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October, 2003
Overview
VC and corporate finance Overview of VC industry The VC life cycle The VC investment process Negotiations Valuation and pricing Deal structure The Venture Capital Method The Shareholders Agreement Growing the business The exit
Conventional Financing
Assets
Inventory & receivables Land & buildings Equipment & vehicles Other
Liabilities & Equities Operating line of credit Mortgage Term loan Share capital & retained earnings
VC Financing
Fills the cash gap between cash needs to finance high growth and cash available from earnings and conventional financing Giving up a piece of the pie to grow a bigger pie
Overview of VC Industry
Angel investors Private equity funds Labor sponsored funds Institutional investors Diversified versus focused Venture Capital Trends
$80 $60 $40 $20 $0 1995 1996 1997 1998 1999 2000 2001
U.S.A. CDN
$Millions
$50 $40 $30 $20 $10 $0 1996 1997 1998 1999 2000 2001 >$5000K
$33M $23M
<$500K
$500-$999K
$1000K-$4999K
$2,986M
1999
2000
2001
Technology
Traditional
Knowledge Acquisition
Concept Investigation
Basic Design
Prototype Building
Market Entry
Manufacturing Ramp-up
Government Programs Public Issues Commercial Banks Non-Financial Corporations Seed Funds Venture Capital Funds
Sales ($ millions)
50 40 30 20
VC Prospects Moderate-Growth Firm
10 0 1 2 3 4 5 6 Years
Low-Growth Firm
10
VC Investment Criteria
Exponential growth potential Attractive industry Sustainable advantage platform Excellent team execution Owners receptive to involvement of outsiders Owners willing to share the wealth creation Credible exit alternatives (4-7 years out)
VC Target IRR
Seed Startup First stage Second stage Bridge Restart IRR>80% 50-70% 40-60% 30-50% 20-35% ??
In early stage companies VCs have to value the ingredients and estimate what the cake might look like in 3 to 5 years!
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Why so High?
Base IRR =risk free rate Plus premiums
Why so High?
Systematic risk in capital markets Unsystematic (unique) risk diversified away VC firms more vulnerable to market swings
Why so High?
Liquidity premium 4-7 year investment time horizon Not easy to liquidate investment
Why so High?
Value added premium Recruitment of key personnel Strategy Board of Directors Network Deep pockets
Why so High?
Portfolio average return 2-6-2 rule
Magnitude of Investment
Typically >$1.0 million for institutional Small deals too costly Typically less than $10 million in Canada Based on business plan pro forma
Staging of Investment
All up front Two or three tranches Contingent on meeting milestones/targest Option to abandon
Syndication
Sharing the deal with other VC firms Diversify the risk Broaden the network Increase size of portfolio
Target IRR
25-80 % Stage of company Use of funds Deal structure
% Ownership Required
Magnitude of investment Duration of investment Target IRR Terminal value of firm Room for future investment?
% Ownership Required
Deal Structure
Shares Shares and subordinated debt Shares and convertible subordinated debt What is the upside? What is the downside? Does the structure affect the risk to the VC?
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Scenario A
Scenario B
Scenario C
Sensitivity Analysis
Terminal Value
Future Earnings (Sales, Expenses, Profits) PER
Target IRR
Risk Deal Structure Liquidity
Dilution
Future Rounds (Amounts, IRR, Horizon) Management incentives
VC Fees
Commitment fee Termination fee Due diligence expenses Legal expenses All paid by company
Shareholders Agreement
Defacto control over critical decisions
Hiring/firing key management personnel Budgets and capital expenditures Financing Strategic changes Veto rights Dispute resolution
Shareholders Agreement
Exit Provisions
Put/ Call Rights Drag Along Rights Tag Along Rights Right of First Refusal Rights Valuation formula/process
Shareholders Agreement
Corporate Governance
Board of Directors Independent members Swing vote to independents Help create value
Corporate Governance
No interference in day-today operations Regular reporting (monthly) Regular Board meetings Annual audits Performance assessment Help out when needed
Exit Alternatives
Sale to company treasury Sale to equity partners Sale to owners/management/employees Sale to third party (VC shares or all) IPO Hold and milk Liquidate
ACF Equity Atlantic Inc. BMO Capital BDC Venture Capital Group Canadian Science and Technology Group Roynat Manulife EDC
CDP Accs Capital CDP - Sofinov Genesys Capital Partners Latitude Partners Ventures West Management Inc ETSIF Skypoint RBCP.