Professional Documents
Culture Documents
VENTURE CAPITAL
What is a venture?
An undertaking that is dangerous, daring or of uncertain out come. A business enterprise involving high risk in expectation of gain. Something, money or cargo, at hazard, in a risky enterprise.
What is Venture Capital? Venture capital is the investment of long term equity finance where the venture capitalist earns his return primarily in the form of capital gains.(Patient Risk Capital). VCs provide their own money for seed capital to research an idea, referred as Angels called Angel Capital.(Informal Venture Capital). Corporate Venture Capital- dedicated pool of money, refers to venture capital investments made by large corporations to further their strategic( Enhancement of financial or market position) interest.
trust. Mostly, VC funds, in India, are organized as limited life trusts, liquidated when the objectives are met. US funds are organized as Limited Liability Partnership while Indian VCs governed mostly by the Indian Trust Act. Both are created for a limited period with a clearly defined purpose and liquidated after achieving the objectives. It is now possible to form LLPs in India under Limited Liability Partnership Act-2008 but VCs are majorly organized as trusts due to 1. In sufficient clarity on the taxation aspects. 2. Ambiguity regarding the applicability of SEBI regulation to LLPs viz lack of clarity about LLPs activities.
Liability Partnerships now also legal in India. Protects external investors from direct liability while providing them of a partnership agreement. VCs are managed by experienced money managers, called General Partners(GPs), responsible for managing the affairs of the fund. Investors are called Limited Partners(LPs).Their involvement is limited , to provide money to create the VC fund. Passive Investors: Institutions, pension funds, banks, insurance companies etc . Professional Money Managers, the GPs, providing limited money & have complete control on the management of the fund with some checks and balance.
VC may be raising money for one fund, investing/monitoring the
Ins com
Pens fund
Large corp
HNWI
General Partners
VC fund
Mgrs
Portfolio
Com-A
Com-B
Com-C
Com-D
Com-E
Com-F
RAISING VC FUNDS:STEPS
1)Private Placement Memorandum(PPM): Document contains information such as the fund size, investment strategy, returns expected, minimum contribution expected, expected life of the firm. Investors make commitment & signs subscription or investment agreement with the VC fund. 2) Closing: The fund remains open for investment for a defined period , say 1 to 2 months, after which it is closed. Usually, 10% to 20% of the amount is collected from the investors at the closing stage. 3) CALLED: The rest of the commitment is Called by the fund in accordance with the call down schedule. Typically, the money is collected from investors in tranches (around 15% to 25% of the commitment amount) over the first two years of the funds life. In the process, money does not remain idle helping VC to maintain the targeted return.
Invested in ventures with defined targeted profile. Substantially Invested and Monitoring Portfolio (Year 4-7): Monitored and to ensure that the requisite value is created. Exit through IPOs and Strategic Sales (Year 5-7): Monies realized will be propotionately distributed to the investors of the fund. Distributions (Year 7-9):Liquidation and distribution to investors in the ratio, invested.
VC RETURN METRICS
Internal Rate of Return:
A. The internal rate of return is an annualized rate of return over the
period between investment and final return and expressed as a percentage. B. VC fund having a fixed life of 10 years earns returns at an IRR 30% per annum, means that the corpus has grown at a compounded rate of 30% per annum over the entire period of 10 years. Exception in VC fund:
A. VC funds, investments are made in stages and also returned in
stages B. IRR measures the time value of money by taking into account the timing of cash flows, in and out, of the fund.
VC RETURN METRICS
Investment Multiple: 1. It is a simple cash-on cash return. 2. Calculated by the monies received divided by the monies invested. 3. Simple measure and does not take into account the number of years the monies remain invested. 4. IRR falls if the money remains invested for a longer period but return the same investment multiple. Example: INR 100 reached at INR176 after 5 years of investment in Bank , at an IRR of 12%.If same amount of money received after 8 years, IRR reduced to 7.5%.The main reasons why VCs are constantly looking for a good exit at the earliest. IRR% for Different Multiples of X
Year 3 5 2x 26.0 14.9 3x 44.2 24.6 4x 58.7 32.0 5x 71.0 38.0 6x 81.7 43.1 7x 91.3 47.6 8x 100.0 51.6 9x 108.0 55.2 10x 115.4 58.5
higher risk by investing in unlisted , risky & even new business. B. Relationship between risk and the build up of return as compensation for assuming greater risks. Risk Free rate of 8%: Usually reflected by the yield on the 10 year Government Bonds. Investors always aim, at least to make an average around 8%, in tune with the Govt bonds yield. Equity Premium of Another 8% for Market Risk Additional return over and above the risk free return , compensating the risks taken due to investing money in the equity, of unlisted company. VC Risk Premium of Another 8%(Investors expectation) Investors like another 50% return over and above they could make by investing in listed securities ,considering average equity return of 16% for longer term.
PORTFOLIO PERFORMANCE
Overview of VCs portfolio return amounting to INR100Million Investment Type No of Companies Total Invested Value after 5 Yrs Stages Industry Sunk 3 30 0 Seed Electro nics Average 3 30 120 Start up Computer Software Superior 2 20 100 Early Stage Consumer related Solid 1 10 80 Later Stage Industrial Products Super Stars 1 10 100 Turnaround Medical (INR in M) Total Portfolio 10 100 400
Return Multiple
IRR%
0X
0%
4X
32%
5X
38%
8X
52%
10X
58%
4X
32%
A. The fund has earned an IRR32% over 5 years in spite of the fact that
30% of its investment were total loses. B. Conclude that in general, every three of VCs investments could able to succeed to generate return multiple.
to be 4. Risk they can take 5. Sources and cost of funds 6. Style of investment i.e. how much involvement in the management, monitoring and control of the business they consider necessary to ensure a profitable exit.
(High Risk)
VC RISK STRATEGY
Early Growth Stage (Medium to High Risk)
inventor or entrepreneur to prove a concept. This involves product development and market research as well as building a management team and developing a business plan, if the initial steps are successful, is a pre-marketing stage. EARLY STAGE FINANCING ( 4 to 7 years , expected return 50%-80%)
This stage provides financing to companies completing development
where products are mostly in testing or pilot production. In some cases, product may have just been made commercially available. Companies may be in the process of organizing or they may already be in business for three years or less. Usually such firms will have made market studies, assembled the key management, developed a business plan, and are ready or have already started conducting business.
company. It may or may not be showing a profit. Some of the uses of capital may include further plant expansion, marketing, working capital, or development of an improved product. More institutional investors are more likely to be included. VCs role evolves from a supportive role to a more strategic role. LATER STAGE ( 3 years to 5 years, expected return 30% to 50%)
Capital in this stage is provided for companies reached at a fairly
stable growth rate , may not be growing as fast as the earlier stage. These companies may or may not be profitable, but are more likely to be better than in previous stages of development. Other financial characteristics include positive cash flow. This also includes companies considering IPO.
companies or assets. A consolidator of companies in specific industries. MANAGEMENT/LEVERAGED BUYOUT (Depends on the situation)
These funds enable an operating management group to acquire a
product line or business, at any stage of development , from either a public or private company , may be closely held or family owned. Management/leveraged buyouts usually involve revitalizing an operation, with entrepreneurial management acquiring a significant equity interest.
VC INVESTMENT PROCESS
A. Deal Sourcing: Identification of attractive investment opportunities B. Evaluation of business aspects: ( 85% to 90% rejection) Management: (Composition,motivation,commitment,vision,partner) Growth Potential (Product/Market Dynamics), (Scalability, industry) Profitability:( Economies, infrastructure, capital intensity,WC Reqr) Investment Requirements:(size, Rounds of finance, portfolio size) Exit Opportunities, timing & Return:( Risks & Reward, exit time) C. Deal Structuring and Negotiation: Creating Documents on accepted agreements-called Term Sheet D. Due Diligence Review: (Scrubbing the Deal) Detailed examination by VC on the business plan & representation. E. Legal Documentation: Finally, Legal vetting of term sheet
ENTREPRENEURS ANXIETY
Myth 1: Take over of Business: VCs primary business is money management. Objectives are protection and harvesting their investment for huge profit. Myth 2: Looking control of Business by Vc. VCs have control over the crucial decision making process, not on day to day operational affairs. Myth 3: Selling of Business to enable the VC to Exit. VCs look clear path to realize their profit, selling is the last resort Myth 4: Need to change the way of working. Founder is more responsible than VCs- to recognize all time Myth 5: Open up of Business secret causing detrimental to business. VC is a partner of your business having same footing like you. Myth 6: VCs unreasonable demand for high return. VC funding carries high risk. High return is the only alternative.
to address any existing pain in the targeted customers. Offering any unique and differentiated products than competitors. Having huge market size & growing rapidly. Existence of entry barriers. Expected revenue to grow over 50% pa over the next five years. Motivated management team, aiming to grow the business. Roles, responsibilities, rewards of the Leaders are clearly defined. No legal violation, compliance of all regulatory requirements. Policy, procedures & process should promote efficiency/scalability. Ready to sell off a part to VC. Willing to be accountable for performance to the VC. Willing to change working style to accommodate VCs monitoring. Have a clear exit strategy.
PROCESS OF RAISING VC
Step 4: Term Sheet Negotiation Awareness of VC terms sheet , transformed to be a legal document Sound negotiating strategy prior to start of the funding by VC. Step 5: Due Diligence. Investigation of ventures business by VC VCs validation of historical and operational information, submitted by ventures Prior competency to know expected issues that lead VCs, saying no. Step 6: Legal Documentation Investment Agreement Share holders Agreement Confidentiality and non disclosure agreement Service Contracts for Key employees and Directors Non negotiable key clauses from the VCs stand point , awareness.
Initiate VC funding activities, when venture has least need of the money . Have a financially good year, move to VC at the end of the fiscal year with audited balance sheet and with current year forecast besides updated achievements. Major event ( Products trial run , acquisition of new customer or big order etc) , having positive impact on the future growth of your business lead to be a positive point to consider by VC. External environment like booming of capital market will help the ventures to get a higher valuation of their business. VCs are also able to raise more money and keen to invest into the best opportunities
OTHER INSTRUMENTS: (Innovative Financial Instrument) A. Participating Debentures stipulating a three phase system charges;
Interest Holiday till the project is implemented successfully. II. Lower rate of interest till the project operates at a particular level of capacity utilization. III. Increased rate of interest and a small royalty on sales once the project takes off. B. Partially convertible debentures, Cumulative convertible preference Shares, C. Hire purchase, lease finance & even overdraft in selected cases.
I.
established in the dot-com boom of the year 2000. The three funding shareholders who are still directors and managers of the company own 30% of PDQ plc. Employees, friends and relatives of the founders own a further 15%. The majority 55% shareholding is owned by a venture capital company that bought a stake in PDQ plc four years ago for INR12M. The venture capital company now wishes to dispose of the holding. The 45% minority shareholders and non-shareholding employees are considering a management buyout. PDQ plc has sustained losses for the past three years but believes it is now moving into profit. Because of this losses, no liability to tax will arise in AY 2014 but the company will begin to pay tax at 30% per annum from AY 2015. It has not declared or paid a dividend since the company was formed.
(INR M)
31/3/2013 14.52 16.97 (2.45) 0.50
Direct Costs & Expenses 12.50 Profit/(Loss) before tax 2.75 BALANCESHEET FOR THE YEAR ENDED Fixed Asset(NV) 0.50 Inventory 1.25 1.25 Receivables 4.25 3.25 Cash & Marketable Securities Current Assets Less Current Liabilities Trade Payables Bank Overdraft Total Net Asset Ordinary Share capital of INR1 Total Reserve Net Worth 0.50 00
6.00
2.80 00 3.20 0.85
4.50
2015-2017 inclusive, falling to 5% each year after that. The average P/E ratio for established listed companies in the industry is currently 28.4 but there is a wide range of between 7.5 and 51.5. The average post tax cost of equity capital for the industry, according to a recent study, is 15%. Requirements Advise the founders/employees on the following: The price they might have to offer the venture capitalist to succeed with a management buyout. You should include in your discussion the various methods of share valuation that might be suitable in the circumstances. Make and state whatever assumptions you feel are necessary and appropriate. The Advantages and disadvantages of pursuing a management buyout at the present time compared with the possibility of a sale of the venture capitalists shareholding to another investor.
VENTURE CAPITAL
GOOD WISHES
TO ALL