equity venture capital pdf

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Equity Venture Capital

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This slide set is a work in progress and is embedded in my Principles of Finance course, which is also a work in progress, that I teach to computer scientists and engineers http://awesomefinance.weebly.com/

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  • 1. Equity Venture Capital
  • 2. 2 Return On Investment Within five years, a portfolio company should be able to deliver five to ten times the return on CenterPoint's investment, with CenterPoint retaining a meaningful equity share of 10% or higher for its Limited Partners. N=5$years 5$times$the$investment PV=1 FV=5 5$$=$$1(1+k%)5 $ $ k=38.0% 5"years 10"times"the"investment 10""=""1(1+k%)5 " " k=58.5% FV=PV(1+k)N ++ PV= FV (1+k)N ++
  • 3. Discussion What is Centerpoints targeted rate of return on its investment? How are present and future value related when there are no intermediate cash flows? Define the following o Future value rate and future value factor o Discount rate and discount factor 3
  • 4. Discussion What is a firms equity? How is a VC firm organized? Who are the general and limited partners? 4
  • 5. Reference For These Lectures 5 Students must obtain this background note from HBSP We will follow that methodology and example
  • 6. Scenario Three entrepreneurs founded a so3ware company, LeanTech, last year. LeanTechs incorpora
  • 7. Scenario (Continued) Companies in that industry have an average equity value of 15
  • 8. Discussion How is the economic value of an entity or security determined? o Discounted cash flow o Relative and multiples valuation Where are debt, equity, and net profits in the financial accounting statements? Whats the cash flow timeline? 8 investment VC exit time 0 1 2 3 4 5 6 pe= EN NPN+1 = E5 E[NP6 ]
  • 9. Discussion What is capital ? o Look at the balance sheet 9 Non-interest bearing liabilities Interest bearing liabilities Equity Assets Capital
  • 10. Expected Value 10 The expected value of the equity after 5 years, E, is E = NPpe = $2,500,00015 = $37,500,000 The expected value of the VCs share of the firm after 5 years, EVC, is E I (1 k)N $3,500,000 (1 50%)5 $26,578,125 vc = + = + = The fraction of the firm that the VC will own after the investment, fVC, is f Evc vc E $26,578,125 $37,500,000 = 70.875% = = I: VC investment NP: annual net profit of company during Nth year pe: price to earnings ra
  • 11. Equity Alloca
  • 12. Discussion Mean value is an average value of a sample, a population, an experiment, a measurement, etc. Expected value is a probability-weighted average of all possible values or outcomes The financial context is different from running an experiment or sampling a population repeatedly We may have a historical mean annual return rate and an expected return rate next year o Expected value of the net profit in year 6, E[NP6] o Year 6 is not actually run repeatedly to find the average value! 12
  • 13. Equity Shares 13 How many shares must LeanTechs board approve for LeanTechs treasury (under the CFO) to issue to the VC? ns = ns + ns = post pre ns f ns vc post = ns post pre f ns ns vc pre ns 70.875% 1,000,000 (1 70.875%) = = 2,433,476 ns nspre nspost ns post = ns ns pre + 1,000,000 2,433,476 = + 3,433,476 = ns: number of shares ns: number of new shares issued to the VC (1 f ) ns (ns ns) f ns vc vc = + =
  • 14. Discussion 14 How many shares of common stock does Netflix have ? o Authorized o Issued o Outstanding o Treasury shares = Issued - Outstanding
  • 15. Discussion What is preferred and common stock? What is additional paid in capital? What are retained earnings? What is the top job in a companys accounting department? In its financing department? 15
  • 16. Post-Money Equity Value 16 I = ns p p I ns $3,500,000 2,433,476 $1.438 post post = = = E post = ns ppost post 3,433,476 $1.438 = $4,938,272 = p: Share price E: Equity value ns: number of new shares issued
  • 17. Pre-Money Equity Value 17 E E I pre = post $4,938,272 $3,500,000 = $1,438,272 = E pre ns $1,438,272 1,000,000 = $1.438 p pre pre = = pexit= E nspost ++++++=$37,500,000 3,433,476 =$10.922 p: Share price E: Equity value ns: number of equity shares
  • 18. VC App 18
  • 19. Mul< Round Investment VCs can manage risk by inves
  • 20. Cash Flow Timeline 20 0 4 i 2 5 fA rA dA fB rB dB fC rC dC Round A FVC IA Round B IB Round C IC VC Exit d: ini
  • 21. Equity Alloca
  • 22. Equity Alloca
  • 23. Ini
  • 24. Initial & Final Equity Fraction 24
  • 25. Investment Cash Flow 25 0 4 i 2 5 pA nsA pB nsB pC nsC pFDR nsFDR Round A FVC IA nsA Round B IB nsB Round C IC nsC VC Exit pexit
  • 26. Equity Shares 26 515,055 33.996% 1,000,000 (1 33.996%) d ns A FDR (1 d ) ns A A ns = ns + ns = 1,000,000 + 515,055 = 1,515,055 A FDR A = = = 124,077 7.570% 1,515.055 (1 7.570%) d ns B A (1 d ) ns B B ns = ns + ns = 1,515,055 + 124,077 = 1,639,131 B A B = = = 56,522 3.333% 1,639,131 (1 3.333%) d ns C B (1 d ) ns C C ns = ns + ns = 1,639,131 + 56,522 = 1,695,653 C B C = = = Ini
  • 27. Share Price 27 $17.692 $1,500,000 $1,000,000 $1,000,000 56,522 I I I ns p $8.060 124,077 ns p $2.912 515,055 ns p C C C B B B A A A = = = = = = = = = $22.115 p $37,500,000 exit = = 1,695,653 ns 515,055 = ns 1,515,055 A A = ns 124,077 = ns 1,639,131 B B = ns 56,522 = ns 1,695,653 C C = I: VC investment p: price of an equity share ns: number of common equity shares
  • 28. Discussion Note that the VCs ownership fraction is being diluted, but diluted down to their targeted ownership fraction at exit (IPO, M&A) The VCs targeted ROI is achieved 28
  • 29. VC App 29
  • 30. VC App 30
  • 31. Management Shares Consider another alterna
  • 32. Discussion How do employee incentive stock options work? 32
  • 33. 33 Final Alloca
  • 34. Reten
  • 35. Share Issuance 35 nsA= dA nsFDR (1+dA ) ------- = 36.011%1,000,000 (136.011%) = 562,767 nsA=nsFDR+nsA=1,000,000+562,767 =1,562,767 nsB= dB nsA (1)dB) +++++++=7.983%1,562,767 (1)7.983%) =135,570 nsB=nsA++nsB=1,562,767+135,570=1,698,338 Ini
  • 36. Share Issuance 3366 nsC= dC nsB (1)dC ) +++++++=3.509%1,698,338 (1)3.509%) =61,757 nsC=nsB+nsC=1,698,338+61,757=1,760,095 Ini
  • 37. Share Price 37 pA = IA nsA = $1,500,000 562,767 = $2.665 pB= IB nsB = $1,000,000 135,570 = $7.376 pC = IC nsC = $1,000,000 61,757 = $16.192 pM = $16.194 pEXIT = $37,500,000 1,852,732 = $20.240 nsA = 562,767 nsA =1,562,767 nsB=135,570 nsB=1,698,338 nsC=61,757 nsC=1,760,095 I: VC investment p: price of a share ns: number of common equity shares nsM=92,636 nsEXIT=1,852,732
  • 38. VC App 38
  • 39. Investment Alternatives 39
  • 40. Final Note VC investment shares are more typically issued as preferred conver
  • 41. Finance Concepts Introduced Risk Uncertainty Risk management Return and return rate Equity valua