Private Equity Tutorials
- Private Equity Basics
- What is Private Equity?
- Private Equity Analyst
- How to Get Into Private Equity?
- Private Equity Interview Questions
- What is Growth Capital?
- Term Sheet in Private Equity
- LP vs GP
- General Partner in Private Equity
- Carried Interest in Private Equity
- Clawback in Private Equity
- Preemptive Rights
- Drag-Along Rights
- Types of Alternative Investments
- Private Equity Course
- Private Equity vs Hedge Fund
- Project Finance vs Private Equity
- Private Equity Books
- Venture Capital Books
- Venture Capital
- Private Equity Firms
- List of Top Private Equity Firms
- Private Equity in India
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What is Venture Capital? – A friend of mine started organic store business recently. He wanted to grow further, had decent sales but the company was in existence for 2 years only so getting a $200,000 debt was not possible as it is a risky investment. In such a scenario he was referred to a Venture capitalist. He came to me asking – what is venture capital? Who is the venture capitalist?
Venture capital is an investment made by wealthy investors in a new business idea or start-up companies. Venture capital helps start-ups as well as small companies by giving them the requisite finance.
Venture capital money gets invested in those businesses that have tremendous potential to grow. People who invest in Venture capital are known as venture capitalists. Venture capital is an essential way for start-ups and small companies to get finance as they do not have access to capital markets. Venture capital funding has become popular as it provides above average returns to investors.
Uber has received a total funding close to $8.8 billion dollars. The above table shows the timeline of Uber’s Investments and known valuations.
For start-ups and small businesses, it is easy money when compared to raising money through loans & other forms of debts.
- History of Venture Capital
- Who are the Venture capitalists?
- How does the Venture Capital Industry work?
- The structure of Venture Capital Firm
- Venture Capital Funding Process
- Types of Venture Capital funding
- Venture Capital Exit Route
- Advantages and Disadvantages of a Venture capital
- Returns for a Venture Capital
- Life of a Venture Capital Fund
- Top VC Deals of All Time
- Top 20 Venture Capitalists
- Difference between Venture Capital and Private Equity
History of Venture Capital
Venture capital investments started in mid-1900s that is during the Second World War. The first VC was ARDC formed by Georges Doriot. They raised $3.5 million, of which $1.8 million came from nine institutional investors.
The industry picked up steam in 1958. Xerox, Intel, and American Microsystems are few companies who got funded by a venture capitalist in those years.
Who are the Venture capitalists?
These are those wealthy investors who have already made a mark and have a good amount of money to invest. Apart from these Investors even Investment banks, other financial institutions come in as Investors.
The reason they are interested in taking this risk is that they get much higher returns when compared to traditional investments. The losses are also huge if the investment fails but the investors have the requisite risk appetite to bear it.
How does the Venture Capital Industry work?
The venture capital industry has four important players’
- Venture Capitalists
- Investment Bank
- Private Investors
Entrepreneurs are those who need funding. Investors are the High Net worth Individuals who wish to make high returns. Investment bankers are those who need companies that can be sold and venture capitalist that create a market for these three players.
The structure of Venture Capital Firm
A basic venture capital fund structure would be structured as a limited partner. The fund is governed by a partnership agreement.
Management Company is the business of the fund. The management company would receive a management fee of 2%. These fees are used for meeting the general administrative expenses, such as rent, salaries of employees, etc.
Limited Partners (LPs) is someone who commits capital to the venture fund. LPs are mostly institutional investors, such as pension funds, insurance companies, endowments, foundations, family offices, and high net worth individuals.
General Partner (GP) is the venture capital partner of the management company. He is vested with the responsibility of raising and managing venture funds, making the required investment decisions, and helping the portfolio companies to exit. This is so as they have a fiduciary responsibility to their Limited Partners.
Portfolio Companies or Start ups are the companies that need finance and they receive financing from the venture fund in exchange for preferred equity or general equity. The venture fund would be able to realize gains when there is a liquidity event such as mergers and acquisitions or when a company decides to go for an IPO and these shares can be converted to cash.
Also, you can look for more details here at – LP GP Relationship
Venture Capital Funding Process
There are various stages through which the funding happens. These are -:
- Stage I – The funding process starts with the submission of a plan by an entrepreneur to a Venture capital. A business plan helps to convey to venture capital your business idea, a market where you intend to sell and how you plan to make profits & grow your business. The requisite details required in a business plan are an Executive summary of the proposal, Market size, information on management, forecast financials, competitive scenario. If the VC is attracted towards the Business plan then the process moves to the second stage.
- Stage II – First meeting among parties – After going through the business plan that posts the preliminary study the VC calls for a Face to face meeting with the management of the start-up. This meeting is important as a post that it is decided whether the VC would invest in the business or not. If all goes well the VC goes to next stage that is conducting Due diligence.
- Stage III – Conducting Due Diligence – This process is a quick evaluation of the references given by business owner about the customer, business strategy evaluation, re-confirmation of debtors and creditors, and quick check on other relevant information exchanged between the two parties.
- Stage IV – Finalizing the Term sheet – After conducting the due diligence if everything falls in place, VC would offer a term sheet. The term sheet is a nonbinding document which lists the terms & conditions between the two parties. The term sheet is negotiable and is finalized after all parties agree to it. Post agreement all legal documents are prepared & a legal due diligence is carried upon the start-up. After this, the funds are released to business.
Types of Venture Capital funding
Classification of various types of venture capital is based on their application at various stages of a business. Three main types of venture capital are early stage financing and acquisition/buyout financing. Venture capital funding procedure is completed through six stage of financing. These stages are as per the stage of company’s development. These stages are -:
- Seed Money -: This is a low-level financing provided for developing an idea of an entrepreneur.
- Start-up – These are those businesses that are operational and need finance for meeting marketing expenses and product development expenses. This is generally given to businesses to finish the development of their products or services.
- First- Round – This type of finance is for manufacturing and funding for early sales. This type of financing help companies who have utilised all of their capital and need finance to start full fledge business activities
- Second- Round – This financing for those companies who have sales but they are still not in profits or have just break even
- Third-Round – This is Mezzanine financing, funds are used in this financing for the expansion of the newly valuable company.
- Fourth Round – This is money used for going public. This round is also known as called bridge financing.
Early stage financing has seed financing, start-up financing & first stage financing as three sub divisions. Whereas, Expansion financing can be categorized into second-stage financing, bridge financing, and third stage financing or mezzanine financing.
Apart from this Second-stage financing is also provided to companies for expanding their business. Bridge financing is generally provided for short-term interest only finance. It is also at times provided as a way of assisting in monetary terms to companies who employ Initial Public offers (IPO).
Venture Capital Exit Route
There are various exit routes available Venture capitalists. They can cash out their investments by way of -:
- Initial Public Offering (IPO)
- Promoters buying back the equity
- Mergers & Acquisitions
- Selling the stake to other strategic investors
Advantages and Disadvantages of a Venture capital
- Wealth and expertise can be brought into the business
- Financing is done by way of equity so the burden which a business face is less compared to when it borrows money for a business that is debt money.
- Businesses also get valuable connections through a VC and also technical, marketing or strategic expertise which helps a less experienced business person to make his business more successful.
- There is no obligation to repay the money.
- Autonomy gets lost as investors became part owners. Due to their substantial stake, they try to have a say in business decisions.
- The process of getting investor on board is a lengthy and time-consuming process
- Generally, as Investor has the money so he has the say when it comes to closing the deal. So the term sheet generally is more biased towards Investor unless the business is a novel idea or has huge potential demand.
- Benefits from Venture capital financing are realized in long run only.
Returns for a Venture Capital
Venture funds will be able to realize gains only when there is a liquidity event (that is “exit”), This happens in three situations namely:
- Share Purchase: This happens when a new investor looking to buy ownership in the company buys the stake from existing Investor. Sometimes the owner of the company would also repurchase the stock.
- Strategic Acquisition: Strategic acquisition happens by way of a merger or an acquisition. This is done by a company willing to buy a differentiated technology, a large customer base, a rockstar team, or some other combinations. Example Hotmail acquisition by Microsoft
- Initial Public Offerings (IPO): Companies with a standalone business and in profits with the stable customer base, product strategy and growth would prefer raising money for future growth by IPO.
Life of a Venture Capital Fund
The average life of a VC fund is in the range of 7 to 10 years. However, they remain active for a period of 3-4 years only. The reason is that by end of 4 years majority of the fund money is already invested. The remaining years are for harvesting consequential investments in few exceptional performers.
Generally, VC funds reserve about 50% of funds as a reserve so as to support the existing portfolio companies. However, a smaller fund would not do a subsequent investment as it would not be economically viable due to large capital that is required for a small incremental ownership.
So if you are a start-up looking for funds you need to ensure that you approach a VC which is less than four years old.
Just like a PE fund first, the limited partners get paid and then the fund. Each fund is active for four years and then subsequently harvest returns. A VC would have multiple funds active at the same time but only a few are active for accepting new investments. The term used to refer to unallocated funds is “Dry Powder”
Top VC Deals of All Time
- Alibaba – Softbank: – Softbank invested $20 million on Alibaba in 2000. In 2016, they sold $8 billion worth Alibaba stocks. And still, own over 28% of the Alibaba (market capitalization of closer to $400 billion). No prizes for guessing that this investment gave Softbank more than 500x returns.
- WhatsApp – Sequoia – Sequoia invested a total of about $60 million in WhatsApp, increasing its stake to approx 40%, after an initial $8 million investment in 2011. Whatsapp got acquired by Facebook for $19 billion and helping Sequoia make $6.4 billion on the deal. Guess what is the total return that Sequoia made?
- eBay – Benchmark – Benchmark invested $6.7 million in Ebay’s Series A. After the IPO, the investment was worth more than $5 billion. Again, the returns were mind-boggling.
Top 20 Venture Capitalists
|S. No||Name||VC Firm|
|2||Chris Sacca||Lowercase Capital|
|3||Jeffrey Jordan||Andreessen Horowitz|
|4||Alfred Lin||Sequoia Capital|
|5||Brian Singerman||Founders Fund|
|6||Ravi Mhatre||Lightspeed Venture Partners|
|7||Josh Kopelman||First Round Capital|
|9||Nanpeng (Neil) Shen||Sequoia Capital (China)|
|10||Steve Anderson||Baseline Ventures|
|11||Fred Wilson||Union Square Ventures|
|12||Kirsten Green||Forerunner Ventures|
|13||Jeremy Liew||Lightspeed Venture Partners|
|14||Neeraj Agrawal||Battery Ventures|
|15||Michael Moritz||Sequoia Capital|
|16||Danny Rimer||Index Ventures|
|17||Aydin Senkut||Felicis Ventures|
|18||Asheem Chandna||Greylock Partners|
|20||Mary Meeker||Kleiner Perkins Caufield & Byers|
Difference between Venture Capital and Private Equity
Generally, there is confusion among the terms VC & PE. However, there is a difference between the two. The primary difference between VC & PE is that PE mostly buys 100% of the company in which they invest whereas VC invest 50% or less than that. Apart from that, the concentration of PE firms is in mature companies while VC concentrates on start-ups with potential growth.
Also, have a look at this detailed article on VC vs PE
As an investor getting associated with a Venture capital fund requires research and analysis as there is high risk involved with investments. As a start-up, it is necessary that you get associated with right venture fund as they apart from the fund they do provide the necessary expertise.
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