Course Description
MBA Program
SB/ENTR6910.030A: VENTURE CAPITAL AND PRIVATE EQUITY
Fall 2007
R 08:30 - 11:30
Room SSB W136
Catalogue # K96S01
Term: F2
Exam: D1
Kevin Talbot
COURSE
DIRECTOR:
SSB N305P
OFFICE:
OFFICE
TELEPHONE:
By appointment
OFFICE
HOURS:
ktalbot@schulich.yorku.ca
EMAIL:
ENTR 6910A – Fall 2007 Final 1
ADMINISTRATIVEClara Kan
ASSISTANT:
SSB N305A
OFFICE:
416-736--2100 x 77960
TELEPHONE:
EMAIL:
ckan@schulich.yorku.ca
Schulich School of Business
York University
ENTR 6910A
Venture Capital and Private Equity
Fall 2007
W136 SSB
Thursdays 8:30am – 11:30am
Syllabus and Class Schedule
Course Director: Kevin Talbot Secretary: Clara Kan
Office: SSB N305P Office: SSB N305A
E-mail: ktalbot@schulich.yorku.ca E-mail: ckan@schulich.yorku.ca
Office Hours: By Appointment Phone: (416) 736-2100 x77960
Website: www.carriedinterest.net
Please read this outline in its entirety as there are very specific instructions and details
about which you must be aware. Ignorance of the contents of this document and
procedures desribed herein will not be accepted as an excuse for not adhering to the
procedures for this course.
Overview
The 1980s and 1990s saw a tremendous boom in the private equity industry. The pool of U.S.
private equity funds – partnerships specializing in venture capital, leveraged buyouts, mezzanine
investments, build-ups, distressed debt, and related investments – has grown by over 3000% in
the last fifteen years. Private equity’s growth over that period has outstripped that of almost
every class of financial product.
Despite this growth, many questions about private equity remain unanswered, and many of its
features continue to be mysterious. How do venture capital and buyout funds create value? What
explains this tremendous growth in these funds? What explains the process of boom and bust: the
rapid increases in fund-raising in the late 1960s, mid-1980s and late 1990s, and the precipitous
declines in the 1970s, early 1990s and early 2000s? To what extent is the model developed and
refined over the past several decades likely to be translated into other countries and types of
investments? Lerner, J., Venture Capital and Private Equity, New York, John Wiley & Sons, 2005, p. 1
This course explores these exciting and important questions by looking at how these
organizations work, why they are structured the way they are and what implications are in-store
for innovation and entrepreneurship in the future.
Career Focus
This course is primarily geared to students interested in working in venture capital or other
private equity organizations at some point in the their careers. It is also valuable for those who
intend to work alongside venture capitalists as managers of firms being financed by such
investors, as lenders to companies in knowledge-based industries, as investment bankers taking
these companies public or as money managers investing in this asset class. It is also relevant to
students interested in applying aspects of private equity investing to established organizations in
both the private and public sectors.
Course Outline
This course focuses on the "private equity cycle” beginning by considering how private equity
funds are raised and structured, paying special attention to the differing perspectives and
incentives of institutional investors, "gatekeepers," fund-of-fund managers, and private equity
investors. Second, we will explore how investments are evaluated, structured, and overseen. We
use two frameworks to understand the crucial problems that firms seeking private equity pose to
investors: illiquidity and information asymmetry; and how private equity organizations address
them. Finally, the course addresses the often-problematic ways in which venture capitalists
harvest investments. The final module explores whether the private equity system can be
duplicated in other settings. Throughout the course we will also touch on career issues with
respect to private equity.
Module One – Fundraising
We will examine and analyze the process of how private equity funds are structured and raised.
These funds are often shaped by complex and arcane legal issues and the structure of such funds
has a profound effect on the behaviour of venture investors and fund managers. As a result, it is
as important for entrepreneurs raising capital to understand these issues as it is for partners in a
fund.
Module Two – Investing:
In the second module we will consider the interactions between private equity investors and the
entrepreneurs that they finance. We will examine the process of identification, selection, due
diligence, valuation and term sheet negotiation from both the investor and entrepreneur’s
perspective.
Module Three – Harvesting:
The third module examines the process by which private equity investors exit their investments.
A fund’s ability to generate attractive returns for investors is dependent upon successful and
timely exits. We will look at the inherent conflict between the private equity investor’s mandate
and their behaviour during the exiting process, and the needs of the entrepreneur.
Module Four – New Models:
In the final module we will review many of the key ideas developed during the course in the
context of organizations with different goals from traditional private equity organizations
including large corporations, government agencies, and non-profit organizations that are
increasingly emulating private equity funds. In many cases, the goals of these organizations are
quite different (e.g. enlightened self interest or effective commercialization). In this module we
will examine the similarities and differences with a view to identifying key success factors for
traditional venture organizations.
In considering this material, we will investigate the internal management challenges faced by
venture capital and private equity organizations, as well as their relationships with pension funds,
investment managers, entrepreneurs, and investment bankers.
This course is based entirely on US and International case studies that are taught at the Harvard
Business School. This course is intended to complement others in entrepreneurial studies and
corporate finance that students should have completed prior to enrolling in this course.
Completion of all 5000-level courses is a pre-requisite without exception.
Format, Grading and Assignments
This course is case-based with a heavy emphasis on class discussion. You are recommended to
form study teams to prepare for each case. Individual students will be asked to lead discussions
and make spontaneous presentations about the cases and discussion topics. Teamwork is actively
encouraged to frame and solve problems and the workload is heavy. Throughout the term, guest
speakers from the world of private equity will bring context to our discussions. Participation is
determined based on preparedness for and contribution to class discussions. All students are
expected to participate in class discussion and should prepare to be cold-called. Students should
note that the workload for this course is heavy.
Class Participation (30% of overall grade)
Class participation is very important in a case-based course. Class discussion is an excellent way
of learning from your fellow students and, perhaps as important, learning how to make
constructive and valuable comments that contribute positively. In this regard, it is impossible for
you to make very insightful comments without adequate preparation including reading the
assigned material, reviewing the assigned cases and preparing responses to these cases on a
weekly basis. Class participation, however, is about quality of contribution not quantity.
You are better off making one insightful comment in a class than either not contributing at all or
trying to overpower the discussion in the hope that at least one comment is of value.
Assessment of student participation is entirely subjective and based on the instructor’s
observations of your positive performance during class discussions. Attendance will be taken in
this course; however, simply attending class without active participation will not earn a passing
grade on the participation component of the overall grade. You cannot participate if you do not
attend; however, your participation grade is based entirely on your preparedness for and
contribution to class discussion. Students are required to display their name cards and sit in
the same seat for each class.
Case Study Assignment (20% of overall grade)
Students will complete the Case Study Assignment on an individual basis. You are required to
submit up to a three-page double spaced report (plus up to two pages of supporting calculations
(including spreadsheets, assumptions, etc.), if applicable) for the Adams Capital Management:
March 2002 case being discussed in Week 6. The case study must be submitted by email,
before 5am eastern time on October 18th, to entr6910@gmail.com. Please do not include a
cover page but do ensure that your name and student number are included in the footer. Careful
attention to spelling and grammar are suggested as this will affect your grade. Late submissions
will NOT be accepted.
It is strongly recommended that you form study groups to discuss, prepare and review case
submissions as part of your preparation for class discussion and to learn how to write effective
case study reports well in advance of this assignment.
Mid-term Assignment (20% of overall grade)
The mid-term assignment is an individual project consisting of a short and concise PowerPoint
presentation articulating your recommendation for the Martin Smith – May 2002 case assigned
in Week 7. The presentation must be submitted electronically (by email to
entr6910@gmail.com and cc to ktalbot@schulich.yorku.ca) by 5am eastern time on the day
BEFORE session 7 (which is October 31st). You will be graded on your submission and several
students will be cold-called to present their assignments to the class. Late submissions will NOT
be accepted.
Final Assignment (30% of overall grade)
An important component of the course is the final assignment The final assignment must be
completed on an individual basis (i.e. no group work). The assignment will be distributed at the
end of session 12 and is due during exam week. Specific details of the assignment, its due date
and arrangements for submission will be discussed in class. Attendance at session 12, to receive
your final assignment, is mandatory. Late submissions will not be accepted.
Grading Scale & Calculation of Final Grades
A+
9
B+
6
C+
3
A
8
B
5
C
2
A-
7
B-
4
C-
1
You will be assigned a letter grade for each of the four grading components of the course. Each
of these letter grades are converted into their numerical equivalent and multiplied by their
representative percentages. The calculated scores for all four segments are then added together
(and rounded up or down to the nearest whole number) and you are assigned the corresponding
letter as your final grade for the course.
Academic Honesty
Please familiarize yourself with the University’s policies with respect to Academic Honesty (see
Academic Policies and Regulations in the Graduate Student Handbook). These policies will be
strictly enforced by the instructor.
The Course Director reserves the right to make changes to this course outline at any time and
for any reason.
Course Materials
Required Texts:
Hardymon, Felda, Leamon, Ann and Lerner, Josh, “Venture Capital and Private Equity –
A Casebook – Third Edition”, 2005, John Wiley & Sons Inc.
Strongly Recommended Reading:
Ellet, William, “The Case Study Handbook”, 2007, Harvard Business School Press.
Recommended Reading:
Gompers, Paul A. and Lerner, Josh, “The Venture Capital Cycle”, 2001, MIT Press.
Gompers, Paul A. and Lerner, Josh, “The Money of Invention”, 2001, Harvard Business
School Press.
Gupta, Udayan, “Done Deals: Venture Capitalists Tell Their Stories”, 2000, Harvard
Business School Press.
Wilson, John W., “The New Venturers – Inside the High-Stakes World of Venture
Capital”, 1985, Addison-Wesley Publishing Company. (Note: This book is out of print
and may be difficult to locate.)
Fenn, George, Liang, Nellie, and Prowse, Steven, “The Private Equity Industry: An
Overview”, (Financial Markets, Institutions and Instruments Series, Volume 6, Number
4), Boston, Blackwell Publishers, 1997. (An older version was published as The
Economics of the Private Equity Industry, Washington: Federal Reserve Board, 1995,
and is available on-line).
Course Outline
Please Note: There will be no session on September 6th. The first meeting of the class will be
September 20th. You are required to complete the cases and readings assigned for Session 2
prior to the first meeting of the class.
Week Topic & Case
Reading
Advance Preparation
Students wishing to do advance reading for this The Private Equity Industry:
course are recommended to review the following An Overview (see
prior to the first session.
Recommended List above)
The Money of Invention
Chapters 1-4
Course Introduction
1
There will be no class held on September 6th
Module One – Fundraising
2
An Introduction to the Private Equity
Industry
Private Equity Today and
Tomorrow
(Casebook pp. 1-9)
Case: Martin Smith - January 2002
An MBA candidate faces a choice between
positions in different private equity
organizations. To make the best career choice,
the student must consider a large number of
features of these funds. The opportunities appear
to differ significantly and fully assessing the
extent of these differences is challenging.
Introduction to Module 1 The Private Equity Cycle:
Fundraising
(Casebook pp. 21-24)
Objectives and Perspectives of Institutional
Investors
Case: Yale University Investments Office - July
2003
A large university endowment has relied on
private equity to achieve very attractive returns
over the past 17 years. The fund manager must
decide whether to continue to invest heavily in
private equity in light of current market
conditions, and – if so – which sub-segments of
private equity and which types of funds to select.
3
The Structure and Role of Compensation
Schemes
Case: Acme Investment Trust: January 2001
A pension fund must decide whether to invest in
a new private equity fund organized by Hicks,
Muse, Tate and Furst (HMTF). The proposed
terms of the new fund include a personal
guarantee from the general partners of a 20%
return over 5 years on the $200 million already
invested in 13 Internet transactions. The pension
fund officials must assess the reasons behind and
implications of this offer.
4
Intermediation in Private Equity
Case: Grove Street Advisors
Note on Private Equity
Partnership Agreements
(Casebook pp. 64-75)
Clint Harris, the managing partner and cofounder of Grove Street Advisors, a provider of
individually tailored private equity investment
programs for large institutions, has been
pleasantly surprised by the success of his
organization over its five-year life. By offering a
unique combination of private equity experience
and knowledge of the needs of public pension
funds, the group now has over $3 billion under
management. Along with one of the largest
pension funds in the world (California Public
Employees Retirement Systems, or CalPERS),
his firm’s client list includes a major European
pension manager and a mid-sized state
organization. Looking forward, though, he and
his partners must decide how they can grow in a
market that is becoming increasingly
competitive.
5
Challenges of Fund Raising
Case: Gold Hill Venture Lending
Note on Private Equity
Fundraising Process
(Casebook pp. 105-110)
Dave Fischer, one of the founding partners of
Gold Hill Venture Lending, a new venture debt
fund, is trying to raise $200 million to get the
operation off the ground. Gold Hill is a spin-off
from Silicon Valley Bank (SVB), the world’s
largest technology lender, and the founders plan
to work closely with the parent, sharing deal
flow, back office support, and the contacts and
background information developed during
SVB’s 20 year history in providing banking
services to venture-backed companies. Yet the
fund-raising has proceeded less smoothly than
anticipated. Fischer and his partners have to
consider whether to continue to try to raise the
full amount or to raise a smaller fund, prove the
model, and then return to the market with a more
substantial track record.
Module Two – Investing
6
Case: Adams Capital Management – March
2002
Introduction to Module 2 The Private Equity Cycle:
Investing
(Casebook pp. 137-142)
Adams Capital Management (ACM), an earlystage venture capital investment firm, has
developed a strict set of guidelines to use in
assessing and managing its portfolio companies.
On the basis of this system, which emphasizes
NOTE: Case Study
Assignment Due before 5am
today. Please see
instructions for submission
above.
Investment and Monitoring Strategies
investing in applied business-oriented
technology that exploits fundamental market
changes, the partners raised $700 million in
three funds between 1997 and 2000. By 2002,
however, the venture environment had changed
substantially and ACM’s partners must reexamine both their markets of interest and their
strategy.
7
Evaluating Investment Opportunities
Case: Martin Smith - May 2002
Martin Smith has just started his career as an
associate with Newport Partners, a prestigious
East Coast leveraged buyout (LBO) firm. His
first assignment is to assess three possible
investments, based on their PowerPoint
presentations, and report to the partners’
meeting. Each company has different strengths
and weaknesses, and Martin must try to
evaluate them in the context of his firm’s own
assets and constraints.
8
Deal Structure, Negotiation, Due Diligence,
and Valuation Techniques
NOTE: Mid-term
Assignment Due before 5am
October 31st. Please see
instructions for submission
above.
Note on Valuation in Private
Equity Settings
(Casebook pp. 204-223)
Case: Brazos Partners: the CoMark LBO
The partners of a new mid-market buyout fund
are working on a buyout of a closely held
modular building company. Although originally
structured as a stock deal, they have realized
that an asset deal would be preferable from their
point of view and are trying to determine what
benefits it might hold for the sellers, whose
continuing involvement in the company is
essential for success. This case describes the
process of the deal’s due diligence, the
structuring of a leveraged buyout, and the state
of the buyout industry in the early 21 st century.
9
Introduction to Venture Capital Term Sheets Note on Private Equity
Securities (Casebook pp.
Case: TBD (will be handed out in class)
288-295)
10
Term Sheet Simulation
Case: The Endeca Negotiation
NOTE: Case study will be
handed out in Session 9 (we
are not using the version in
the case book).
Steve Papa, CEO of Endeca Technologies is
trying to decide between two term sheets for his
company’s C round. Although the company’s
product is installed at some well-known
customers, the fund-raising has coincided with
the NASDAQ downdraft of 2001. Both term
sheets value the company at far less than the
pre-money at which Papa had started the
process. One comes from the insiders; the other
offers a slightly higher price per share but will
change a board that has worked well thus far. In
addition, the insiders have requested full-ratchet
anti-dilution protection on the B round shares, a
change from the weighted-average protection in
the contract. How did this happen and which
term sheet should Papa accept?
Module Three – Exiting
11
Exiting the Investment
Case: Apax Partners and Xerium S.A.
Introduction to Module 3 The Private Equity Cycle:
Exiting
(Casebook pp. 349-352)
Apax Partners, a global private equity firm, is
considering the best approach to exiting one of Note on the Initial Public
its buyout investments: Xerium SA, a maker of Offering Process
inputs to the paper industry. While the company (Casebook pp. 398-403)
is doing well and has paid off its acquisition-
related debt ahead of schedule, a sale – either to
another private equity house or to an industry
acquirer – is proving difficult, and the company
is not well suited for an initial public offering
(IPO). The Apax partner involved must
investigate the possibility of doing a
recapitalization, and how that will affect the
firm’s efforts at raising a new fund, returns to
the fund out of which Apax purchased the
company, and the company’s future
performance.
Between a Rock and Hard
Place: Valuation and
Distribution in Private Equity
(Casebook pp. 404-432)
Module Four – New Models
12
Introduction to Module 4 The Private Equity Cycle:
New Frontiers
(Casebook pp. 433-439)
Corporate Venture Capital
Case: In-Q-Tel
Gilman Louie, CEO of In-Q-Tel, the investment
arm of the Central Intelligence Agency (CIA)
must recommend whether or not to expand the
number of government agencies his group will
serve. This case presents the history and
structure of the unusual effort and explores the
public sector’s attempts to stimulate private
sector innovation for its own use.
Note on Corporate Venture
Capital
(Casebook pp. 505-509)
Note on Private Equity in
Developing Countries
(Casebook pp. 336-347)
Final Assignment Handedout (Due Exam Week)
Course At-a-Glance
Week
1
2
3
4
5
6
Date
Sept 6
Sept 20
Sept 27
Oct 4
Oct 11
Oct 18
Module
Topic
Fundraising
NO
CLASS
An
Introduction
to the Private
Equity
Industry
Investing
The Structure Intermediation Challenges
and Role of
in Private
of
Compensation Equity
Fundraising
Schemes
Investment
and
Monitoring
Strategies
Acme
Grove Street
Investment
Advisors
Trust January 2001
Gold Hill
Venture
Lending
Adams
Capital
Management:
March 2002
Note on
Note on
Intro to
Objectives
and
Perspectives
of
Institutional
Investors
Case
Martin Smith
– January
2002
Yale
University
Investments
Office – July
2003
Reading
Private
Oct 25
READING
WEEK
Equity Today
and
Tomorrow
pp. 1-9
Intro to
Module 1 –
Fundraising
pp. 21-24
Private
Module 2 –
Equity
Investing
Fundraising pp. 137-142
Process
pp. 105110
Private Equity
Partnership
Agreements
pp. 64-75
Week
7
8
9
10
11
12
Date
Nov 1
Nov 8
Nov 15
Nov 22
Nov 29
Dec 6
Exiting
New
Models
Investing
Topic
Evaluating
Deal
Introduction Term Sheet Exiting the Corporate
Investment Structure, to Term
Simulation Investment Venture
Opportunities Negotiation, Sheets
Capital
Diligence
and
Valuation
Techniques
Case
Martin
Smith: May
2002
Brazos
TBD
Partners:
the CoMark
LBO
Mid-Term
Assignment
Due
Reading
Note on
Valuation in
Private
Equity
Settings
pp. 204-223
Note on
Private
Equity
Securities
pp. 288-295
The Endeca
Negotiation
(handed out
Nov 16th)
Dec 13
Apax
In-Q-Tel
Final
Partners
Assignment
and Xerium Final
Due
S.A.
Assignment
Handed-out
Intro to
Module 3 –
Exiting
pp. 349-352
Note on
Initial
Public
Offering
Process
pp. 398-403
Between a
Rock and a
Hard Place:
Valuation
and
Distribution
in Private
Equity
pp. 404-432
Intro to
Module 4 –
New
Frontiers
pp. 433439
Note on
Corporate
Venture
Capital
pp. 505509
Note on
Private
Equity in
Developing
Countries
pp. 336347
Case Study Questions for Class Discussion and Case Reports
The following are suggested study questions for the cases covered in this course. These questions
may be used as a framework for class discussion, but this is not meant to be an exhaustive list
and, in class, we may deviate from the framework. Analysis of cases is left to your discretion and
there is no requirement that you restrict yourself to these questions. You should feel free to
address any other issues that seem relevant.
You are required to prepare all cases for purposes of class discussion.
Martin Smith – January 2002
What job should Martin Smith take?
Yale University Investments Office – July 2003
Why is Yale investing in private equity?
What is Yale’s private equity investment strategy?
How is the private equity industry changing and what are the implications for Yale’s strategy?
Acme Investment Trust – January 2001
What differentiates HMTF from other private equity groups?
Why are the incentives offered to private equity investors so similar?
What are the financial implications of HMTF’s offer?
Should Acme invest?
Grove Street Advisors
How does Grove Street Advisors propose to create value for its investors? Are their arguments
plausible?
Why are venture capitalists interested in having GSA as a potential investor?
How should GSA address the strategic choices that it is currently facing?
Gold Hill Venture Lending
Why would a CEO of an entrepreneurial firm and her board take venture debt? What does it
offer that other financing sources don’t?
Why are Fischer and his colleagues raising a separate fund, rather than to operate within Silicon
Valley Bank? Are investor concerns with respect to conflict of interest legitimate? Has Gold Hill
taken adequate steps to address these concerns?
Evaluate the terms Gold Hill has proposed. Are these reasonable or problematic? What are the
financial and non-financial implications of a decision to raise a smaller fund?
How can Gold Hill mitigate the challenges faced by first-time funds?
Adams Capital Management – March 2002
Adams espouses a “market-first” analysis of opportunity by looking for discontinuities. Is this
substantive or window-dressing?
Analyze Structured Navigation. Is this a valid measurement of progress in early stage investing?
How should ACM shift its strategy?
Martin Smith – May 2002
Please review the case and the three PowerPoint presentations. As you read over the materials,
consider how Martin should structure his presentation at the partners’ meeting. Among the issues
you may wish to consider are:
Which company should he recommend?
Which uncertainties should he highlight?
Are there valuation issues that he should highlight?
What organizational issues are likely to influence the partners’ decision?
Please choose one deal on Martin’s behalf and prepare a short and concise PowerPoint
presentation (no more than 3 slides) that he should use when presenting to the general partners.
You should give serious consideration to the context in which this recommendation is being
made. For this assignment, you ARE Martin.
Brazos Partners: the CoMark LBO
What is Brazos’ investment strategy? Does it seem well suited for its position as a first-time
fund? How do you assess the merits of the GTI transaction?
How has the current recessionary climate affected Brazos’ investment strategy, in both
favourable and unfavourable ways?
Is CoMark an attractive investment? What are your major concerns with the proposed deal? How
attractive is the purchase price?
Apax Partners and Xerium S.A.
What are the difficulties associated with exiting private equity investments? Xerium might in
many respects be seen as an ideal LBO: a solid firm that has generated lots of cash, paid down its
debt ahead of schedule, and so forth. Why is it, then, that Apax is having so many problems
selling the firm? Or has the LBO world’s expectations changed?
What are the issues associated with the recapitalization of Xerium? How will the firm’s capital
structure change after the deal? How are the various parties likely to view the transaction?
What should Apax do – sell Xerium, recapitalize the firm, or wait?
In-Q-Tel
What were the key design choices made when structuring in-Q-Tel? Are these choices still
valid?
If you were a CEO of a private company that has a choice of several traditional venture sources
and the In-Q-Tel fund, would you be inclined to accept money from the fund? What are the
major concerns that you would have?
As a traditional financially oriented venture capitalist, would you co-invest with the fund?
Does it make sense to expand In-Q-Tel to include other intelligence agencies? What about other
government agencies? How significantly could proliferation of the In-Q-Tel model by other
agencies affect “return on technology”? What about impact to In-Q-Tel’s financial returns?
Last revised: 07/30/2007