Slide 1
The Investment Cycle
Fund Economics
Raising Money, Investing It, and Getting it Back!
Investment Frameworks and Filters (Part 1)
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah and William C. Hulley
Slide 2
Agenda
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Assignments due tonight
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Fund economics
The investment lifecycle
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Info Card B
Question Card A
Raising
Harvesting
Investing
Investment frameworks and filters
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah and William C. Hulley
Slide 3
Fund Economics – venture capital firms
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Where does the money come from?
What are VC’s allowed to do with the money?
Who governs the VC?
Who are the people in the firm?
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Partners
Associates
Industry Experts
Venture Partners/Entrepreneur In Residence
How do they get paid?
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70-397 Venture Finance
Management Fee/Salary
Carry
Fall 2002
© Andrew W. Hannah
Slide 4
Where VIs Spend Time
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Raising Money
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Harvesting
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Angels – little to none
VCs – junior partners, associates or analysts, little to none
VCs – senior partners, ten to twenty percent
Angels – very little to twenty percent
VCs – junior partners, associates or analysts, little to none
VCs – senior partners, ten to twenty percent
Investing
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70-397 Venture Finance
Angels – eighty to one hundred percent
VCs – junior partners, associates or analysts, almost all the time
VCs – senior partners, sixty to eighty percent
Fall 2002
© William C. Hulley
Slide 5
Raising Money – Sources
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Pension Funds – the biggest dollars
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Families and individuals – the oldest dollars
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Unleashed by changes in the ERISA Prudent Man rules
Old economy players (CALPERS, Crown and Cork, Mellon)
Most dollars, most professional, biggest check writers
The first venture capitalists
Largest group, hardest to access, smaller check writers
All shapes and sizes (Rockefellers, CEOs, 401(k) owners)
Corporations – the fashionable dollars
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70-397 Venture Finance
Investing for synergy
Across many industries (Intel, GM, Nortel, Glaxo)
Most opportunistic
Fall 2002
© William C. Hulley
Slide 6
Raising Money – What Happens?
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Venture firms gravitate to the largest pool of capital
Brand name and short term returns mean more
Defined investment strategies mean more
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What happens to venture investing as a result?
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70-397 Venture Finance
Venture funds get bigger
Deals get bigger
Syndication gets less important
Stage gets later
Funds become “category” investors
Fall 2002
© Andrew W. Hannah and William C. Hulley
Slide 7
Harvesting Investments
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Harvesting
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Exiting
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Trading an investment for something else
Exiting methods
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Turning illiquid investments into liquid cash or securities
IPO – initial public offering of stock
Sale – getting cash, securities or a note
Bankruptcy – liquidating the business
Write-off – valuing the company’s stock at zero
Exiting is not always the same thing as harvesting
70-397 Venture Finance
Fall 2002
© William C. Hulley
Slide 8
When Exits Go Bad…
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What categories of bad are there?
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What can the investor do to avoid them?
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The living dead
The lifestyle business
The virtual bankruptcy
Contractual rights – put, demand, board rights
Sell the position
Why are they bad?
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70-397 Venture Finance
The lost time
The temptation to try and save them…
Fall 2002
© William C. Hulley
Slide 9
Investing – What Matters
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The ingredients…
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Money
Time
Experience
Risk
Control
The questions…
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70-397 Venture Finance
How do I turn this into a strategy?
How do I use it to decide upon a particular deal?
Fall 2002
© William C. Hulley
Slide 10
The Strategy
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What Matters – The Model
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What you invest – what mix of time and money?
How much you invest – what do you put into any deal?
How often you invest – one deal or ten?
How much risk you take – do you swing for the fence?
After answering these questions you can determine
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70-397 Venture Finance
What your deal filter will look like
How your portfolio might look
What your risk profile is likely to be
The match between strategy, skills and the deal market
Fall 2002
© Andrew W. Hannah and William C. Hulley
Slide 11
Model and Deal Filter Exercise
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Separate into four groups
Answer these two questions:
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What does your investment model look like?
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What does your deal filter look like?
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Five qualifiers that help you sift the 2000 plans that hit your
desk
10 things you look for to narrow the 200 to 50
Take 20 minutes
Its all about prioritization – getting from 2000 plans
to the 5 to 10 deals that you will do
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 12
The Investment Model
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Industry
Markets
Products
Stage
Size of Investment
Geography
Leads to the DEAL FILTER that answers the
question – can I make money on my investment?
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 13
The Deal Filter
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Management team – domain expertise (demonstrated
execution)
Large, growing market ($100M+ revenue opportunity)
“Have-to-have” product/service (value proposition)
(customer ROI is clear)
Unfair advantage (can beat the competition; barriers to
entry)
Leverageable business model (strength of margins)
Path to profitability (sound projections with deliverables)
Strong partners/investors/board/advisors
Developed sales and marketing plan – knows how to
get to customer (buyer is well-defined and has budget)
Exit Opportunity (IPO and Trade Sale)
70-397 Venture Finance
Fall 2002
© Andrew W. Hannah
Slide 14
The Deal Filter
A good deal filter disqualifies
deals that don’t fit your
strategy quickly and
highlights deals that do.
70-397 Venture Finance
Fall 2002
© William C. Hulley
Slide 15
The Portfolio
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What matters…
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Expected return profile
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Distribution of outcomes
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How do deals usually do?
Are strike outs common?
Are home runs?
Can you limit losses?
Do home runs matter?
Time spans – how long to exit
Invested
Lose All
1X
4X
10X
10
2
5
2
1
Lose All
1X
4X
10X
$50
-$100
$250
$400
$500
$50
$50
$50
-$250
-$50
-$100
$100
$250
$100
$400
$400 $1,000
$500 $1,000
$500
$1,050
$550
2.10
$750 $1,600 $1,500
$250 $1,100 $1,000
1.50
3.20
3.00
Total Return
Net Return
Cash-on-Cash
10
5
2
2
1
10
1
5
2
2
10
2
2
5
1
Showa the importance of lass
management
70-397 Venture Finance
Fall 2002
© William C. Hulley
Slide 16
Tonight’s Key Concepts
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Fundraising
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Harvesting
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Most capital comes from pension funds
Fundraising is a highly institutionalized process
Harvests generate liquid cash
Bad exits (living dead, etc) must be avoided
Most harvests are sales or write offs
Success is measured by successful investing
Investing
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70-397 Venture Finance
VIs need a plan as much as any entrepreneur
Expressed by an investment model and deal filter
Fall 2002
© Andrew W. Hannah and William C. Hulley
Slide 17
Next Week
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Guest Panel
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The Venture Capitalist Case
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Jay Katarincic, Draper Triangle
Paul Cohn, Mellon Ventures
Jane Kirkpatrick, Angel Investor
Come prepared to discuss
Info card C
WA pp 83 - 114
70-397 Venture Finance
Fall 2002