Transcript Venture Capital

Venture Capital and Private
Equity
Session 3
Professor Sandeep Dahiya
Georgetown University
Course Road Map
• What is Venture Capital - Introduction
• VC Cycle
– Fund raising
– Investing
• VC Valuation Methods
• Term Sheets
• Design of Private Equity securities
– Exiting
• Time permitting – Corporate Venture
Capital (CVC)
Accel Partners VII
Accel Partners – High Level
Questions
• How are VCs compensated? How does the
compensation structure of VCs differ from
CEOs or Fund managers
• Why do we observe the partnership
structure?
• Why do GPs need to put down 1%?
• Why not take down the entire capital at one
go?
• Why do we see the various restrictions on
size and co-investment in previous deals?
Accel Partners – More General
Issues
• How do Management Fee and Carry
interact with Fund size?
– $20 million fund with 2 partners(2.5%
Mgmt fee)
– $400 million fund with 4 partners (2.5%
Mgmt fee)
Accel Partners VII
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•
•
•
Would you invest in Accel Partners VII
Would David Swensen invest ?
How they done in the past?
How are they likely to do in the future?
Accel Partners Now
• Did close Fund VII with 30% carry
• Accel VIII – mother of all funds $1.6
BILLION proposed in 2000 scaled back
to $950 million later
• Accel IX 400 million
• Accel X $520 million
• Now in London, China and India
• No Idea how the funds are doing but
was Series A investor in FACEBOOK.
VC Method For Valuation
Professor Sandeep Dahiya
Georgetown University
Quick Review of Valuation
Methodologies
• DCF
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–
–
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Estimate FCF (EBIAT+Dep-CapEx-ΔNWC)
Estimate WACC
Estimate Terminal Value (Perpetual growth g)
Discount FCF and TV to get Enterprise Value
• Multiples Based
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Choose a set of Peers/Comprables
Choose the multiple(s) e.g. EV/EBIT, P/E
Estimate Median/Average Multiple
Apply to target
Please Read “Note on Valuation in Private Equity Settings”
VC Method
• Flavor of both DCF and Multiples but
is different.
•
•
•
•
•
FCF is highly uncertain
WACC is almost meaningless
Multiples are hard to get by
Most firms will NOT survive
A few firms would have incredible growth
VC Method-Implied Valuation
Information you would almost always have
• I – Amount being raised from VC
• X- Number of Shares currently owned by entrepreneur
Information that requires judgment call
• R – VC’s required return (IRR) usually between 25% to 80%
• T – Time to exit (When VC gets money back)
• V – Value of the company at time of exit
Numbers you need to calculate
• F – Fraction of company VC would need to get the return
• Post-Money Valuation – Value of company after funding is
received
• Pre-money Valuation - Value of company before funding is
received
• P – Price per share.
• Y – Number of shares to be issued to the VC
An Example
• Hoya.com is asking for $5 million, Projected income in year 5
is $ 4 million and expected exit multiple is 25x. Company
currently has 1 million shares all owned by the entrepreneur.
What share of company would a VC require today if VC’s
required return is 50%?
•What if VC
Exit Value of Hoya.com = $4 x 25 = $100 million
Exit Value of VC has tobe =$5x(1+50%)5 = 37.97 million
Fraction of Company Needed = 37.97/100=37.97%
required
30%?
•What if
need was for
$12 million?
Implied POST MONEY Valuation=5/0.3797=13.17 million
Implied PRE MONEY Valuation= 13.17-5=8.17 million
Let us assume Y is the number of new shares that must be issued to the
VC, X are the existing number of shares
Y/(X+Y) = F =37.97%; algebraic manipulation yields Y = 612,091 shares.
Price per share = 5,000,000/612,091 = $8.17
Same Example – Alternative
Approach
• Hoya.com is asking for $5 million, Projected income in year 5
is $ 4 million and expected exit multiple is 25x. Company
currently has 1 million shares all owned by the entrepreneur.
What share of company would a VC require today if VC’s
required return is 50%?
Exit Value = $4 x 25 = $100 million
POST MONEY VALUATION = 100/(1+50%)5 = 13.169 million
PRE MONEY VALUATION = 13.169 – 5 = $8.169 million
•What if VC
required
30%?
•What if
need was for
$12 million?
Since 1 million shares outstanding Price per share = $8.17
Alternatively VC must get 5/13.17 = 37.97% of the company
Let us assume Y is the number of new shares that must be issued to the
VC, X are the existing number of shares
Y/(X+Y) = F =38% algebraic manipulation yields Y = 612,091 shares.
Price per share = 5,000,000/612,091 = $8.17
VC Valuation Problem Set
• Hoya.com is asking for $5 million, Projected income in year 5
is $ 4 million and expected exit multiple is 25x. Comapny
currently has 1 million shares all owned by the entrepreneur.
What share of company would a VC require today if VC’s
required return is 30%?
Exit Value = $4 x 25 = $100 million
Value of VC’s 5 million investment at 30% = 5*(1+.30)5 = $18.6 million
VC would ask for 18.6/100 = 18.6% of the firm!
How many shares if VC needs
50% return (would ask for 38% of
the firm).
How many shares if VC needs
30% return (would ask for 18.6%
of the firm).
X original number of Shares, Y
new shares
Y = X(F/1-F) = 1*(0.186/10.186)
Y/(X+Y) =0.38, since X =1,
Y=0.612
Y = 0.2285 million shares
Multiple Rounds/ Exit
Dilution
• Imagine that you need 15% of the company at the exit
to get your mandated return.
• Simple case – 100 shares would want 15 shares
• What if along the way company issues another 50
shares (option/new investor) what happens to your
stake?
– New total shares = 100+50= 150
– You interest = 15/150 = 10%!! – you have been diluted
• You would insist on more than 15% today to end with
15% eventually – how to figure that out
• Expected dilution = 50/150 = 0.333
• Fraction needed today = Final ownership/(1-Dilution)
• =15%/(1-0.333)= 22.5% implying 22.5 shares today
• Check>>> at the end 22.5/150 = 15%
Example Contd.
• Hoya.com is asking for $5 million, Projected income in year 5
is $ 4 million and expected exit multiple is 25x. What share of
company would a VC require today if VC’s required return is
50%?
• Need to reserve 15% of the firm in terminal year for the option
pool for mangers.
VC still needs to get $5 million*(1.5)5 = 37.97 million
Only 85 million available after the option pool
VC would want 37.97/85 = 44.67% of the company AT EXIT.
5 million for 44.67% of the company imply Post money
valuation of 5/0.4467= 11.193 million and pre-money
valuation of 11.19 -5=6.193 million
New Shares to VC =5/6.193=0.807 million shares
New # of Shares Y  X
F1
(1- (F1 OP))
0.3797
Y 1
 0.807 m illion shares
(1- (0.3797 0.15))
Another Approach (easier).
• Hoya.com is asking for $5 million, Projected income in year 5
is $ 4 million and expected exit multiple is 25x. What share of
company would a VC require today if VC’s required return is
50%?
• Need to reserve 15% of the firm in terminal year for the option
pool for mangers.
VC still needs to get $5 million*(1.5)5 = 37.97 million
At Exit Firm is Still Worth 100 Million
VC still needs 37.97/100 = 37.97% of the Firm AT TIME OF EXIT!
However what VC needs TODAY is higher since extra shares would
be issued to the Option Pool causing dilution
Final Ownership%
CurrentOwnership%
Retention%  (1  Later Owner's Final%)
Retention% 
CurrentOwnership%
Final Ownership%
Final Ownership%

Retention%
(1  Later Owner's Final%)
VC Current Ownership = 0.3797/(1-0.15) = 44.67%
Multiple Rounds of Financing
•
•
Hoya.com is asking for $5 million, Projected income in year 5 is $ 4
million and expected exit multiple is 25x. What share of company
would a VC require today if VC’s required return is 50%?
Need to reserve 15% of the firm in terminal year for the option pool
for mangers. Would need another $ 3 million at the beginning of
year 3 – round 2 investors require 30% return
Round 2 investor need 30% on its 3 million i.e. 3(1.30)3 = 6.59 million
Amount available after option pool is 85 million implying 6.59/85 = 7.75%
Round 1 still needs $38 million to generate 50% but only has (100-6.59-15)
million to get it out of implying initial stake = 38/(100-6.59-15)=0.485 or
48.5% stake.
Multiple Rounds of Financing
•
•
Hoya.com is asking for $5 million, Projected income in year 5 is $ 4
million and expected exit multiple is 25x. What share of company
would a VC require today if VC’s required return is 50%?
Need to reserve 15% of the firm in terminal year for the option pool
for mangers. Would need another $ 3 million at the beginning of
year 3 – round 2 investors require 30% return
Round 2 investor need 30% on its 3 million i.e. 3(1.30)3 = 6.59 million
Final value is still 100 million, Thus Round 2 investor need 6.59% of the
company AT EXIT Implying that at time of investment it needs to own
Round 2 VC need 0.659/(1-0.15)=7.75%
Round 1 still needs 38% at the time of EXIT
implying initial stake = 0.38/(1-(0.0659+0.15))=0.485 or 48.5% stake.
5/0.485=10.32;
What is the Post and Pre Money Valuation at round 1?
5.32
How many shares need to be issued to Round 1, Round 2 and option pool?
Round 1 = 1x[0.485/(1-0.485)] =941,748
Round 2 = 1.941748x[0.0775/(1-0.0775)]=163,128
Option Pool =(1.942+0.163)X[0.15/(1-0.15)]= 371,448
Tomorrow
• How Do VCs Evaluate Investments
• Term sheet for Trendsetter