Chapter 14

Entrepreneurial Finance, Smith and Kiholm Smith

Venture Capital
 Historical Development of
Venture Capital as an Institution
 Venture Capital New Commitments
Venture Capital New Commitments

$50,000

$45,000

$40,000

$35,000
Millions of Dollars

$30,000

$25,000

$20,000

$15,000

$10,000

$5,000

$0
1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999
Year
Sources: Statistical Abstract of the U.S. (various issues), Venture Economics Investor Service, Sahlman (1990).
 Sources Sources
of Venture Capital
of Venture Capital Funds Funds
100%

90%

80%

70%
Foreign Investors
Percent of Total

60% Individuals
50% Corporations
Endowments
40%
Insurance Companies
30%
Pension Funds
20%

10%

0%
1986

1988

1996
1978

1980

1982

1984

1990

1992

1994

Year
Sources: Statistical Abstract of the U.S. (various issues), Gompers and Lerner (1996, 1997).
 Organizational Structure of
Venture Capital Investment
General Partners
– Generate deal flow – Negotiate deals
– Screen opportunities – Monitor and advise
– Harvest investments

Effort and Annual Carried

1% of Management Interest 20-
capital Fee 2-3% 30% of Gain Investment
Capital and
Portfolio
Effort
Venture Capital Fund Companies
Financial –Value creation
99% of Investment Capital Appreciation Claims
Capital 70-80% of Gain

Limited Partners
– Pension plan – Corporations
– Endowments – Individuals
– Life insurance companies
 Summary of Terms:
Venture Capital Limited
Summary of Terms:
Partnership
Venture Capital Agreement
Limited Partnership Agreement
Venture.com VC Fund, L.P. (the “Fund”)
Terms and Provisions
Purpose
General Partner
Limited Partnership Interests
General Partner’s Investment
Minimum for Closing
Payment of Subscriptions
Term
Allocation of Profit and Loss
Distributions
Service Fee
Organizational Expenses
Conflicts of Interest
Other Restrictions and Limitations
 Percent of time

Source: Zider (1998)

10%
15%
20%
25%

0%
5%
Soliciting Business

Selecting Opportunities
Allocation Allocation

Analyzing Business Plans

Negotiating Deals

Directing and Monitoring

of Venture

Activity
Consulting

Recruiting Management
of Venture Capitalist

Assisting in Outside
Relationships
Time

Exiting
Capitalist Time
 The Venture Capital Investment
Process
Development of Fund Concept

Secure Commitments Generate Deal Flow

from Investors

Year 0
Closing of Fund
First Capital Call

2-3 years Screen Evaluate and Negotiate Additional Invest

Business Conduct Due Deals and Capital Funds
Plans Diligence Staging Calls

Value Creation and Monitoring

4-5 years
– Board service – Assist with external relationships
– Performance evaluation and review – Help arrange additional financing
– Recruitment management

2-3 years Harvesting Investment Distributing Proceeds

or more – IPO – LBO – Cash – Other
– Acquisition – Liquidation – Public Shares

7-10 years plus extensions

 Key Covenant Classes
Key Covenant of Venture
Classes
CapitalCapital
of Venture Limited Partnerships
Limited Partnerships
Overall Fund Management
Investment in a single firm
Use of debt
Coinvestment by Venture Capitalist’s Other Funds
Reinvestment of profits
Activities of General Partner
Personal investing in portfolio companies
Sale of interest by General Partner
Fund-raising
Outside activities
Addition of General Partners
Types of investments
Restrictions on asset classes

Based on Gompers and Lerner (l997).