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
•
•
•
•
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
• 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
–
–
–
–
Estimate FCF (EBIAT+Dep-CapEx-ΔNWC)
Estimate WACC
Estimate Terminal Value (Perpetual growth g)
Discount FCF and TV to get Enterprise Value
• Multiples Based
–
–
–
–
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%?
Exit Value = $4 x 25 = $100 million
Analysis based on
value TODAY !
POST MONEY VALUATION = 100/(1+50%)5 = 13.169 million
PRE MONEY VALUATION = 13.169 – 5 = $8.169 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
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%?
Exit Value of Hoya.com = $4 x 25 = $100 million
Analysis based on
value at EXIT DATE!
Exit Value of VC has to be =$5x(1+50%)5 = 37.97 million
Fraction of Company Needed = 37.97/100=37.97%
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
An Example
• 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!
What fraction does VC need if $
12 Million is needed and VC
needs 50% IRR
Value of VC at Exit =12x(1.5)^5
=91.125!!!
How many shares if VC needs 30%
return (would ask for 18.6% of the
firm).
Y = X(F/1-F) = 1*(0.186/1-0.186)
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 today so
that at exit its share is 37.97%.
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
N ew N u m b er o f S h a r es Y  X
Y  1
0.3797
( 1 -( 0 . 3 7 9 7  0 . 1 5 ) )
F1
( 1 -( F 1  O P ) )
 0 . 8 0 7 m illio n sh a r es
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
Retention%

Final Ownership%
Current
Retention%
Current
Ownership%
 (1  Later Owner' s Final%)
Ownership%

Final Ownership%
Retention%

Final Ownership%
(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
For Practice
• Recalcualte the numbers detailed in
“The Basic Venture Capital Formula”
Quick Review of VC Valuation
Method
• Remember - In venture capital all valuation
is “implied valuation”. Simply put, the value
arises because VC(s) is(are) willing to
finance the company!
• The terms (amount invested, fraction of
ownership received) fix the post-money and
pre-money value of the business
• This process is made transparent by
reporting of “Capitalization Table” or simply
“Cap Tables” – Let us see how these are
created…
Tomorrow
• How Do VCs Evaluate Investments
• Term sheet for Trendsetter
VC Framework
• Critical Issues
– Uncertainty
– Asymmetric
Information
– Nature of Firm’s
assets
– Conditions of
relevant financial
and product
markets
• Responses by investors
–
–
–
–
Active Screening
Stage financing
Syndication
Use of Stock
options/grants with
strict vesting
requirements
– Contingent control
mechanisms –
Covenants and
restrictions
– Strategic composition of
Board of Directors
Capitalization Tables
Page 10 (Bottom) of ONSET ventures case describes the financing
history of TallyUp. Onset offered to invest $750,000 at a price $1
per share in return for 31.6% of the company. Later, ONSET
invested another $250,000 at the same price ($ 1 per share) when
Reed Tausig as the CEO. Please draw up the capitalization tables,
pre-money and post money valuations for tally before and after
each round of financing.
B e fo re F in a n c in g
A fte r In tia l 7 5 0 ,0 0 0 in ve s tm e n t
%
In vestor
# of sh ares
F ounders
1,625,000
$ p er sh are
$ total
$0.000
$0
$ p er
ow n ersh ip # of sh ares
100%
O N S E T V entures
1,625,000
%
sh are
$ total
ow n ersh ip
-
$1,625,000
68.42%
750,000
$1.00
$750,000
31.58%
2,375,000
$1.00
$2,375,000
100%
O ption P ool
T otal F or R ou n d
C u m u lative T otal
1,625,000
$0.000
$0
100%
P ric e P e r S h a re
P re -M o n e y V a lu a tio n
C a s h In fu s io n
P o s t-m o n e y V a lu a tio n
$1
1 ,6 2 5 ,0 0 0
7 5 0 ,0 0 0
2 ,3 7 5 ,0 0 0
After Next Investment of
$250,000
A fte r In tia l 7 5 0 ,0 0 0 in ve s tm e n t
$ p er
In vestor
# of sh ares
F ounders
1,625,000
O N S E T V entures
750,000
A fte r n e x t 2 5 0 ,0 0 0 in ve s tm e n t
%
sh are
$ total
-
$1,625,000
68.42%
$1.00
$750,000
31.58%
$ p er
ow n ersh ip # of sh ares
%
sh are
$ total
ow n ersh ip
1,625,000
-
$1,625,000
61.90%
1,000,000
$1.00
$1,000,000
38.10%
250,000
$1.00
$250,000
9.52%
2,625,000
$1.00
$2,625,000
100%
O ption P ool
T otal F or R ou n d
C u m u lative T otal
2,375,000
$1.00
$2,375,000
100%
P ric e P e r S h a re
P re -M o n e y V a lu a tio n
C a s h In fu s io n
P o s t-m o n e y V a lu a tio n
$1
1 ,6 2 5 ,0 0 0
7 5 0 ,0 0 0
2 ,3 7 5 ,0 0 0
$1
$ 2 ,3 7 5 ,0 0 0
250000
$ 2 ,6 2 5 ,0 0 0
After option pool creation of
750,000 Shares
A fte r n e x t 2 5 0 ,0 0 0 in ve s tm e n t
A fte r O p tio n P o o l
%
$ p er
In vestor
# of sh ares
F ounders
O N S E T V entures
%
$ p er
sh are
$ total
ow n ersh ip
# of sh ares
1,625,000
-
$1,625,000
61.90%
1,000,000
$1.00
$1,000,000
38.10%
O ption P ool
ow n ersh i
sh are
$ total
p
1,625,000
-
$1,625,000
48.15%
1,000,000
$1.00
$1,000,000
29.63%
750,000
$1.00
$750,000
22.22%
T otal F or R ou n d
250,000
$1.00
$250,000
9.52%
750,000
$0.00
$0
22.22%
C u m u lative T otal
2,625,000
$1.00
$2,625,000
100%
3,375,000
$1.00
$3,375,000
100%
P ric e P e r S h a re
P re -M o n e y V a lu a tio n
C a s h In fu s io n
P o s t-m o n e y V a lu a tio n
$1
$ 2 ,3 7 5 ,0 0 0
250000
$ 2 ,6 2 5 ,0 0 0
$1
$ 2 ,6 2 5 ,0 0 0
0
$ 3 ,3 7 5 ,0 0 0
What if Mann is able to do a $3.5
million round at 2.5 times step up
(ONSET invests $1 million in this
round)
A fte r O p tio n P o o l
$ p er
R a is e 3 .5 M illio n T o ta l a t 2 .5 S te p U p
%
In vestor
# of sh ares
sh are
$ total
ow n ersh ip
F ounders
1,625,000
-
$1,625,000
48.15%
O N S E T V entures
1,000,000
$1.00
$1,000,000
750,000
$1.00
$750,000
O ption P ool
$ p er
# of sh ares
%
sh are
$ total
ow n ersh ip
1,625,000
-
$4,062,500
34.03%
29.63%
1,400,000
$2.50
$3,500,000
29.32%
22.22%
750,000
$2.50
$1,875,000
15.71%
1,000,000
$2.50
N ew V C
2500000
20.94%
T otal F or R ou n d
750,000
$0.00
$0
22.22%
1,400,000
$2.50
$3,500,000
29.32%
C u m u lative T otal
3,375,000
$1.00
$3,375,000
100%
4,775,000
$2.50
$11,937,500
100%
P ric e P e r S h a re
P re -M o n e y V a lu a tio n
C a s h In fu s io n
P o s t-m o n e y V a lu a tio n
$1
$ 2 ,6 2 5 ,0 0 0
0
$ 3 ,3 7 5 ,0 0 0
$ 2 .5 0
$ 3 ,3 7 5 ,0 0 0
3 ,5 0 0 ,0 0 0
$ 1 1 ,9 3 7 ,5 0 0