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Industry CharacteristicsHigh risk
Many, many losers
Difficult to discern in advance: No “rules”
Massive gains concentrated in few top deals
Many ways to lose your money
Venture Capital Lifecycle Fund life cycle:
Raise a Fund
(Pension, Families, Corporations)
Invest (Evaluate, due
diligence, close…)
Harvest(IPO, mergers, management
buyout)
Core Venture Capital Process
• Raise capital from institutional and individual investors
- Finance new and growing companies; - Purchase preferred equity- Add value through active participation
VC’s segment in a number of waysStageSector
Healthcare versus IT versus clean energyGeography
US, EU, China, India, Israel Independent
vs Corporate VCSize
Small fund (<$100M) to large fund (>$1B+)
Specialization leads to deep expertise
Source: W. Price, 3/6/07 Hummer Winblad
Venture Capital Model
Flavors of VCs
5
Initial contact Review business plan… basic diligencebasic diligence Emergence of deal advocate Partners meeting with entrepreneur Due diligenceDue diligence Unanimous partner approval Unanimous partner approval Term sheet Final due diligenceFinal due diligence Legal documentation Funding
Multi-stage, extended process, very few selected
Venture Capital Model
Investment Process
The Entire Business Model Presumes & Leverages Multiple Failures
• Deal with entrepreneurs: - Gives VCs control for course change- Puts VCs first in line on pay day
• Deal with limited partners: - Participate on fund upside, but not on downside
• Deal with other VCs: - Home run phenomena - Broad deal sharing
among VCs - Enables many bites on few home runs
• Investment process: - Optimized to avoid losers- Funds participate in many big
“at bats”
8
Reverse Vesting of Founder Stock Mandatory Minimum Employment PeriodMandatory Minimum Employment Period
Voting rights a/k/a veto rightsa/k/a veto rights
Liquidation preference a/k/a VC gets 2-5 multiple before you see a dimea/k/a VC gets 2-5 multiple before you see a dime
Options & vesting A/k/a you’re locked in baby. A/k/a you’re locked in baby.
Redemption A/k/a in a sideways play, we’re out of here … with our money & profit of course.A/k/a in a sideways play, we’re out of here … with our money & profit of course.
Anti-dilution (weighted average vs full-ratchet) … … if things go bad (under full ratchet) you can get wiped outif things go bad (under full ratchet) you can get wiped out
Enables effective control
Venture Capital Model
Deal w/ Entrepreneurs
9
Positive Covenants – things you will do Information rights, auditing requirements
Negative Covenants – things you will not do Selling debt, raising money, hiring management
Representations We’ve told you everything that is material to making your investment
decision
Venture Capital Model
Deal w/ Entrepreneurs
Venture Capital Model
Deal with Limited PartnersManagement Fees (typically 2-2.5% of AUM)
Charge a management fee to cover the costs of managing the committed capital. $100 M fund generates $2m per year in management fees
Carried Interest (typically 20-25%) "Carried interest" is the term used to denote the profit split of proceeds to the general partner.
Participate on fund upside, but not downside
Source: W. Price, 3/6/07 Hummer Winblad
Venture Capital Model
Deal with Other VCs Industry with blockbuster winners!
Broad deal sharing among VCs enables many bites on few big home runs …. multiplying effect.
Portfolio effect allows for big success while absorbing many failures.
Impact of few very large numbers
VC gets portfolio effect, (while entrepreneur is all or nothing)
Venture Capital Model
Investment Process
Multi-phase, intense, in-depth due diligence process
Deep evaluation process
Decision to invest requires consensus of all general partners
Only invest if other VCs go in (syndication)
Multi-round investment process Short leash
Seed, series A, B, C, D, Mezzanine…
Venture Capital Model
Fundamentals of VC structure, deal terms, timing, and core processes presume and work with “failure”
But…..