Chapter 14 Venture Capital Copyright¸ 2003 John Wiley & Sons, Inc. All rights reserved....

Chapter 14

Venture Capital

Copyright¸ 2003 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. Instructors may make copies of the PowerPoint Presentations contained herein for classroom distribution only. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

Learning Objectives• How venture capital fund structure is influenced by

regulation and other factors.

• How venture capital fund structure influences the kinds of investors who can invest.

• How the role of the fund’s general partner changes over the life of the fund.

• How the contract structure of venture capital funds promotes efficient investment and management.

• The role of reputation in defining relationships among the venture capitalist, investors, and portfolio companies.

©2003, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 14

Historical Development of Venture Capital As an Institution

©2003, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 14

• Legal environment:

–1933 and 1934 SEC Acts

– Investment Company Act of 1940

–ERISA Act (1974 and 1979).

• Fund structure:

–Closed-end mutual fund.

–Limited partnership.

Fig 14-1

©2003, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 14

Figure 14-2

©2003, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 14

Venture Capital Investments by Stage of Development

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%1

98

0

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

Pe

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nt

of

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w C

om

mit

me

nt

Do

lla

rs

Later Stage

Expansion

Early Stage

Seed/Start-up

Figure 14-3

©2003, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 14

©2003, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 14

€ 20

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€ 5,

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€ 3,

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€ 1,

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€ 1,

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€ 75

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€ 71

6

€ 66

7

€ 65

1

€ 49

4

€ 40

7

€ 36

6

€ 21

0

€ 17

6

€ 13

7

€ 11

8

€ 60

€ 51

€ 24

€ 6

€ 5

€ 0

€ 5,000

€ 10,000

€ 15,000

€ 20,000

€ 25,000

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Italy

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European Venture Capital and Private Equity Funds Raised in 2001

©2003, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 14

Expected Allocation of Funds Raised in 2001European Venture Capital

56.4%

11.3%

10.4%

3.0%

14.6%

4.3%

Buyout

Non High-tech Expansion

High-tech Expansion

Non High-tech Early-stage

High-tech Early-stage

Not Available

©2003, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 14

Private Equity Raised by Investor Type (1997 - 2001)European Venture Capital

24.8%

25.8%

13.3%

9.7%

7.3%

6.8%

5.2%

7.1%

Pension Funds

Banks

Insurance Companies

Corporate Investors

Fund of Funds

Individuals

Government Agencies

Other

Organizational Structure of Venture Capital Investment

©2003, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 14

Figure 14-4

Summary of Terms:Venture Capital Limited Partnership Agreement

©2003, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 14

Managing The Investment Portfolio

©2003, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 14

The Venture Capital Investment Process (Figure 14-6)

©2003, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 14

Allocation of Venture Capitalist Time (Figure 14-7)

©2003, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 14

Incentive Conflicts and Structures

©2003, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 14

©2003, Entrepreneurial Finance, Smith and Kiholm Smith Chapter 14

Figure 14-8