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Venture Capital and Private Equity Session 2

Venture Capital and Private Equity Session 2. Professor Sandeep Dahiya Georgetown University. Course Road Map. What is Venture Capital - Introduction VC Cycle Fund raising Investing Exiting Time permitting – Corporate Venture Capital (CVC). ONSET What Happened.

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Venture Capital and Private Equity Session 2

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  1. Venture Capital and Private Equity Session 2 Professor Sandeep Dahiya Georgetown University

  2. Course Road Map • What is Venture Capital - Introduction • VC Cycle • Fund raising • Investing • Exiting • Time permitting – Corporate Venture Capital (CVC)

  3. ONSET What Happened • Raised 100 million for ONSET III • Has raised 7 funds to date inclusing a $200 million fund in 2004! • Now has over $1 billion in assets under management (Seed Stage???) • We will return to TallyUp later in the course

  4. Quick Overview of Venture Capital Institutional Investors (Pension Funds/ Endowments etc) Fund of Funds (FOF) Individual Investors Family Offices Limited Partners (LP) € € € VC FUND (Partnership Agreement) Advice VC Fund Management Company Portfolio Company 1 General Partner (GP) € Portfolio Company 2 + Advice Portfolio Company 3 …

  5. Concerns for LPs Institutional Investors (Pension Funds/ Endowments etc) Fund of Funds (FOF) Individual Investors Family Offices Limited Partners (LP) € € € • Hand over money for 10 years – No control once committed!!! • Hard to get out mid-way VC FUND (Partnership Agreement) • Restrictions on size of fund, size and type of investment, and use of debt • Restrictions on co-investments with earlier funds • Pre Agreed “Take Down” Schedule – will give money when “Capital Calls” are made • Fund Life restricted to 10 years (may be extended by additional 2 years) • Compensation Structure of GP!

  6. Compensation of VCs Management Fee (2% of Committed Capital) • How do GPs get compensated? • Carried Interest (20% of Profits) • Reputation • Signal VC FUND (Partnership Agreement) Advice VC Fund Management Company VC Fund Management Company General Partner (GP)

  7. Exit and Distribution Institutional Investors (Pension Funds/ Endowments etc) Fund of Funds (FOF) Individual Investors Family Offices Limited Partners (LP) € € € VC FUND (Partnership Agreement) € Advice VC Fund Management Company Portfolio Company 1 General Partner (GP) € Portfolio Company 2 + € Advice Portfolio Company 3 …

  8. ONSET Ventures Fund NameVintage YearCommittedIRR CapitalFundLP ONSET 1984 $5M ONSET I 1989 $30M 26.30% 21.72% ONSET II 1994 $67M 15.49% 11.69% ONSET III 1997 $100M

  9. Review of Important Terms • VC firm • General partner (GP) • VC fund • Limited partner (LP) • Capital call = drawdown = takedown • Committed capital • Early-stage fund, late-stage fund, multi-stage fund • Vintage year • Management Fees • Carried interest

  10. 0 1 2 3 4 5 6 7 8 9 10 Some Basics • How is return of a fund measured? • Consider a fund that raised 100 million – Drew down 50 million at start of year 1 and Year 2. Distributed 100 million at the end of year 7 and 80 million at the end of year 10. -50 -50 100 80 IRR=7.87% Multiple 1.8x What if 100 was distributed at the end of Year 5 instead of Year 7? • What is distribution? • What is the IRR when the Fund was 4 years old? • How does the VC get paid?

  11. Basics of Fund Performance • Simple calculations have ignored fees/expenses to be paid • We shall see a more realistic example in Key Ventures

  12. Key Ventures • Size is $250 million, life 10 years • Management Fee 2% collected at start of each year. (2%x250 = 5 million each year) • Lifetime fees = 10x5=50 million • Investment Capital = 250-10x5= 200 • Assume 4 equal take downs (200/4=50) • Assume gross return is 25% • 10% of portfolio value is distributed every year starting in Year 4 (end of year). • No carry till the entire 250 million is returned to investors

  13. 9 10 5 0 0.0 0.0 0.0 0.0 360.4 456.1 649.4 730.5 0.0 0.0 0.0 0.0 45.6 64.9 730.5 0.0 0.0 0.0 0.0 36.0 122.2 296.1 1026.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0 9.2 146.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 9.2 155.3 0.0 0.0 0.0 0.0 36.0 45.6 55.7 584.4 0.0 0.0 0.0 0.0 36.0 122.2 286.9 871.3 288.3 410.5 584.4 0.0 220.0 235.0 250.0 250.0 50.0 100.0 150.0 200.0 200.0 200.0 200.0 5.0 5.0 5.0 5.0 5.0 5.0 5.0 14.2 146.1 82 -55.00 -55.00 -55.00 -55.00 31.04 35.54 40.61 50.71 584.43 Key Ventures Year 0 1 2 3 4 5 6 5 5 5 5 5 5 5 Management Fee 50.00 50.00 50.00 50.00 0.0 Investment 50.0 112.5 190.6 288.3 405.4 Estimated Portfolio Value 36.0 40.5 Distributions 76.6 Cumulative Distributions Distribution to Key Cumulative Distributions to Key 40.5 Distribution to LPs 76.6 Cumulative Distributions to LPs 50.0 112.5 190.6 324.3 364.9 Portfolio value after capital returned 55.0 110.0 165.0 225.0 230.0 Contributed Capital Invested Capital 200.0 200.0 Cash Flow to Key Ventures NPV for Key Ventures Cash Flow to LPs What effect would having a 25% carry but management fee only for the first 4 years have?

  14. A Clear Philosophy • Focus on Equities--public or private. • Avoiding market timing. • Focus on inefficient markets. • Pick investment managers rather than investments. • Focus on incentives.

  15. An Unconventional Mix

  16. Strong Track Record • 15 year return of 14.2%: • 2.7% above S&P 500 • 4.3% above all universities.

  17. Private Equity is an Important Element • Investor since 1973. • Repeated investments in partnerships formed by a select group of organizations. • Emphasis on value-added strategies. • Focus on incentives.

  18. Spectacular Success in Private Equity • 31% over 29 years--well above benchmarks. • Success in venture capital, buyouts, and oil & gas. • Prestige investor.

  19. But Worries About Future • Recent fund influx: • Private pension funds in 1980s. • Public pension funds in 1990s. • Private equity pool--from $4B in 1980 to ~$300B in 2004. • “Virtual overhang.”

  20. Private Equity Fundraising

  21. Private Equity Returns

  22. Mixture of Funding Sources

  23. Implications of Fund Influx • Alteration in incentives. • Relaxation of covenants. • Concerns about within-fund compensation. • Quality of deals.

  24. But ... • Good returns during last fund influx. • Inter-quartile spreads: • 3% in public equities. • 12% in private equity. • Private equity small relative to potential: $1:$30.

  25. But…. (2) • Ways to manage risks: • Top down: Optimizer. • Drove decision to undertake major hedging effort in 1999. • Bottom up: What—in Swensen’s team’s judgment—are the interesting areas going forward? • Swensen: Must use both approaches! • Need for communication and trust with Investment Committee.

  26. Challenge of Internationalization • 10% of Yale’s private equity, mostly Europe. • Poorer returns. • Organizational worries and difficulties of assessment. • Who to back?

  27. Swensen’s Dilemma • Is private equity still viable for Yale? • If so, where? • If not, what other asset classes should they pursue? • How far can it go in pursuit of returns? • How dangerous is it to be different?

  28. Yale Investment Office 2006 • Domestic Equity 12%, Bonds 4%!!! • Private Equity 17% • Real Assets 27% • Beat S&P500 in every year since 2002 by Wide mragins!! Endowment size $18 billion

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