul><ul><li>Exit those investments in the 10...
What is  y ? <ul><li>Usually target 2-1/2 to 4 years </li></ul><ul><li>Less – too much time raising funds </li></ul><ul><l...
What is  n ? <ul><li>Balance: diversification vs. focus and impact </li></ul><ul><li>Inverse of targeted $ per deal ( d ) ...
How to Set Fund Size <ul><li>Function of: </li></ul><ul><ul><li>$ per deal ( d ) – physics of companies </li></ul></ul><ul...
Objective Revisited – Make Money for LPs and GP <ul><li>Measure success over 10-12 years </li></ul><ul><li>Metrics: IRR or...
Objective Revisited – Make Money for LPs and GP <ul><li>Given 10 year life, we need to make a multiple of the fund: </li><...
And That’s Not All <ul><li>Layer on top of that: </li></ul><ul><ul><li>Historical batting average - .500, plus or minus </...
So, What Really Happens? Fund I Fund IV Fund III Fund II
So, What Really Happens? <ul><li>Fund I – 9.2x overall </li></ul><ul><ul><li>2 @ 20-40x; 3 @ 10x; .529 avg. </li></ul></ul...
Practical Impact <ul><li>Capital invested matters </li></ul><ul><li>Valuation matters </li></ul><ul><li>VCs are sluggers, ...
How Do We Manage Such a Process? <ul><li>Deal making – very hard because: </li></ul><ul><ul><li>Usually invest before mark...
Who Are Deal Makers? <ul><li>Each firm has deal makers of varying experience </li></ul><ul><ul><li>General partner, managi...
Key Role - General Partner <ul><li>Make investment decisions </li></ul><ul><ul><li>Initial investment is most important </...
Herding Cats <ul><li>Very different models </li></ul><ul><ul><li>Cowboy confederation model </li></ul></ul><ul><ul><li>Con...
How We Make Decisions <ul><li>Slowly (these days) </li></ul><ul><ul><li>Due diligence hell </li></ul></ul><ul><li>Some nev...
How we get paid <ul><li>Depends on the model </li></ul><ul><li>Management fee </li></ul><ul><ul><li>% of committed capital...
What Breaks Down? <ul><li>Management fee </li></ul><ul><ul><li>Role of multiple funds </li></ul></ul><ul><li>Carry </li></...
Wait – What Happens When Fund is Fully Invested <ul><li>You raise another fund </li></ul><ul><li>You don’t </li></ul>
Multi-fund Firms <ul><li>Series of partnerships every 2-4 years </li></ul><ul><li>Generally don’t overlap portfolios </li>...
What Can Go Wrong – New Investments? <ul><li>Unseen scar tissue </li></ul><ul><li>Bad chemistry </li></ul><ul><li>Bad hair...
What Can Go Wrong – Existing Portfolio Companies? <ul><li>The living dead syndrome </li></ul><ul><li>Chronic fatigue syndr...
What Can Go Right? <ul><li>Well established firm </li></ul><ul><li>Capital access – direct and referrals </li></ul><ul><li...
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Understanding Venture Capital Stock Funds

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Understanding Venture Capital Stock Funds

  1. 1. Understanding Venture Capital
  2. 2. Where Does VC Fit in the Financial Cosmos? <ul><li>Stock Funds </li></ul><ul><li>Bond Funds </li></ul><ul><li>Hedge Funds </li></ul><ul><li>Private Equity </li></ul><ul><ul><li>VC </li></ul></ul><ul><ul><li>LBO </li></ul></ul><ul><ul><li>Other </li></ul></ul><ul><li>Pension Funds </li></ul><ul><li>Wealthy Families </li></ul><ul><li>University Endowments </li></ul><ul><li>Foundations </li></ul><ul><li>Others </li></ul>Fund of Funds <ul><li>Entrepreneurs trying to start a business </li></ul><ul><li>Entrepreneurs trying to buy a business </li></ul>Sources of Capital Users of Capital Money Managers Public markets
  3. 3. Within VC Asset Class Seed / Incubation Early Stage Late Stage / Mezzanine Multi-Stage <ul><li>Or by … </li></ul><ul><li>Industry </li></ul><ul><li>Technology </li></ul>
  4. 4. What Is The Point? <ul><li>Raise money </li></ul><ul><li>Invest it </li></ul><ul><li>Give back lots more than we took in </li></ul><ul><li>Repeat </li></ul>
  5. 5. Why Do It? <ul><li>Oh, yeah, we keep some for ourselves </li></ul><ul><li>Management fees – 2-2.5% per year </li></ul><ul><li>Profits interest: 20-30% </li></ul>
  6. 6. Really, Why Do It? <ul><li>Spend all your time on the cutting edge </li></ul><ul><li>Meet very interesting people </li></ul><ul><li>Change the world </li></ul><ul><li>New challenge every day </li></ul><ul><li>Can be very lucrative </li></ul>
  7. 7. Exactly What Do We Do? <ul><li>Raise money </li></ul><ul><li>Make investments </li></ul><ul><li>Monitor investments </li></ul><ul><li>Exit investments </li></ul>
  8. 8. Examples <ul><li>COMPAQ </li></ul><ul><li>CIENA </li></ul><ul><li>Citrix Systems </li></ul>
  9. 10. What Does VC Mean to an Institutional Investor? <ul><li>Illiquid </li></ul><ul><li>Takedown over time </li></ul><ul><li>Very long gestation </li></ul><ul><li>Series of pools, or “funds” </li></ul><ul><li>Part of small allocation (5-10%) to “alternative assets” </li></ul>
  10. 11. Institutional Investor Perspective <ul><li>VC firm is just a money manager with multiple funds </li></ul><ul><li>Difference: </li></ul><ul><ul><li>Stock fund money manager – different funds by strategy </li></ul></ul><ul><ul><li>VC fund money manager – different funds by vintage </li></ul></ul>
  11. 12. Example: Sevin Rosen Funds <ul><li>Early stage technology - constant </li></ul><ul><li>Multiple funds </li></ul><ul><ul><li>Fund I (1981) - $25 million </li></ul></ul><ul><ul><li>Funds II (1983) through VII (1999) </li></ul></ul><ul><ul><li>Fund VIII (2000) - $600 million </li></ul></ul>
  12. 13. What is a Fund? <ul><li>Legally: a limited partnership </li></ul><ul><li>Characteristics: </li></ul><ul><ul><li>Committed capital </li></ul></ul><ul><ul><li>Term </li></ul></ul><ul><ul><li>Takedown schedule </li></ul></ul><ul><ul><li>Investment restrictions </li></ul></ul><ul><ul><li>Lots more </li></ul></ul>
  13. 14. Objective <ul><li>Make n investments over 1 st y years of the fund </li></ul><ul><li>Exit those investments in the 10-12 year term at a profit </li></ul>
  14. 15. What is y ? <ul><li>Usually target 2-1/2 to 4 years </li></ul><ul><li>Less – too much time raising funds </li></ul><ul><li>More – LPs want chance to re-up more often than that </li></ul><ul><li>Sometimes miss the target </li></ul>
  15. 16. What is n ? <ul><li>Balance: diversification vs. focus and impact </li></ul><ul><li>Inverse of targeted $ per deal ( d ) </li></ul><ul><li>d is over the life of the deal </li></ul><ul><ul><li>Typically 1 st investment is 30-40% of expected d </li></ul></ul>
  16. 17. How to Set Fund Size <ul><li>Function of: </li></ul><ul><ul><li>$ per deal ( d ) – physics of companies </li></ul></ul><ul><ul><li># of GP equivalents </li></ul></ul><ul><ul><li>Companies / GP </li></ul></ul><ul><ul><ul><li>Steady state board capacity </li></ul></ul></ul><ul><ul><ul><li>Turnover rate </li></ul></ul></ul>
  17. 18. Objective Revisited – Make Money for LPs and GP <ul><li>Measure success over 10-12 years </li></ul><ul><li>Metrics: IRR or cash-on-cash over the life of the fund </li></ul><ul><li>Looking to juice “returns” over public equity (15-20+% vs. 12-15%) </li></ul><ul><li>Spoiled in the boom with 100%+ IRRs </li></ul>
  18. 19. Objective Revisited – Make Money for LPs and GP <ul><li>Given 10 year life, we need to make a multiple of the fund: </li></ul>25.8% 17.5% 5x 38.9% 25.9% 10x 34.6% 23.1% 8x 21.9% 14.9% 4x 17.0% 11.6% 3x 10.4% 7.2% 2x 10 year IRR 7 year IRR
  19. 20. And That’s Not All <ul><li>Layer on top of that: </li></ul><ul><ul><li>Historical batting average - .500, plus or minus </li></ul></ul><ul><li>So 5x the fund means 10x on the deals that work </li></ul><ul><li>On average </li></ul>
  20. 21. So, What Really Happens? Fund I Fund IV Fund III Fund II
  21. 22. So, What Really Happens? <ul><li>Fund I – 9.2x overall </li></ul><ul><ul><li>2 @ 20-40x; 3 @ 10x; .529 avg. </li></ul></ul><ul><li>Fund II – 3.7x overall </li></ul><ul><ul><li>2 @ 20-40x; 2 @ 10-15x; .560 avg. </li></ul></ul><ul><li>Fund III – 4.1x overall </li></ul><ul><ul><li>2 @ 40-50x; .409 avg. </li></ul></ul><ul><li>Fund IV – 12.5x overall </li></ul><ul><ul><li>1 @ 140x; 3 @ 10-20x; .526 avg. </li></ul></ul>
  22. 23. Practical Impact <ul><li>Capital invested matters </li></ul><ul><li>Valuation matters </li></ul><ul><li>VCs are sluggers, not looking for infield singles and walks </li></ul><ul><li>Focus on potential winners </li></ul><ul><li>Cents on dollar in bad deals not worth much </li></ul>
  23. 24. How Do We Manage Such a Process? <ul><li>Deal making – very hard because: </li></ul><ul><ul><li>Usually invest before market is clear </li></ul></ul><ul><ul><li>Feedback loop very long (and expensive) </li></ul></ul><ul><ul><li>Success (and failure) has large luck component </li></ul></ul><ul><li>Success in other venues no guarantee </li></ul><ul><li>Like sailing blindfolded </li></ul>
  24. 25. Who Are Deal Makers? <ul><li>Each firm has deal makers of varying experience </li></ul><ul><ul><li>General partner, managing director, etc. </li></ul></ul><ul><ul><li>Partner, principal, etc. </li></ul></ul><ul><ul><li>Associate, more or less senior </li></ul></ul><ul><ul><li>Analysts </li></ul></ul>
  25. 26. Key Role - General Partner <ul><li>Make investment decisions </li></ul><ul><ul><li>Initial investment is most important </li></ul></ul><ul><li>Help each company be as successful as it can be </li></ul><ul><li>Sometimes less is more </li></ul><ul><li>Help others apprentice </li></ul>
  26. 27. Herding Cats <ul><li>Very different models </li></ul><ul><ul><li>Cowboy confederation model </li></ul></ul><ul><ul><li>Consensus models </li></ul></ul><ul><ul><li>Joe Blow Ventures – either you’re Joe or you’re not </li></ul></ul><ul><li>Lots of blends of these </li></ul><ul><li>Explains a lot of behavior </li></ul>
  27. 28. How We Make Decisions <ul><li>Slowly (these days) </li></ul><ul><ul><li>Due diligence hell </li></ul></ul><ul><li>Some never tell you no </li></ul><ul><li>The role of partners meetings </li></ul><ul><li>Type of investment matters </li></ul><ul><ul><li>New investments </li></ul></ul><ul><ul><li>Follow-on investments </li></ul></ul>
  28. 29. How we get paid <ul><li>Depends on the model </li></ul><ul><li>Management fee </li></ul><ul><ul><li>% of committed capital </li></ul></ul><ul><ul><li>Imagine 10 year revenue visibility </li></ul></ul><ul><li>Profits interest (carry) </li></ul><ul><ul><li>Helps if there are profits </li></ul></ul>
  29. 30. What Breaks Down? <ul><li>Management fee </li></ul><ul><ul><li>Role of multiple funds </li></ul></ul><ul><li>Carry </li></ul><ul><ul><li>Fund by fund </li></ul></ul><ul><ul><li>Sharing philosophy </li></ul></ul>
  30. 31. Wait – What Happens When Fund is Fully Invested <ul><li>You raise another fund </li></ul><ul><li>You don’t </li></ul>
  31. 32. Multi-fund Firms <ul><li>Series of partnerships every 2-4 years </li></ul><ul><li>Generally don’t overlap portfolios </li></ul><ul><li>Crossover investing is big issue </li></ul><ul><li>Know what fund you are in, and the rules </li></ul><ul><li>Amplifies the management fee issue </li></ul>
  32. 33. What Can Go Wrong – New Investments? <ul><li>Unseen scar tissue </li></ul><ul><li>Bad chemistry </li></ul><ul><li>Bad hair day </li></ul><ul><li>Misjudge the DMU </li></ul><ul><li>Ego crowding </li></ul>
  33. 34. What Can Go Wrong – Existing Portfolio Companies? <ul><li>The living dead syndrome </li></ul><ul><li>Chronic fatigue syndrome, VC style </li></ul><ul><li>No money left problem </li></ul><ul><li>Partner on the roof problem </li></ul><ul><li>With some firms, “it’s in their nature” </li></ul><ul><li>GP overload – drive-by board meetings </li></ul>
  34. 35. What Can Go Right? <ul><li>Well established firm </li></ul><ul><li>Capital access – direct and referrals </li></ul><ul><li>GP – operating and domain experience </li></ul><ul><li>Other resources </li></ul><ul><li>Know your partner </li></ul>

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