A Pilot Study and Analysis of the Role of Venture Capital in Our Economy

By: Charles M. Webb, III

What is Venture Capital

• Money provided to privately held firms• New entrepreneurial ventures• Long term horizon• Seed Capital• High Risk / High Return

What is a Venture Capital Fund

• Legal entity , usually a limited partnership

• General Partners manage the fund and select the investments

• Limited Partners provide the money usually more than 99 %

General Partners in a Venture Fund

• Manage the fund• Select the investments• Are liable for the debts of the fund beyond the

amount they invest in the fund• Generally not a natural person but some sort

of limited liability entity • Well Compensated

General Partner Compensation

• Two tiered• Fixed component usually 2 to 3 percent

of the funds already invested• Performance component approximately

20 percent of the profits of the fund.• Performance portion commonly referred

to as the “Carried Interest”

Limited Partners

• Play a limited roll, mostly passive investors

• Have some voting rights similar to investors in a mutual fund

• Provide the bulk of the capital• Have protection provided by the

partnership agreement

Partnership Agreement

• Sets the rights and responsibilities of both general partners and limited partners.

• Governs the activities of the fund.• Sets the life of the fund.• Defines the objectives and goals of the

fund.

Who Invests in Venture Capital

• Pension Funds• Endowment Funds• Other Venture Funds• Wealthy Individuals• Governments• Corporations • Must be an Accredited Investor

What are the Advantages

• Higher Return• Greater Diversity• Benefit from the inefficiency in pricing to

get a better buy in.• Using a fund allows them to outsource

the selection and management of their investment.

Corporate and Strategic Venture Funds

• Access to new products, markets, and technology

• Speeds up time to market• Allows the firm to aggregate all of their

R&D and Corporate Development initiatives.

Governments and Community Based Funds

• CIA, NASA, and The US ARMY have all started VC funds

• Like Corporations provides access to technology quicker than acquiring it thru the traditional means.

• Community based funds target blighted areas and invest in them to revive them

• Community based funds are profit driven and do not rely on taxes or donations

• Community based funds largest investors are banks

Intermediaries

• Funds of Funds• Consultants• Sponsors• Gatekeepers

Investment Selection and Oversight• Due Diligence• Where did the deal Originate• Business Plan Review• Is the investment inline with the goals of

the fund• Right location• Right product, market, technology• Right life stage

Investment Selection and Oversight

• Are the GPs familiar with the industry• Is the Management top notch• Are there gaps than need to be filled on the

management team• Can the VC team work with the Entrepreneurial team

on a personal level.• Is the potential investment sound financially.• Have all of the legal questions been addressed

satisfactorily.• Have all of the competitive issues been analyzed with

a satisfactorily result.

Value Added Services

• VC firms add more than just money• Management Advice• Recruiting Assistance• Board Representation• VCs only make money if the investment

is successful so they will help in any way to make that happen.

Term Sheets

• Set the structure of the deal• How much money will the VC firm provide• What percent of ownership will the VC get in

return• Contain the Securities Purchase Agreement• Covenants which both affirm and negate

actions taken by both parties.

Securities Purchase Agreement

• Describes the class of stock represented• What rights are attached to owning that stock• The amount of ownership the stock

represents• Voting rights• Dividend rights• What type of Board Representation they will

receive.

Types of Stock used in VC Deals

• Preferred Stock• Redeemable Preferred Stock• Convertible Preferred Stock• Common Stock

Employment Agreements

• Protect both the entrepreneur and the VC investors

• Defines the role and responsibilities of the Entrepreneurs who are working in the firm

• Defines compensation• Often includes non compete clauses

Stages of Venture Capital

• Seed • Start-up• Rapid Growth• First Stage• Second Stage• Mezzanine or Bridge Stage• Harvest $$

Valuation Concepts

• Asset Based Valuation• Comparable Capital Structure, Credit

Status, Depth of management, experience, and competitive factors

• DCF techniques• The Venture Method

Primary Research - Economist and Finance Professional Survey

On a scale of 1 strongly agree to 5 strongly disagree the average response was 2.8

10 questions Most agreed that innovation was most helped

by VC firms Least amount agreed that VC firms add jobs