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Table of contents
1. Venture Capital overview
What is VC?
Business model
Risks – Reward curve
2. Investment framework
Team
Business Specifics
Market Opportunity
Exit returns
Risk mitigation
3. Lessons learned
2
3
What is Venture capital and why it exists.
Venture capital (VC) is type of funding for a new or growing business which usually involves
high risk financial risks.
Difficult for traditional financiers (banks / capital markets) to fund these firms due to low credible information and low ticket sizes
VC’s address with three key mechanisms:
Sorting: picking the right entrepreneurs.
Controlling: limiting “agency” problems, through
a mixture of incentives and monitoring.
Certifying: developing a tradition of quality and
fair dealings.
What
Why
Venture Capital overview
VС Business / Economic Model
4
Assets
Investments
Entry
Deal sourcing
Due diligence
Decision making
Deal documentation
Value creation
“6-month plan”
Portfolio review:
Budgeting & strategic decision-making
HR
Exit
Decision making
Organizing exit process
Deal documentation
KPIs
Cash-on-cash multiple also known as
multiple of cost
IRR
Liabilities – Limited Partner commitment
Investment team
Track record
Investment philosophy (investment themes, investment approach)
Investment strategy (deal sourcing, structuring, return targets / risk-reward curve)
Fundraising
Key deal metrics with LPs:
Carried interest rate (standard rate 20%)
Hurdle rate (standard rate 8%)
Management fee (standard rate 2%)
Equity – General Partner commitment
“Skin in the game”
Income
statement
Fund & investors Fund managers
Investment income (+) MF income (+)
Investment cost (-) Carry income (+)
Deal expenses (-) Operational expenses (-)
Gross result / IRR
Net income / (loss)MF expense (-)
Carry expense (-)
Net result / IRR
Venture Capital overview
5
Risk – reward curve
100%
30%
10%
1%
3%
Venture Capital overview
VC’s goal is to provide 5-10x gross return over
7-10 years timeframe
To accomplish one must focus not just on
excess returns, but protecting downside
64.8%
25.3%
5.9%2.5% 1.1… 0.4%
32.4%
48.6%
11.3%
4.8%2.1% 0.8%
0-1x 1-5x 5-10x 10-20x 20-50x 50x+
Gross return based of companies '04-'13Simulated returns if losses reduced by 50%
By % of financings in companies going out-of-
business, acquired, or IPO ‘04-’13. N = 21,460 3
Gross realized Multiple range
% o
f finan
cin
gs
Gross return: 7.5%
Cash-on-cash return: 2.1x
Realized
14.7%
3.9x
Simulated:
Targ
et
retu
rns
Risk
Investment framework
6
Issues /
Conclusions
1. Team
2. Business
specifics
3. Market
opportunity
4. Exit
returns
5. Risk
mitigation
How to protect downside?
(negative protections, liq. pref. and liq. value)
Is founder's team an A-level one?
Is there enough muscle in the company?
(business model, traction, product market fit)
Is there an opportunity to create a large company?
(market, competition, defensibility / entry barriers)
Is there an opportunity to return a >10x?
( successful previous exits in industry, good deal terms)
1. Team:
7
Is founder's team an A-level one?
• Sufficient management team industry expertise
• Serial entrepreneurs
• Founders’ capital contribution US$150k+
• Multiple founders
1
Integrity:
Qualities of Founders:
Reduce asymmetry of
information risk
Goal to accomplish
Reduce founder “flight” risk
Reduce chance of failure
Reduce chance of failure
Scoring questions
Passionate vision:
Experience & expertize:
Leadership:
Commitment.
Cash contribution
Time
Reduce founder “flight” and
asymmetry of information risk
Investment framework
2. Business specifics
8
Scoring questions
• Buran primary investment theme
• First revenues recorded
• Multiple sources of revenue
• Tested and scalable business model
• No external working capital funding required
• Breakeven achievable with Buran investment
2
Business and Financial Metrics
Revenue recurrence (ARR / MRR)
Customer Concentration Risk
Gross margin
LTV (Life Time Value)
CAC
Product and Engagement Metrics
Downloads / Active Users / Customers
Month-on-month (MoM) growth
Net Promoter Score (NPS)
Cohort Analysis / churn:
Gross churn
Net churn
Is there enough muscle in the company?
Company metrics: Threshold levels:
MRR > US$40k
Concertation <15%
margins > 30%
LTV / CAC >4-5x
CAC payback 6-9 months
100’s of paying customers / 100k’s of users
Growth is >2-2.5x y/y, >10-15% M/M
NPS >0
Gross (max): -10% per annum for SaaS or
20% for marketplaces
Net is hopefully negative
Investment framework
• Addressable market size US$100m+
• Market CAGR for next three years 50%+
• #1 position in niche achievable
• Sufficient entry barriers
3
3. Market opportunity
9
Is there an opportunity to create a large company?
Scoring questionsMarket metrics: Threshold levels:
Market Size:
TAM (Total Addressable),
SAM (Served/Serviceable Available),
SOM (Serviceable & Obtainable)
SAM Market growth
HHI of customers
Competition
HHI of competitors
Porter’ 5 Forces analysis
Opportunity timing
Regulatory changes
Technology adoption
UX / Behaviors shifts
SAM >US$100-150m
SOM share 20-30%
in 5-7 years
20-50%
Highly fragmented market
HHI* - Herfindahl-Hirschman Index
Few competitors
Bitcoins
Whatsapp, Youtube, Dropbox, Autonomous driving
Examples:
Dating, Taxi, Snapchat
Investment framework
• Successful international peers
• At least one equity exit in this niche occurred in
the last three years
• Target EBITDA margin > 20%
• Fairly priced rounds
(vs. revenue metrics, vs. previous capital raised)
4
4. Exit returns
10
Is there an opportunity to return a >10x?
Scoring questionsReturn characteristics: Targets:
Exit environment
Diversity of buyers
Sustainable company
cash flow in future
Deal parameters:
Entry valuation
Deal structure
Healthy captable
Investment framework
Fairly priced rounds
(vs. revenue metrics, vs. previous capital raised)
No secondary
Founders own >50% of the company
EBITDA margin > 20%
Gross margin >50%
Ability to create auction
5. Risk mitigation
11
How to protect downside?
Scoring questionsRisk mitigation:
Portfolio diversification:
Minority protective provisions:
Board seat
Reps and warranties
Covenants
Pre- and post-closing conditions
Anti-dilution provisions
Liquidity rights / transfer provisions (tag, drag,
pre-emptions, ROFR, CoC)
Information rights
Indemnities (protection if rights are breached)
• Investment size between US$500-5,000k
• Liquidation preference over 1x
• Liquidation value over BVC investment size
• Board seat and minority protective provisions
• Positive feedback from industry experts
5
Investment framework
Liquidation value:
Liquidation preference > hurdle rate
Important pieces:
Title to the shares
Level of indebtedness
intellectual property
Fraud is a real issue. Protections: due diligence,
personal guarantees, funding in installments.
The only real levers that we have are:
1. Funding schedule and triggers
2. Instigate management changes
3. Forcing a default or an exit
Main consequences:
Follow investment strategy
Lessons learned
12
Founder is the key:
• He needs to be a true entrepreneur: leader, ready to experiment, never gives up
• Better to have several founders than one – improves probability that they have a real entrepreneur inside
• Key founder skills: product, technology, HR, marketing and sales
Our how-to toolbox:
• We are investors, not entrepreneurs. Better to pull the plug early, than become the CEO
• Right motivation builds the business
• If the management is not focused, they lose
• Simpler is better
• Product wins over development
Cream of the crop guide:
• Best investments are counterintuitive – betting against the market. What does this really mean?
- You need to spot the value way before anyone else
- Insider trading is not prohibited on private markets
• Winner takes all” does not always apply
• Underfunding could kill the best idea