Private Equity Investment: Lecture 2 - VC and other financing
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Transcript of Private Equity Investment: Lecture 2 - VC and other financing
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Professional Equity Investment (Venture Capital and Angel) Lecture 2
EBD 481, Fall 2009Galbraith
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Equity Investment Process
SeedMoney
1st RoundFinancing (Series A)
2nd RoundFinancing(Series B)
Clean-upFinancing(Series C)
Year 1 Year 3 Year 5
$50k $1 million $3 million $1 million
Milestones and Benchmarks
Private InvestmentVenture Capital Firms
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Historical Development of Professional Venture Capital
1946: Beginning of Professional VCsFormation of American Research & Development (ARD)
ARD’s Performance$3.5 million was raised ($2 million from institutional investors)By end of 1947, ARD had invested in eight ventures, six of which were startupsBy 1951 the performance was still lack-luster (stock price was at $19 down from the initial offering price of $25 in 1946)1957 Invested in Digital Electronic CorporationARD Sold 1972; made money, about 15.0% annual return for investors (v. 7.2% in stock market)
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Historical Development of Professional Venture Capital (cont’d)
1953: Small Business Administration (SBA) was formed
Legislation permitted the federal government to actively engage in fostering new business formation
1958:SBA Created Small Business Investment Companies (SBICs)
Due to tax and leverage advantages, the SBIC became the primary vehicle for professionally managed venture capital
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Corporate Venture CapitalAbout 7 to 10% of VC dollarsInvest in technologies/deals that have transferability to the corporationDon’t necessarily share the “profit” motive as Angels and fund-based VCsDeal rate is much lower, but support is much higher for funded firmsPopular in pharmaceuticals, telecommunications, software and defense technologies
Microsoft, Intel, Merck, Qualcomm, and Millennium
Pharmaceuticals
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Qualcomm Ventures (QVC)Qualcomm Ventures (QCV) was formed and began funding in 2000, with a $500-million fund commitment to make strategic investments in early-stage high-technology ventures. Since then, QCV has funded numerous companies in the wireless sector, and set up several exclusive regional funds to spur development in key strategic markets, including a $60-million fund in Korea, a $30-million fund in Japan, a $100-million fund in China and a €100-million fund in Europe.QCV makes strategic investments in wireless-industry ventures that provide both a strong potential return on investment (ROI) and complement existing Qualcomm products and services. When selecting portfolio companies, QCV seeks a balance between ROI and long-range strategic value to the company and the wireless industry.
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Qualcomm Ventures – Investment Criteria
Strategic Value CriteriaA strong fit with Qualcomm's products and initiatives The potential to significantly affect the wireless value chain A significant and sustainable competitive advantage
Financial CriteriaPotential liquidity and financial returns - Comparable to VC investors Investment stage - Expansion, typically the second round of financing Investment size - Between $500,000 and $10M, based on the opportunity Ownership - Typically investing in privately held entities Syndication - A strong investor group and board; typically QCV co-invests with financial VCs
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SOLICITING INVESTMENTS: Suppliers of Venture Capital – 25-Year Average
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Professional Venture Capital Investing Cycle
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ORGANIZING THE FUND:VC Fund Placement Memorandum
Front-matter DeclarationsState Securities DisclosuresOffering SummaryFund OverviewExecutive SummarySummary of Terms
Fund is Formed, Investments Made, New Fund Created
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Useful TermsCarried Interest:portion of profits paid to the professional venture capitalist as incentive compensation
Two and Twenty Shops:investment management firms having a contract that gives them a 2% of assets annual management fee and 20 percent carried interest
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OBTAINING COMMITMENTS:Arrangements with Fund Investors
Capital Call:when the venture fund calls upon the investors to deliver their investment funds
Common to require subsequent investments consistent with the levels of investors’ initial contributions
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DUE DILIGENCE AND ACTIVE INVESTING: VC Fund Management
Deal flow:flow of business plans and term sheets involved in the venture capital investing process
Due diligence (in venture investing context):process of ascertaining the viability of a business plan
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VC and Angel Screening - Venture Characteristics
ProprietaryGrowthFounder CommitmentExperienceTrack Record
ManagementFire WithinBusiness ModelBusiness PlanDeal StructureExit Plan
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Screening Outcomes
Seek lead investor positionSeek a non-lead investor positionRefer venture to more appropriate
financial market participantsSLOR (standard letter of rejection) the venture
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Structuring an Equity InvestmentTerm Sheet:summary of the investment terms and conditions accompanying an investment
Typical Issues Addressed in a Term SheetValuationOngoing funding needsSize and staging of financingPreemptive rights on new issuesCommitments for future financing rounds and performance conditionsForm of security or investmentRedemption rights and responsibilities
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Structuring (cont’d)Typical Issues Addressed in a Term Sheet
Dividend structure (Number of VCs and outsiders)Additional managementBoard appointmentsConversion value protectionRegistration rightsExit conditions and strategyIPO-dictated events (e.g. conversion)Co-sale rights (with founders)Lock-up provisions
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Structuring (cont’d)Typical Issues Addressed in a Term Sheet
Employment contracts
Incentive options
Founder employment conditions: compensation, benefits, duties, firing conditions, repurchase of stock o termination, term of agreement, post-employment activities and competition
Founder stock vesting
Confidentiality agreements and protection for intellectual property
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Exit Strategies
Acquisition -- least costly of exit strategiesPublic Offering -- most costly, but exciting and maintain some control (Future Lecture?)Joint Venture -- intermediate strategyEquity Buyback -- expensive, but way to get venture capitalists out of business
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Summary - Advantages and Disadvantages of VC Funding
EquityOversightControlOver payment for fundsNeed to have exit strategy
Contractual CommitmentsLegal and paperworkMarketing and Management AssistanceLeverage for debt financingNetworking for additional funds and contacts
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Grant and Guerrilla Financing
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Grant FinancingGovernment and Private Grants for R&D and Commercialization
No equityAmount may be about $10billion per year in U.S. (angel financing about $20billion per year) – largest in segments which are funded
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Grant FinancingSmall Business Innovation Research (SBIR)
DoD, NASA, DHS, DoC, EPA, DoT, DoEd, DoE, HHS (NIH), NSF & USDA The SBIR Program provides up to $850,000 in early-stage R&D funding directly to small technology companies (or individual entrepreneurs who form a company);
• Phase 1 ($75,000)• Phase II ($750,000)• Phase III (sell product)
Small Business Technology Transfer & Research (STTR)
The STTR Program provides up to $850,000 in early-stage R&D funding directly to small companies working cooperatively with researchers at universities and other research institutions;
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Grant Financing
Department of Defense: SBIR/STTR/Fast Track - Main PageTechLink : : Links to Department of Defense, DoD Component, and Related Websites for SBIR/STTR Information
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Grant FinancingOther Grants (CCAT, TechLink, BAAs, etc) Local and Regional Economic Development Grants
Industrial Development BondsTax BreaksOther Incentives
Private Foundations
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Guerrilla Financing
Credit CardsRelatives and FriendsTrade CreditRevenue FinancingSmall Shares, with buyback provisionFactoring
BOOTSTRAPPING