EDWIN L. COX SCHOOL OF BUSINESS
SOUTHERN METHODIST UNIVERSITY
PRIVATE EQUITY & VENTURE CAPITAL - STRA 6219
Fall 2010
Section 714 – Tuesdays 6:30 to 9:20 pm – 190 Crow Building
Professor Gary Moskowitz
Office: 352 Maguire
E-mail: gmoskowi@mail.cox.smu.edu
Phone: (214) 768-1575
Office Hours: Tuesdays, 3:30 pm to 4:30 pm, and by appointment
Overview
This course is a module-long elective that focuses on the management challenges faced
by private equity firms. Private equity firms have grown in number, size, and prominence
in recent years. We will focus on venture capital firms; in addition, we will discuss
leveraged buyout funds and hedge funds.
This course examines issues central to the operation of private equity firms. We will
follow the operational cycle of these firms. We begin by examining the issues associated
with the raising of an investment fund. We then discuss how private equity firms invest
their funds, how they interact with portfolio companies, and how they realize the gains on
the investment. We will also evaluate cases devoted to hedge funds and leveraged
buyouts. The module concludes with a discussion of the use of the private equity model
in other settings.
Most of the class sessions will revolve around a discussion of assigned cases. Consistent
with traditional case instruction techniques, students will be called upon to discuss the
case using the concepts and models taught in this class.
Prerequisites
The prerequisite for this course is STRA 6201.
Readings
A case packet is required for this course and is available for purchase through study.net
(www.study.net).
Private Equity & Venture Capital
Prof. Moskowitz
Fall 2010
Page 2
Student Learning Outcomes
Student learning outcomes for this course are as follows:
 Students should be able to identify the reasons investors invest in private equity
funds.
 Students should understand the structure of private equity firms and funds.
 Students should be able to use the venture capital method for the valuation of
venture capital investments.
 Students should understand the major decisions that are made at a private equity
firm throughout the life cycle of a fund: fundraising, investing, and harvesting the
investments.
 Students should understand the differences between venture capital, leveraged
buyout, and hedge funds.
Disability Accommodations
If you need academic accommodations for a disability, you must first contact Disability
Accommodations
&
Success
Strategies
(DASS)
at
214-768-1470
or
www.smu.edu/alec/dass.asp to verify the disability and to establish eligibility for
accommodations. Then you must schedule an appointment with the professor to make
appropriate arrangements.
Students who will be requesting a disability accommodation should do so on the first day
of the course that they attend.
Religious Observance
Religiously observant students who wish to be absent on holidays that require missing
class should notify their professors in writing at the beginning of the semester, and should
discuss with them, in advance, acceptable ways of making up any work missed because of
the absence. (See University Policy No. 1.9.)
Excused Absences for University Extracurricular Activities
Students participating in an officially sanctioned, scheduled University extracurricular
activity should be given the opportunity to make up class assignments or other graded
assignments missed as a result of their participation. It is the responsibility of the student
to make arrangements with the instructor prior to any missed scheduled examination or
other missed assignment for making up the work.
Private Equity & Venture Capital
Prof. Moskowitz
Fall 2010
Page 3
Electronic Devices in the Classroom
Laptop computers are permitted in the classroom. Students are asked to adhere to The
Cox Charter of Community Conduct and to use laptop computers solely for class
purposes during class sessions.
Attendance
Please attend every class and arrive on time so that we may start promptly.
Please note that an excused absence is one for which the student will be given the
opportunity to earn credit for the missed class by completing an assignment. The student
must complete the assignment in a reasonable amount of time, and the student’s credit for
the missed class will be based on the quality of the completed assignment.
Students who are unable to attend a class session may receive participation credit for that
day’s class by turning in a brief written case analyses for each case schedule to be
discussed in class on that day (if two cases are scheduled, and you submit only one such
case analysis, you will receive half-credit for participation). Each brief written case
analysis should be no more than 3 pages in length (double spaced, 12 point font, one inch
margins), and it should address the questions for that case in listed in this syllabus. If the
absence if reasonably foreseeable in advance, then the written case analyses must be
turned in before the start of the class session that is being missed; if the absence is
not reasonably foreseeable, then the students must produce written documentation
supporting the unforeseeable nature of the missed class and turn in the written cases
as soon as possible. If no other means of transmitting the cases to the professor is
available, then students should use e-mail. In writing the case analyses, you should be
sure to use the models and frameworks that we discuss in class (including, without
limitation, the frameworks from the reading associated with the cases being written up).
Participation credit can be earned through written case analyses for up to two missed
classes.
Please note that a case write-up submitted for participation credit may not also be
submitted as the required case write-up. Please plan ahead so that you do not want to
write-up the same case for both participation and for the required case write-up.
Preparation
I expect you to be fully prepared for each class. I will cold call on students to open the
case and to continue the discussion of the case. If for some reason you are not prepared,
please inform me before the start of the class so that I will not call on you inadvertently.
Please come to class even if you are not adequately prepared.
Case discussions are intended to present dilemmas as they are encountered by managers,
so it is important to deal with the cases as you find them (i.e., no “Monday morning
Private Equity & Venture Capital
Prof. Moskowitz
Fall 2010
Page 4
quarterbacking” based on knowledge of what happened after the time frame of the case).
In case discussions, the present tense should be interpreted as referring to the time frame
of the case or its end. Please do not prepare for the class discussion by seeking out
additional or more recent data on the firms or industries in the case.
In evaluating the cases, you should use the concepts and models discussed in the readings.
Learning how to apply these concepts and models is essential for success in this class.
Please note that the concepts and models from both the current day’s readings and from
prior readings are often useful in the case analysis.
Group work is helpful for case preparation. You are encouraged to work with your
classmates on all of the cases that you are not turning in for a grade (please see the Honor
Code section for additional information).
Honor Code
As with all classes and work conducted at the Cox School, the principles and articles of
The Graduate Cox Honor Code and the Honor Code of Southern Methodist University
are in force. In addition, the following six principles apply to this class:
1)
Discussion with others about written submissions to be graded (including, without
limitation, case write-ups) is a violation of the Honor Code. Also, please note
that passing case notes and class handouts to students who have yet to take
the course, who took the class in a previous semester, or who are enrolled in
other sections is also a violation of the Honor Code.
Please note that you should not discuss a case with others if you are going to turn
in a write-up for that case (except, of course, for discussions with group members
if you are turning in a group case write-up).
2)
Group projects should reflect the work of group members only. Each and every
member of a group should contribute to the final group project in an equitable
manner.
3)
All individual written case assignments should reflect your own effort only.
4)
Plagiarizing (the misrepresentation of work done by others as being one’s own
work) is a violation of the honor code. Remember to cite all sources of
information and ideas to prevent problems.
5)
You may not submit the same paper (or substantially similar papers) to meet the
requirements of more than one course without the written consent of all
instructors concerned.
6)
You may not sign the attendance sheet with any name other than your own.
Private Equity & Venture Capital
Prof. Moskowitz
Fall 2010
Page 5
If you have any questions about the Honor Code please contact the instructor.
Evaluation
You will receive the grade that you deserve. The number of students to receive each
grade will be based on the Cox School’s guidelines concerning grade distributions. A
minimum level of performance in each grade component will be required for passing the
course. In determining the final course grades, I will add up each student’s grade on the
components, weighted by the appropriate amount. I will then assign the final grades
based on natural break points in the distribution.
There are three components to your grade in this class:
1)
Class participation will account for 25% of your grade. Participation is based on
the quality and quantity of your insights and contribution to the class discussion.
Students who are unprepared will be marked down; this is especially true for
students who do not alert me to their unprepared status at the start of class. Please
note that attendance does not constitute participation. Only students who sign
the attendance sheet can receive credit for participation in that class session.
I reserve the right to give surprise quizzes during the semester. If I believe that
student preparation and participation is inadequate, the likelihood of a quiz will
increase. Quiz grades will count as a part of the participation grade.
2)
Two written case analyses each will count for 37.5% of your grade. You may
choose to write any two of the cases that are listed in the syllabus as being a
potential written case, with the following guidelines. No more than one case
analysis may be submitted in the same week. Each write-up must be turned in at
(or before) the start of the class in which that case will be discussed. No case
analyses may be turned in after the case has been discussed in class. You may
choose to write one of your cases in a group of no more than 5 students; at least
one of your analyses must be an individually-written paper. Please note that the
same case may not be submitted for both participation credit and for the written
case analysis requirement (However, you may submit in the same week one case
for the written case requirement and one case for half participation credit.)
Written Case Analysis
A written case analysis must not exceed 5 typewritten, double-spaced pages (not
including exhibits, an unlimited number of which are permitted), in a 12 point font. As
you prepare a written analyses, consider (but do not feel constrained to) the questions
listed for the case in the syllabus. Exhibits are to be used for quantitative and graphical
information only. Exhibits are NOT to be used to go past the limit of five pages of text.
Private Equity & Venture Capital
Prof. Moskowitz
Fall 2010
Page 6
If your exhibit contains textual information (other than an explanation of a calculation),
then it should not be an exhibit. I will read a maximum of five pages of text.
Assume that I have read the case, so do not repeat history or facts unless in support of
your argument. Be sure to demonstrate your value added beyond positions proposed
within the case itself.
In grading your assignments, I look for effective use of the concepts, models, and
techniques taught in this class. You should begin by identifying the problem facing the
strategic decision maker in the case (this may be an area for “peeling the onion”). You
should use analytic tools to develop an answer to this strategic problem. The course
concepts should support your recommendation, which should be clearly articulated in the
paper. Use exhibits to provide support for your recommendation. I will be grading you
on the choice of analytic tools, the effectiveness of your use of such tools, and on the
support for and quality of the recommendation.
Please keep in mind that for the written case assignments you should use only that
information presented in the case materials (i.e., no outside research on the company or
industry is permitted).
Some helpful hints for the written papers:
 Please include page numbers.
 Avoid the use of the passive tense. “A strategy for the company has been formulated”
is unclear, as it does not indicate who created the strategy. “I recommend the
following strategy for the company” is a much better phrase. Please note that the use
of the first person will often make the paper much clearer.
 Be sure to footnote the source of all factual information. In general, all numbers in
the text and the exhibits should be accompanied by the location of their source in the
case (or other assigned readings for this course).
 Please be sure to include dollar signs, percent signs, etc. Numbers should have
identifying information attached, including the type of information (e.g., sales,
income, assets), the year of the information; and the company to whom this
information applies.
 The exhibits should be placed in the same order as they are referred to in the text of
the paper. Exhibits should be used for graphical or numeric information only (i.e., do
not place written text in an exhibit; all written text belongs in the body of the paper).
 If you write carefully, you can say a lot in 5 pages. If you write poorly, you can say
very little in 5 pages.
Private Equity & Venture Capital
Prof. Moskowitz
Fall 2010
Page 7
My Approach To Grading
In both written assignments and class participation, I am looking primarily for effective
use of the concepts taught in this class, and secondarily for effective use of the concepts
taught in related MBA classes, such as strategic management, finance, and organizational
behavior. For written papers, these grading standards lead to the following grades:
6 or less
Paper does not address the key issues in the case and/or the paper
contains serious analytic errors. As a result, the paper does not
meet the standards for a passing grade.
7 out of 10
Paper consists primarily of information and statements that are
repeated from the case without any critical thinking or value-added
analysis. There is little original analysis, and there is weak support
for the student’s recommendations.
8 out of 10
Demonstrates the ability to use the concepts, models, and
techniques taught in the course in answering case questions.
Analysis has some flaws or is disconnected from the student’s
recommendations.
9 out of 10
Paper makes effective use of the concepts taught in this course.
The student’s recommendation flows logically from and is wellconnected to the analysis.
10 out of 10
Meets requirements for a 9 and continues the analysis to ask and
answer the next logical question.
All calculated numbers should be accompanied by an explanation of how the number was
calculated (including the values used in the calculation, the source of these values, and
the formula used).
Please note that the grading standards follow the concept of “peeling the onion.” Each
problem has many layers: as you address each issue (by peeling the onion), you reveal
another layer of issues.
Private Equity & Venture Capital
Prof. Moskowitz
Fall 2010
Page 8
Class participation will be assessed using the following guidelines:
Outstanding Contributor:
Contributions in class reflect exceptional
preparation. Ideas offered provide major insights as
well as direction for the class. If this person were
not a member of the class, the quality of the
discussions would be diminished significantly.
Adequate Contributor:
Contributions in class reflect adequate preparation.
Ideas offered provide useful insights but seldom
offer a new direction for the class. If this person
were not a member of the class, the quality of the
discussions would be diminished slightly.
Non-participant:
This person says little or nothing in this class. If
this person were not a member of the class, the
quality of the discussions would be unaffected.
All requests for a re-examination of a grade must be submitted in writing within two
weeks from the date the graded papers were returned to the class. The written request for
a re-examination of the grade must include a description of the specific bases upon which
the request is being made.
Private Equity & Venture Capital
Prof. Moskowitz
Fall 2010
Page 9
LIST OF ASSIGNMENTS
Note on the assignments: The questions listed in this syllabus are intended to provide a
starting point for your analysis of the case. The class discussion may include other
questions and topics in addition to the listed questions.
Unless otherwise noted, all readings and cases are in the case pack on www.study.net.
1)
Tuesday, August 24, 2010: Introduction to Private Equity and Investing in
Private Equity – Part 1
Reading #1:
“How Venture Capital Works” by B. Zider.
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Reading #2:
“Rehabilitating the Leveraged Buyout” by W.C. Kester and T.A.
Luehrman.
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Reading #3:
“The Hedge Fund Industry” by W. E. Fruhan, Jr.
Case:
Questions:
“Yale University Investments Office: August 2006” by J. Lerner.
1)
How has the Investment Office selected, compensated, and
controlled private equity fund managers? What explains the
differences between their strategy in private equity with that in
other asset classes (e.g., real estate)?
2)
How has the Investment Office decided when to make private
equity investments? What explains the differences between their
strategy in private equity with that in other asset classes (e.g., real
estate)?
3)
How has the Investment Office made international private equity
investments?
What explains the differences between the
performance of their international and domestic private equity
investments?
4)
How is the private equity industry changing? How could
Swensen’s private equity strategy go wrong?
5)
Should David Swensen shift his private equity strategy?
Private Equity & Venture Capital
Prof. Moskowitz
Fall 2010
Page 10
2)
Tuesday, August 31, 2010: Investing in Private Equity – Part 2 and Venture
Capital Math
Reading #1:
“Note on Private Equity Partnership Agreements” by J. Lerner, F.
Hardymon, and A. Leamon.
Reading #2:
“The Basic Venture Capital Formula” by W.A. Sahlman.
Problem Set: Venture Capital Valuation Problem Set
This problem set is available on study.net.
Please be prepared to discuss your solutions in class. I will cold call
students and ask them to present their answers to the entire class.
Private Equity & Venture Capital
Prof. Moskowitz
Fall 2010
Page 11
3)
Tuesday, September 7, 2010: Evaluating Potential Venture Capital
Investments – Part 1
Reading #1:
“Analyzing New Venture Opportunities,” by M.J. Roberts.
Reading #2:
“How Venture Capitalists Evaluate Potential Venture Opportunities,” by
M.J. Roberts and L. Barley.
Case:
“AudienceView” by T. Rosenberg
and
“AudienceView Additional Information” by G. Moskowitz.
* * THIS CASE MAY BE WRITTEN UP * *
1)
Evaluate AudienceView’s strategy. Do you think this is a good
strategy for the company to pursue? Why or why not?
2)
Should Ventures West consider investing in AV?
3)
What is an appropriate valuation for an investment by Ventures
West in AV? How did you calculate this value?
4)
What additional due diligence would you suggest that Ventures
West perform before investing in AV?
Questions:
Private Equity & Venture Capital
Prof. Moskowitz
Fall 2010
Page 12
4)
Tuesday, September 14, 2010: Evaluating Potential Venture Capital
Investments – Part 2
Case #1:
Questions:
Case #2:
Questions:
“Khosla Ventures: Biofuels Strategy” by J. B. Lassiter, III, W. A.
Sahlman, and A. B. Wagonfeld.
and
“Khosla Ventures Additional Information Spreadsheet” by G. Moskowitz.
* * THIS CASE MAY BE WRITTEN UP * *
1)
Analyze an investment in the Hypothetical Pre-Revenue Biofuels
Company described in Exhibits 10a, 10b, and 11, and on page 13
of the case. What is the strategy of the Hypothetical Pre-Revenue
Biofuels Company?
2)
Analyze the Summary Capitalization Table in Exhibit 10b. What
prices were paid by the investors in the various rounds of
financing? What is the profitability of the different rounds of
investment? What is the post-money value after the Series D
round?
3)
Analyze the information in Exhibit 13 and in the spreadsheet with
additional information for this case. At what multiples do biofuels
companies trade? Hint: you should examine EBIT, EBITDA, book
value, and net income multiples.
4)
Using the multiples you calculated in question 3, find the value of
the Hypothetical Biofuels Company in 2012E. How much of this
value is attributable to shares sold in the 2010 to 2012 time frame?
How much of this value is attributable to shares sold during the
pre-revenue phase (i.e., the shares described in Exhibit 10b)?
5)
What is Khosla Ventures’ strategy? How successful has the
investment firm been?
6)
Should Khosla Ventures start a later-stage investment fund for
scaling their biofuels ventures? Why or why not?
“Explo Leisure Products” by R.G. Hamermesh.
* * THIS CASE MAY BE WRITTEN UP * *
1)
How serious are the problems facing Tim Trowac and Dave
Rahall? Why are they having so many problems?
2)
What are the critical success factors of running a recycling
business, such as golf ball recycling?
3)
What actions should Trowac and Rahall take now? Please be as
specific as possible.
Private Equity & Venture Capital
Prof. Moskowitz
Fall 2010
Page 13
5)
Tuesday, September 21, 2010: Hedge Funds and Harvesting Investments
Questions:
“Maverick Capital” by A.F. Perold.
* * THIS CASE MAY BE WRITTEN UP * *
1)
What is Maverick Capital’s strategy?
2)
Why is Maverick a “hedge fund?” Against what is it hedged?
3)
Evaluate the five possible ways to grow. Which would you
recommend that Maverick implement?
Reading:
“A Note on the Initial Public Offering Process” by J. Lerner.
Case #2:
“Greenbriar Growth Partners and Microsurgery Devices” by N. N. ElHage and K. Meyer.
* * THIS CASE MAY BE WRITTEN UP * *
1)
On page four of the case, there is a description of the conversion
terms of the Series A Preferred. Why is a “successful IPO” defined
this way? What is the purpose of this conversion term? Who is
protected by this contract term?
2)
Why did MSD go public?
3)
Why do Private Equity firms own shares of portfolio companies
after their IPO?
4)
Discuss MSD’s stock price history. Why did it increase from $30
at the time of the IPO to $42.33, and then fall to $14.62?
5)
When should Greenbriar Growth Partners exit the MSD investment
and distribute the profits to its LPs?
6)
What should Greenbriar Growth Partners do about the board seats?
Case #1:
Questions:
Private Equity & Venture Capital
Prof. Moskowitz
Fall 2010
Page 14
6)
Tuesday, September 28, 2010: Leveraged Buyouts
Reading:
“Note on Leveraged Buyouts” by G. Moskowitz
Case:
“Brazos Partners: The CoMark LBO” by J. Lerner, F. Hardymon, and A.
Leamon
and
“Brazos Partners: The CoMark LBO Spreadsheet” by G. Moskowitz
* * THIS CASE MAY BE WRITTEN UP * *
1)
What is Brazos Partners’ strategy? How successful has the
company been? Why has the company been successful or not
successful?
2)
What is CoMark’s strategy? How successful has the company
been?
3)
Why is Brazos considering an LBO of CoMark?
4)
How can Brazos add value to CoMark?
5)
What is the expected return to Brazos if the deal is structured as a
stock sale?
Hint: You will need to use the spreadsheet model.
6)
What is the expected return to Brazos if the deal is structured as an
asset purchase?
Hint: You will need to use the spreadsheet model.
Questions:
Private Equity & Venture Capital
Prof. Moskowitz
Fall 2010
Page 15
7)
Tuesday, October 8, 2010: Applying the Venture Capital Model in Other
Settings
Reading #1:
“Finding Its Niche: Community Development Venture Capital” by W.
Brissett.
Case #1:
“Northeast Ventures: January 1996” by J. Lerner and E.K. Jackson.
* * THIS CASE MAY BE WRITTEN UP * *
1)
How successful has Northeast Ventures been? How successful has
the community development venture capital sector been?
2)
How has Northeast sought to blend community development with
the traditional venture capital model? What alternative structures
could or should they consider adopting?
3)
Will institutional investors become a major source of capital for
community development venture capitalists? Will the Federal and
state governments? What will be the implications if either of these
become a more important capital source?
4)
What are the relative strengths and weaknesses of community
development venture capital and community development lending?
How do equity and debt investments affect the growth of young
firms, particularly those in disadvantaged regions?
Questions:
Reading #2:
“Making Sense of Corporate Venture Capital” by H.W. Chesbrough.
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Case #2:
Questions:
“Corporate Venture Capital at Eli Lilly” by R. Hammermesh, R. Laufer,
and D. Lane.
* * THIS CASE MAY BE WRITTEN UP * *
1)
What is Eli Lilly’s strategy? What strategic challenges does the
company face?
2)
Why did Lilly establish corporate venture capital operations?
3)
What is Lilly Ventures’ process for making investments?
4)
What challenges does Lilly face in its venture capital operations?
What improvements would you suggest Lilly make in this process?
5)
Should Lilly Ventures invest in Protagonist? Why or why not?