Section 4: How venture capital funds work This video is part of a series of lectures by Chad Jardine, teaching FINAN 6310, Adv. Venture Capital at the University of Utah, 2008–. This video series is NOT a complete online course of itself (with context, exercises, examinations, etc.), but it contains lecture content from FINAN 6310 Advanced Venture Capital, which builds on the concepts introduced in FINAN 6300 and further develops the language, skills, know-how, concepts, attitudes and information surrounding raising capital for new and growing businesses. We’ll focus on four dimensions of funding a new venture: Company, Context, Investors and the terms of the Deal. This course aims to increase your odds for success in dealing with investors, by learning to think like one. In addition to becoming familiar with the process of financing a new venture, the course focuses on how to build fundamental value within a company and increase a new venture’s investment worthiness. These include concepts like the importance of the opportunity, favorable deal structure, clear customer acquisition strategy, presentation of current and projected financials, mitigating the four components of risk, legal and capital structures, venture capital, private placements, initial public offerings (IPO), mezzanine debt, preferred stock, warrants and other forms of new venture financing.

2. Venture Capital: FINAN 6310
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Venture Capital: FINAN 6310
Lecture 3

3. Advanced Venture Capital: FINAN 6310
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Time-Value of Money
VC Power Law
VC Fund Structure
Convertible Notes
Agenda

4. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Thinking Like A Venture Capitalist: Know Your Audience

5. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Investors approach a deal from the
perspective that
• Money is time that is monetized—i.e.,
inventory that must be turned.
• ROI versus the dollars and risk of the
investment.

6. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Thinking Like A Venture Capitalist
$10 million
Invested
$20 million
Return
Good Deal?

7. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Depends on time.
1-year = 100% IRR
7-years = 12.25% IRR

8. Venture Capital: Financing New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
P/E Ratio

9. Venture Capital: Financing New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.

10. Venture Capital: Financing New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.

11. Advanced Venture Capital: FINAN 6310
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Time-Value of Money
VC Power Law
VC Fund Structure
Convertible Notes
Agenda
✓

12. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
“The biggest secret in
venture capital is that the
best investment in a
successful fund equals or
outperforms the entire
rest of the fund
combined.”
Photo Credit: Forbes
The VC Power Law
—Peter Thiel
Cofounder and former CEO of Paypal.
Author of Zero to One

13. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
You mean most VC investments are losers?

14. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
“You can only make money
by being right about
something that most
people think is wrong.”
—Bill Gurley
General Partner, Benchmark
Photo Credit: Forbes
The VC Power Law

15. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Photo Credit: Forbes

17. Advanced Venture Capital: FINAN 6310
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Time-Value of Money
VC Power Law
VC Fund Structure
Convertible Notes
Agenda
✓
✓

18. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Venture Capital is a subset of Private Equity
Invest in private companies/shares rather
than public.
Private Equity Structure
VC vs. Private Equity
Venture Capital Private Equity
Target Company Startup Mature/Underperforming/
Undervalued
Ownership Minority Control
Exit IPO LBO

19. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
VCs normally only have a token
amount of their own money in
their fund to invest.
Private Equity Structure

20. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Private Equity Structure
Tim Ferriss
Author, Podcaster, Investor
Basics of how
venture capital is
structured

21. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Member/Manager
LLC
NewCo
ENT–2
ENT–1
INV–1 INV–2 TRUST
INV–3
REIT
INV–4
Sub Sub Sub Sub
Private Equity Structure
Accredited Investors: High net-worth individuals & institutions such as:
pension funds, insurance companies, family offices, endowments,
sovereign wealth funds, foundations, etc.
GP LP
LP
LP LP
30%
70%
Investment Portfolio: All
the companies invested
in by the fund.
Y/N Investment Fund
1–3%
Mgt. Fee
MGT
20/80 profit
distribution
“carry”
P.Ag.
LLC
VC Firm/
Brand/MGT Co
LP
“2–20” is the cliche
VC structure
LLC
VC–2
VC–1 VC–3
VC Principals/Sponsors
Fund II
Fund III

22. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Member/Manager
LLC
NewCo
ENT–2
ENT–1
INV–1 INV–2 TRUST
INV–3
REIT
INV–4
Sub Sub Sub Sub
Private Equity Structure
Accredited Investors: High net-worth individuals & institutions such as:
pension funds, insurance companies, family offices, endowments,
sovereign wealth funds, foundations, etc.
GP LP
LP
LP LP
30%
70%
Investment Portfolio: All
the companies invested
in by the fund.
Y/N Investment Fund
1–3%
Mgt. Fee
MGT
20/80 profit
distribution
“carry”
P.Ag.
LLC
VC Firm/
Brand/MGT Co
LP
“2–20” is the cliche
VC structure
LLC
VC–2
VC–1 VC–3
VC Principals/Sponsors
Fund II
Fund III

23. Advanced Venture Capital: FINAN 6310
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Time-Value of Money
VC Power Law
VC Fund Structure
Convertible Notes
Agenda
✓
✓
✓

24. Venture Capital: Financing New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
EQUITY
VALUATION
FINANCING ROUND
Price per Share (PPS)
Bootstrap
$0.003
Angel
$1.00
Seed
$1.25
Series A
$2.00
Series B
$5.00
IPO
$13.00
EOPP
Founder
Accredited
Investor
Employees Seed VC or
Super Angel
A-VC
B-VC
Public
2.9M
$10K
100K
$100K
$0
350K
$1M
800K
$5M
2.5M
$17.5M
3.5M
5.5M
Options are growing for
what happens here
(especially in tech)

25. Advanced Venture Capital: FINAN 6310
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
How do you raise money when
you’re too early to have any
revenue or earnings?

26. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Photo Credit: Business Insider
“It’s harder to make
money in the venture
business, given the
valuation environment
that exists today.”
—Fred Wilson
Managing Partner, Union Square Ventures
Founder, Flatiron Partners

27. Venture Capital: Financing New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
–Paul Graham
Cofounder Y-Combinator

28. Advanced Venture Capital: FINAN 6310
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Convertible Notes
A loan (i.e., debt) that can convert to
equity when a subsequent equity
round is raised.

29. Advanced Venture Capital: FINAN 6310
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Convertible Notes
Need an interest rate and a term
Intend that it convert to equity, but
can be repaid.
May include a cap
Common for
A. Early seed rounds
B. Smaller interim cash infusions

30. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Calculating Convertible Notes
Terms:
Investment: The amount raised
using the convertible note
Discount Rate: Discount to
subsequent round PPS
Valuation Cap: Max valuation at
which note converts
Interest Rate: Interest (accrues to
principal)
Maturity Date: Date the note must
be repaid if unconverted
Pre-Money Valuation: Valuation
before next round of investment
Price per Share (PPS): PPS at the
next round of investment

31. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Convertible Note Example
Seed Round Convertible Note
Raise $750,000 using a CN.
10% interest rate.
$5M cap and 20% discount.
Series A triggers conversion (2 years later)
$4M investment
$2 per share (2M shares)
$10M pre-money valuation
$14M post-money valuation
What happens to the Seed investor?

32. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Convertible Note Example
Principal grows due to interest rate
$750,000(1+.1/1)2
= $907,500
New Principal Amt. $907,500

33. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Convertible Note Example
Calculate PPS using the cap
Formula: (Cap/Pre-money) x Series A PPS
$5M/$10M = 0.5 x $2 PPS = $1 CN PPS
$907,500/$1 =
907,500 shares
(Same amount into Series A would yield 453,750 shares)

34. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Convertible Note Example
Calculate PPS using the discount
Formula: Series A PPS - Discount = Conversion PPS
$2 - 20% = $1.60
$907,500/$1.6 =
567,187 shares
(Same amount into Series A would yield 453,750 shares)

35. Venture Capital: Financing for New Ventures: FINAN 6300
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Convertible Note Example
Noteholder Converts at Lowest PPS
Cap Yields 907,500 shares at $1 PPS
Discount Yields 567,187 shares at $1.60 PPS
Noteholder gets 907,500 shares
For the price of 453,750

36. Advanced Venture Capital: FINAN 6310
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
SAFE
Simple Agreement for Future Equity
Turns out California has a lot of
regulations about loans.

37. Advanced Venture Capital: FINAN 6310
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Time-Value of Money
VC Power Law
VC Fund Structure
Convertible Notes
Agenda
✓
✓
✓
✓

38. Venture Capital: FINAN 6310
Course copyright © Chad Jardine. Images, works cited, etc. are copyright © their respective owners.
Venture Capital: FINAN 6310
Lecture 3

39. Nothing in this presentation should be
construed as legal or accounting advice.
© Copyright Chad Jardine.