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Business, Law, and Innovation
Venture Capital Industry
Lecture 4Spring 2014
Professor Adam Dell
The University of Texas School of Law
Private Debt 35%
Equity Securities 31%
Public Debt
19%
Bank Deposits
12%
Private Equity = 2%
Macro View - Total U.S. Capital Markets
For-Profit Capital Market by SegmentTotal = $48.4 trillion
Private Equity is just a sliver of total capital markets, but it plays an important role in driving economy
LBO Funds
$740B
VC Funds
$260B
Macro View - Hugely Important to Economic Growth
As much as 18% of US GDP attributable to venture backed companies.
Macro View – Sector Concentration...Why?
4Source: VentureOne
% Invested in Sectors of VC by YearTotal = 100%
IT is consistently over 50% of funds invested, but Healthcare has been growing in importance
after tech/dotcom frenzy of 2000 as Baby Boomers age
$94.8B $36.4B $22.1B $19.7B $22.4B $23.8B $25.7B
2000 2001 2002 2003 2004 2005 2006
Information
Technology
Healthcare
Business/
Consumer/Retail
Other
Sector 2006 Median Deal Size
$7.0mm
$8.0mm
$5.7mm
$7.5mm
Macro View
• VCs invest in a limited number of sectors.• Most startups are not suited to be venture bets.
– Not capital efficient, no home run potential– Other sources: credit cards / debt / friends and family $ / Small Business Investment
Corporation (SBIC) & Small Business Administration (SBA) loans.
• New Market = no incumbent, so a new entrant can capture the prize.• Massive Market = lots of room for winners and wiggle room.• Capital Efficient = doesn’t take a lot to get the business off the ground.
J Curve
Portfolio Theory of VC
2x-4x
Nu
mb
er o
f S
ucc
essf
ul C
omp
anie
s in
a C
ycle
Return Multiple Expectation
5x-10x0x-1x
Total Write-off
Get a little more
than our $ back, but not
worth the effort
Home Runs
$100mm Fund, 20 bets, 2 big wins….up to $15mm in any given company
Diversified investments within IT:
SecurityStorageNetworkingSocial MediaRetail.comMobileAdvertising
7
20 bets: 2 HOME RUNS
18 WHATEVERS
Of the 20 bets that a VC firm will make, in a normal distribution of returns (and considering the risks), 2 companies will generate the vast majority of the returns.
But you never know which 2 they will be, so every investment has to have home run potential & be capital efficient.
7
Portfolio Theory of VC:
1995-2000 Portfolio Outlook
2x-4x
Nu
mb
er o
f S
ucc
essf
ul C
omp
anie
s in
a C
ycle
Return Multiple Expectation
5x-10x0x-1x
Total Write-off Get a
little more
than our $ back, but not
worth the effort
Home Runs
Crazy Time
Everybody jumps into VC(hedge funds, private equity funds, grandpas)
Drive prices up
Drive returns down
Macro View
• Most VC Firms Loose Money
• Yet a few great firms make all the $– Kleiner, Sequoia, Benchmark, Accel
• Impossible to Time the Market– Market Conditions
• Public Markets• Customer’s willingness to buy / good vs. bad economy
• If you build real value (regardless of market timing), you’ll probably make money.
Portfolio Management – Fail Fast / Focus on Winners
With limited capital, and the knowledge that the odds are stacked against success, a VC needs to know which companies are the “winners”…what do you do?
Kill the losers. Get them to “fail fast”
Be objective about which companies you continue to fund.
Focus on the “winners”
Every company that is not CF+ is on it’s way to going out of business..
Skills of Top VCPE Investors
Personal Networks
Strong personal networks enable investors to generate dealflow, be the first to learn about industry developments, help portfolio companies secure talent, and provide critical business development introductions.
ManagementExperience
Investor generally sits on Board and serves as close advisor to CEO and management team. When company faces tough decisions (e.g., firing vs. making payroll in a down quarter), it is helpful for investor to be able to draw on personal experience and serve as advisor.
Selectivity & Specialization
With large pipeline of deals and limited time and resources, must efficiently sift through potential investment opportunities. Critical to leverage technical knowledge and to prioritize opportunities based on anticipated return. Each Partner in a firm generally actively manages only around 5-10 investments at a time, depending on lifecycle, so must choose wisely.
IndustryKnowledge
Important for investor to know lay of the land—key competitors, industry developments, technical specifications—to make informed decision about making investment, as well as how to manage development and exit.
Focus onValue Creation
Unlike public companies, ownership and management are generally aligned because of shared economic interests, focused on an exit. It is in investor’s best interest to remain involved and watchful, guiding strategic decisions to create value.
Skill/Experience Description
..and ;)
– Salesmanship– Credibility / Integrity– Tolerance for Risk– Pattern Recognition– Curious…Looking for the next Big Thing
13
It’s a Small Club: Ex. PayPal
PayPal was a highly successful start-up founded in 1998 and sold in 2002 to eBay for $1.5B. The founders and top management have gone on to significant success and remain interconnected:
Sources: Wikipedia, Sequoia Capital, PayPal, Facebook, LinkedIn, Slide, Thank You for Smoking, YouTube
Max LevchinCo-founder
Peter ThielCo-founder
Roelof BothaCFO
Jeremy StoppelmanVP Engineering
Russel SimmonsEngineer
Co-founded successful internet site yelp in
2004
Joined top VC firm Sequoia Capital in
2003
Invested in YouTube in 2005—sold to Google for
$1.6B
Started hedge fund, Clarium, & vc firm, Founders Capital.
Personally invested in:
Founded web property:
Involved with:
Invested in:
Advised: