Venture Capital Industry in US

By: Group 4 208 Abhinav Singh Khanduja 209 Aayush Sharma 215 Nalini Katiyar 220 Mohit Rathi 236 Kriti Singh 261 Keshav Kishore

Objective

To study Venture Capital Industry in purview of US

FLOW OF PRESENTATION
1. Introduction of Venture Capital 2. What Venture Capital is and is not? 3. How Venture Capital Industry works? 4. Stages of VC funding 5. Investment Structure and Valuation 6. Break up of VC Industry 7. Misconceptions about VC Industry 8. Advantages and Disadvantages of VC Industry 9. Conclusion

Introduction of Venture Capital

The VC firm was invented in the United States after WW II as a partnership model. It had a unique provision for facilitating the private funding of new ventures. The limited partners who invest in a venture capital fund must wait patiently up to a maximum of 10-12 years as per the legal agreement for their money to be refund. Purchase preferred equity securities and take board positions. Add value to the company through active participation. Take higher risks with the expectation of higher rewards.

Facts about VC

It is hard to create VC. For 2/3 of the VC firms, the first fund is their last fund. Only 10% of the VC firms launch more than four funds. VC returns on, an average, are comparable to risk adjusted returns. Luck matters but reputation and skill matters too.

How VC firm become Top-Tier?

The relative internal rate of return is a good indicator of a VC funds performance relative to other funds launched at the same time. A venture capital firm becomes top tier by consistently delivering high relative IRRs for its funds, through boom-and-bust cycles. They need to have the bargaining power to get better terms from the entrepreneurs they invest in than other firms. Develop greater skill in choosing the portfolio companies to invest in than other VC firms, they tend to be more patient with the companies they bet on. One reason a VC firm may fall out of the top tier is because its key partners leavefor personal reasons, or because they are not happy with the firm, or because they see better prospects elsewhere.

What do VCs want?

Team Domain expertise with core technical strength and knowledge of given market opportunity. History of collaboration and success. A willingness to allow VCs to help build the team.

Market Emerging and fast growing market.

Business model How will you make money, how will you sell?

Technology Defensible technology/IP that can be protected to form competitive barriers over time.

What Is Venture Capital

Venture capital is the money provided by individual investors or entities seeking a high return on their investment in privately owned business ventures. In order to get those high returns, venture investors are willing to accept a relatively high degree of risk of loss of their investment.

Which Firms Require Venture Capital

What Do Venture Capitalist Want

They want to invest for short period. They want High Rate of Return on their Investment generally in range of 25% or more. They do not expect to get payment Regularly at least until the company is Established or Profitable . They generally look to make their profit when(1) Company is sold

When Do Venture Capitalist Invest

Venture Capital

How the venture capital Industry works

Timing is Everything
Basically, Venture capital fills the void between sources of funds for innovation and traditional, lowercost sources of capital available to ongoing concerns the challenge being to earn a consistently superior return on investments in inherently risky business ventures

Stages of VC funding

Seed Early Stage

Start-up First Stage

Formative Stage
Later Stage
Third Stage Expansion Stage Mezzanine (bridge)

Balanced-stage

Attractive Returns for the VC: An Example

Investment principles guide that most VC firms follow

Be highly selective Seek companies with innovative products and unfair advantages in large, ripe markets

Back outstanding management teams

Invest in companies with a clear and realistic exit strategy Add value to the development of the business and play a significant role in the ongoing management of the company Make sure that companies have access to enough cash to get to cash flow breakeven Build a diverse investment portfolio

Investment Structure and Valuation

Term Sheet A term sheet from the investor outlines the amount of money that will be invested in your company, the percentage of ownership or rights to ownership the investor is expecting, and the significant terms and conditions of the financing.

Facts Needs to be considered In term Sheet:1.

2.

Term sheet, as well any documents that are necessary for the closing of the investment should be reviewed by attorney. It is a non binding agreement so Investors can and do change their minds and decide not to make investments for which they have issued term sheets.

Valuation
It is more art than Science. Valuation requires an estimation of the companys potential for growth and its likelihood of achieving that growth. The entrepreneur argues for a higher valuation so his or her percentage of ownership stays as high as possible. The investor argues for a lower valuation in order to maximize its return on investment.

Method of Valuation
Determine the revenues or profits of the company will be in five years. 2. Multiply those revenues or profits by the projected ratio of price to revenues prevailed in the industry. 3. Then discounted back to the present using a discount rate equal to the hoped-for internal rate of return on the investment
1.

Pre Money & Post Money Valuation

Pre-Money Valuation:-valuation of a company

done by an investor before he or she makes an investment. Post-Money Valuation:- This valuation is the pre-money valuation plus the amount of the new investment in the company.

Stock Options Common stock- A security that represents ownership in a corporation. Preferred stock :- A class of ownership in a corporation that has a higher claim on the assets and earnings than common stock.

Advantage of Preferred stock over common stock:1.

Dividend Preference:- Some preferred stock investments will

2.

3.

4.

5.

require that a dividend of some specified percent be accrued on the preferred stock and paid before any dividend can be paid to holders of common stock. Liquidation Preference:- liquidation preference can also refer to the repayment of Pref. shareholders before common shareholders if a company goes under Liquidation. Conversion Rights:- Preferred stock typically comes with the right to convert to common stock at the option of the holder. Participating Preferred Stock:-preferred stock holders could hold their preferred stock and be paid their investment amount plus any accrued dividends, or they could convert to common stock and share in the bounty of an IPO or favourable sale. Redemption Rights:-Investors usually have the right to require the company to redeem or repurchase the investors shares at or after a designated period of time and at a specified price.

The Caste System in American Venture Capital Firms

Practitioners refer to venture capital firms as belonging to first tier, second tier and so onwith the implication that firms in the top tier consistently perform better than those in the lower tiers VC firms like to advertise themselves as top-tier (some times referred to as bulge bracket), because such a reputation gives them access to the best talent and the best deals, and the money to acquire both.

Top-Tier claims examined

Many VCs can claim that they are toptier because valid and visible performance data are not readily available in the world of private equity, and because it takes years for the returns from the firms current fund to become known. Even for data that are available on past performance, VC firms may try to put a favorable spin on poor past results while painting a rosy picture of future performance.

Few Firms launch more than 4 Funds

The results for a first fund may not be known by the time a VC firm is ready to raise money for a second fund, three to four years later. In all likelihood, these results will only be known six to eight years after the first fund was launched, when the firm is trying to raise a third fund, or certainly by the time a fourth fund is launched a few years after that. As a result, it will be nearly impossible to raise these funds if the results of the first fund are below expectations.

Reasons for launching few Funds (contd)

Another reason why the vast majority of VC firms do not get to a fifth fund is that, since it takes 8-12 years to get to the third and fourth funds, even a successful VC partnership may break up before then, if the partners leave for personal or other reasons. For a VC firm to raise more than four funds, it must not only be successful with its first funds, but it must also implement governance and succession mechanisms that will enable the firm to survive beyond the founding partners.

MISCONCEPTIONS ABOUT VENTURE CAPITAL FUNDING

Will the venture capitalists steal our idea? Over the years, venture capitalists have observed that different start up ideas come in clusters or groups. For example, social networking on the internet started in the past three years. Email companies like Hotmail and Yahoo started around 1996-1998. Similarly, many search engine companies started around 1997-2000. If a venture capitalist steals a business idea, the story spreads among the financial community instantaneously. The venture capitalists credibility would be lost. Entrepreneurs will stop presenting their ideas to the venture firm that employs the tainted VC. Will the VC firm take over the company, fire everyone, and bring in their own people?

Venture capitalists invest in killer teams who are able to bring an idea closer to actualization. VCs do not interfere in the company affairs as long as the process continues at a reasonable pace. VCs do not hesitate to fire the founder of the company if they find him/her incompetent. Problems only arise when the company is not able to meet the targets that

Are venture capitalists risk averse?

While some venture capitalist firms prefer to fund only companies that are not associated with too much risk, others do not hesitate to fund truly revolutionary ideas.
for example, we have a whole new breed of venture capitalists in the San Francisco Bay area funding clean energy technologies, which are considered risky. Is it true that returns and exit strategy are all that matter to venture capitalists? There are some venture capitalists who believe in the true spirit of venture capitalism. They fund companies primarily to make a better place to live in, following John Dorrs example. John Dorr funds companies only if he sees great potential and then wholeheartedly works with the entrepreneurs to take the company forward. Of course, other venture capitalists may be solely interested in the investment returns. It is necessary for entrepreneurs to research the venture capitalist that they plan to approach for equity financing.

BE AWARE OF !
The Good Guy vs. His Bad Partners A venture capitalist may state that he liked your business idea and made every effort to sell it to his business partners, but that his partners rejected the idea in spite of its evident merits. the venture capitalist with whom the entrepreneur has discussed the idea did not feel that the business idea could be successful and therefore did not bother discussing the idea with his or her partners. Venture Capitalist Time Commitment Venture capitalists who tell an approved business that they will devote a good amount of time to supervising the business are usually greatly exaggerating. Including board meetings, an entrepreneur should assume that venture capitalists would spend between five to ten hours a month on a company. Entrepreneurs, then, must handle the day-to-day operations by themselves, keep careful records of interactions and business, and present these findings at the board meetings in a concise, efficient manner.

Advantages

It injects long term equity finance which provides a solid capital base for future growth. The venture capitalist is a business partner, sharing both the risks and rewards. Venture capitalists are rewarded by business success and the capital gain. The venture capitalist is able to provide practical advice and assistance to the company based on past experience with other companies which were in similar situations.

The venture capitalist also has a network of contacts in many areas that can add value to the company.
The venture capitalist may be capable of providing additional rounds of funding should it be required to finance growth. Venture capitalists are experienced in the process of preparing a company for an initial public offering (IPO) of its shares onto the stock exchanges or overseas stock exchange such as NASDAQ. They can also facilitate a trade sale.

Advantages (Cont.)
The primary advantage of venture capital is that they allow entrepreneurs to build their company with OPM. Mentoring Alliances Facilitate exit Heightened credibility with customers and bankers Expert managerial assistance

Continuing source of financing

Smaller burden of risk

Your investor may insist on putting a representative on your board . For VCs, this is usually a non-executive director who will only take an active part if things go wrong. You are under greater scrutiny generally, particularly in relation to your compliance with your duties and responsibilities as a director. Your investor will expect regular information and consultation to check how things are progressing. For example, monthly management accounts and minutes of board meetings. securing a deal with a VC can be a long and complex process. You'll be required to draw up a detailed business plan, including financial projections for which you're likely to need professional help. Most venture capitalists seek to realize their investment in a company in three to five years. You must generate the cash needed to make the agreed payments of capital, interest and dividends. This can create great financial pressure.

Conclusion

We conclude with this video!!!

Thank You!!!