Venture Capital and Private Equity Investing

©Cumming&Johan(2009)VentureCapitalInvestingVentureCapitalandPrivateEquityInvestingCumming&Johan(2009,Chapter10)©Cumming&Johan(2009)VentureCapitalInvesting2Figure1.1.VentureCapitalFinancialIntermediationInvestorsVentureCapitalistEntrepreneurialFirmReturnsCapitalEquity,Debt,Warrants,etc.CapitalPartII:Chapters4-9PartIII:Chapters10-14©Cumming&Johan(2009)VentureCapitalInvestingChapterObjectivesDueDiligenceStageofDevelopmentStagingValuationSyndicationBoardSeatsContractTermsSummary•ThischapteroverviewsissuesconsideredinChapters10-14,andprovidessupplementaryissuesdealingwithventurecapitalandprivateequityinvestmentactivities1.Duediligence(screeningpotentialinvesteefirms)2.Selectingthestageofentrepreneurialfirmdevelopmentatwhichtoinvest(thevariousstageswereindicatedinChapter1)andindustryinwhichtoinvest(e.g.,biotech,computers,etc.)3.Staging(numberoffinancingrounds)4.Valuation5.Syndication(numberofinvestors)6.Boardseats7.Contractsbetweenthefundanditsinvesteefirms,whichincludesdecisionsovermattersthatinclude,butarenotlimitedto:a.Security(debt,preferredequity,commonequity,etc.)b.Controlrights(suchastherighttoreplacethefoundingentrepreneurastheCEO,amongotherrights)c.Vetorights(suchasoverassetsalesandpurchases)©Cumming&Johan(2009)VentureCapitalInvesting1.DueDiligence:HowdoVC’schooseinvestments?DueDiligenceStageofDevelopmentStagingValuationSyndicationBoardSeatsContractTermsSummaryKaplanandStromberg(2004JournalofFinance)“Characteristics,ActionsandAnalyses:EvidencefromVentureCapital”©Cumming&Johan(2009)VentureCapitalInvestingData•67Investmentsfrom11U.S.limitedpartnerships•Specificdetailsintroducedherethathavepreviouslybeen‘unknown’outsidetheventurecapitalfundsthemselvesDueDiligenceStageofDevelopmentStagingValuationSyndicationBoardSeatsContractTermsSummary©Cumming&Johan(2009)VentureCapitalInvestingCriteriaforDecidingtoInvestA.Opportunity:MarketConditions,Product,StrategyandCompetition•Largemarketsizeandgrowth•Attractiveproductand/ortechnology•Attractivebusinessstrategy/model•Highlikelihoodofcustomeradoption•FavourablecompetitivepositionDueDiligenceStageofDevelopmentStagingValuationSyndicationBoardSeatsContractTermsSummary©Cumming&Johan(2009)VentureCapitalInvestingCriteria(continued)B.Management:QualityandPreviousExperience6.Qualityofmanagement7.FavourableperformancetodateDueDiligenceStageofDevelopmentStagingValuationSyndicationBoardSeatsContractTermsSummary©Cumming&Johan(2009)VentureCapitalInvestingCriteria(continued)C.DealTerms:Valuation,ContractualStructure,syndicateandportfolioconsiderations8.Lowvaluation9.Contractualstructurethatlimitsrisk10.Positiveinfluenceofotherinvestors11.GoodfitinVCinvestmentportfolioDueDiligenceStageofDevelopmentStagingValuationSyndicationBoardSeatsContractTermsSummary©Cumming&Johan(2009)VentureCapitalInvestingCriteria(continued)D.FinancialandExitConditions12.FinancialmarketconditionsandexitopportunitiesDueDiligenceStageofDevelopmentStagingValuationSyndicationBoardSeatsContractTermsSummary©Cumming&Johan(2009)VentureCapitalInvestingLargeMarketSizeandGrowth•Examples:•Twoveryimportantandvisiblemarketopportunities,whichshouldbothbeover$1Bwithanfewyears•Largemarketamenabletorapidgrowth•Verylargemarketinwhichincumbentscanearnhighprofitmargins•Virtuallyunlimitedmarketpotentialinthelongrun•Largeandgrowingmarketwithfavourabledemographicandprivatizationtrends•Companycoulddramaticallyimpacttheevolutionofthecomputerindustry•Dramaticshiftsinbusinessfavourthecompany’sproductDueDiligenceStageofDevelopmentStagingValuationSyndicationBoardSeatsContractTermsSummary©Cumming&Johan(2009)VentureCapitalInvestingAttractiveProductand/orTechnology•Examples:•Latestagesofproductdevelopment(firstproductlaunchplannedin15–18months)•Superiortechnologywithlargemarketpotential•Revolutionarynewtechnology•Hasdevelopedexcellentproduct•Hasbuiltarobust,scalablesystemthatcanmeetthecurrentmarketdemands•Bestproductonthemarket•Welltestedtechnology/product•Earlystagecompanywithpost-betaproductwithcompetent/experiencedtechnologyteamDueDiligenceStageofDevelopmentStagingValuationSyndicationBoardSeatsContractTermsSummary©Cumming&Johan(2009)VentureCapitalInvestingAttractiveBusinessStrategy/Model•Examples:•Companysignificantreducescostswhilemaintainingquality•Compellingbusinessstrategy.Presenceorlikelihoodofvalidatingcorporatealliances•Attractiveanddemonstratedprofitabilityofbusinessmodel•Excellentnewconcept•Dinstictivestrategy•Highvalue-added,highmarginstrategyforverylittleupfrontcapital•“Leanandmean”operationwithfewemployeesandgoodcustomerfocus•Pureplay/focusedDueDiligenceStageofDevelopmentStagingValuationSyndicationBoardSeatsContractTermsSummary©Cumming&Johan(2009)VentureCapitalInvestingHighLikelihoodofCustomerAdoption•Examples:•Conceptualacceptancebyprofessionalcommunity•Betaarrangementswithlargecustomers•Solidbaseofcustomerswhoregularlyrenew•Increasingpopularityofapproachamongcustomers•Companyhasveryinterestingbetasites,whohavebeenenthusiasticaboutproduct•Majorcorporationsarecustomersandarepositiveregardingthecapabilitiesoftheproductandthemanag