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Understanding Venture Capital. Public markets. Where Does VC Fit in the Financial Cosmos?. Users of Capital. Money Managers. Sources of Capital. Stock Funds Bond Funds Hedge Funds Private Equity VC LBO Other. Pension Funds Wealthy Families University Endowments Foundations Others. - PowerPoint PPT Presentation
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•Stock Funds
•Bond Funds
•Hedge Funds
•Private Equity
•VC
•LBO
•Other
Where Does VC Fit in the Financial Cosmos?
• Pension Funds
• Wealthy Families
• University Endowments
• Foundations
• Others
Fund of Funds
•Entrepreneurs trying to start a business
•Entrepreneurs trying to buy a business
Public markets
Sources of Capital
Users of Capital
Money Managers
Within VC Asset Class
Seed / Incubation
Early Stage
Late Stage / Mezzanine
Multi-Stage
Or by …
• Industry
• Technology
Why Do It?
• Oh, yeah, we keep some for ourselves
• Management fees – 2-2.5% per year
• Profits interest: 20-30%
Really, Why Do It?
• Spend all your time on the cutting edge
• Meet very interesting people
• Change the world
• New challenge every day
• Can be very lucrative
What Does VC Mean to an Institutional
Investor?
• Illiquid
• Takedown over time
• Very long gestation
• Series of pools, or “funds”
• Part of small allocation (5-10%) to “alternative assets”
Institutional Investor Perspective
• VC firm is just a money manager with multiple funds
• Difference:– Stock fund money manager – different funds by
strategy– VC fund money manager – different funds by
vintage
Example: Sevin Rosen Funds
• Early stage technology - constant
• Multiple funds
– Fund I (1981) - $25 million
– Funds II (1983) through VII (1999)
– Fund VIII (2000) - $600 million
What is a Fund?
• Legally: a limited partnership
• Characteristics:– Committed capital– Term– Takedown schedule– Investment restrictions– Lots more
Objective
• Make n investments over 1st y years of the fund
• Exit those investments in the 10-12 year term at a profit
What is y?
• Usually target 2-1/2 to 4 years
• Less – too much time raising funds
• More – LPs want chance to re-up more often than that
• Sometimes miss the target
What is n?
• Balance: diversification vs. focus and impact
• Inverse of targeted $ per deal (d)
• d is over the life of the deal– Typically 1st investment is 30-40% of
expected d
How to Set Fund Size
• Function of:– $ per deal (d) – physics of companies– # of GP equivalents– Companies / GP
• Steady state board capacity• Turnover rate
Objective Revisited – Make Money for LPs
and GP
• Measure success over 10-12 years
• Metrics: IRR or cash-on-cash over the life of the fund
• Looking to juice “returns” over public equity (15-20+% vs. 12-15%)
• Spoiled in the boom with 100%+ IRRs
Objective Revisited – Make Money for LPs
and GP• Given 10 year life, we need to make a
multiple of the fund:
10 year IRR 7 year IRR
2x 7.2% 10.4%
3x 11.6% 17.0%
4x 14.9% 21.9%
5x 17.5% 25.8%
8x 23.1% 34.6%
10x 25.9% 38.9%
And That’s Not All
• Layer on top of that:– Historical batting average - .500, plus or
minus
• So 5x the fund means 10x on the deals that work
• On average
So, What Really Happens?
FUND I
36.2x
20.9x
9.6x11.0x
10.4x6.3x
7.9x 9.0x3.2x
-10.0
0.0
10.0
20.0
30.0
40.0
50.0
60.0
Capital Invested (in $mm)Capital Returned (in $mm)
Fund I =
$19.6MM
Total returned
$180.6MM9.2x CC
Total invested
$18.3MM93.4% of CC
FUND II
-- -- -- -- -- -- -- --
42.6x
14.7x
19.4x
9.1x
4.1x
3.0x5.6x 2.1x 3.1x
3.8x 4.0x3.9x 0.8x 1.8x 1.2x
0.8x 0.3x
-10.0
0.0
10.0
20.0
30.0
40.0
50.0
60.0
Capital Invested (in $mm)Capital Returned (in $mm)
Fund II =
$60.6MM
Total returned
$223.0MM3.7x CC
Total invested
$53.68MM88.6% of CC
FUND III
-- -- -- -- -- -- -- -- -- --
39.3x
50.8x
4.2x 3.5x2.1x 3.5x 1.9x 0.6x 1.9x
1.0x 0.1x 2.5x
(10.00)
-
10.00
20.00
30.00
40.00
50.00
60.00
70.00
80.00
90.00
100.00
110.00
120.00
130.00
140.00
150.00
Capital Invested (in $mm)Capital Returned (in $mm)
Fund III =
$65MM
Total returned
$266.3MM4.1x CC
Total invested
$69.4MM106.8% of CC
FUND IV
1.0x0.4x0.2x
1.3x
3.2x3.4x3.2x
8.4x
19.6x
11.3x
13.1x
138.5x
(10.00)
-
10.00
20.00
30.00
40.00
50.00
60.00
70.00
80.00
Capital Invested (in $mm)
Capital Returned (in $mm)
590.00
Fund IV = $65MM
Total returned
$826MM
12.5x CC
Total invested
$66.3MM
102% of CC
Fund I
Fund IV
Fund III
Fund II
So, What Really Happens?
• Fund I – 9.2x overall– 2 @ 20-40x; 3 @ 10x; .529 avg.
• Fund II – 3.7x overall– 2 @ 20-40x; 2 @ 10-15x; .560 avg.
• Fund III – 4.1x overall– 2 @ 40-50x; .409 avg.
• Fund IV – 12.5x overall– 1 @ 140x; 3 @ 10-20x; .526 avg.
Practical Impact
• Capital invested matters
• Valuation matters
• VCs are sluggers, not looking for infield singles and walks
• Focus on potential winners
• Cents on dollar in bad deals not worth much
How Do We Manage Such a Process?
• Deal making – very hard because:– Usually invest before market is clear– Feedback loop very long (and expensive)– Success (and failure) has large luck
component
• Success in other venues no guarantee
• Like sailing blindfolded
Who Are Deal Makers?
• Each firm has deal makers of varying experience– General partner, managing director, etc.– Partner, principal, etc.– Associate, more or less senior– Analysts
Key Role - General Partner
• Make investment decisions– Initial investment is most important
• Help each company be as successful as it can be
• Sometimes less is more
• Help others apprentice
Herding Cats
• Very different models– Cowboy confederation model– Consensus models– Joe Blow Ventures – either you’re Joe or
you’re not
• Lots of blends of these
• Explains a lot of behavior
How We Make Decisions
• Slowly (these days)– Due diligence hell
• Some never tell you no
• The role of partners meetings
• Type of investment matters– New investments– Follow-on investments
How we get paid
• Depends on the model
• Management fee– % of committed capital– Imagine 10 year revenue visibility
• Profits interest (carry)– Helps if there are profits
What Breaks Down?
• Management fee– Role of multiple funds
• Carry– Fund by fund– Sharing philosophy
Multi-fund Firms
• Series of partnerships every 2-4 years
• Generally don’t overlap portfolios
• Crossover investing is big issue
• Know what fund you are in, and the rules
• Amplifies the management fee issue
What Can Go Wrong – New Investments?
• Unseen scar tissue
• Bad chemistry
• Bad hair day
• Misjudge the DMU
• Ego crowding
What Can Go Wrong – Existing Portfolio
Companies?• The living dead syndrome
• Chronic fatigue syndrome, VC style
• No money left problem
• Partner on the roof problem
• With some firms, “it’s in their nature”
• GP overload – drive-by board meetings