venture capital and private equity session 3
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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 - PowerPoint PPT PresentationTRANSCRIPT
Venture Capital and Private Equity
Session 3Professor 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 DahiyaGeorgetown 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 entrepreneurInformation 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 exitNumbers 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
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
Analysis based on value TODAY !
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
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
Analysis based on value at EXIT DATE!
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
How many shares if VC needs 30% return (would ask for 18.6% of the firm).
Value of VC at Exit =12x(1.5)^5
=91.125!!!
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 sharesF1New Number of Shares Y X
(1-(F1 OP))0.3797
Y 1 0.807 million 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
VC Current Ownership = 0.3797/(1-0.15) = 44.67%
Final%) sOwner'Later 1(
Ownership% Final
Retention%
Ownership% FinalOwnership%Current
Final%) sOwner'Later 1(Retention%
Ownership%Current
Ownership% FinalRetention%
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.
What is the Post and Pre Money Valuation at round 1?
How many shares need to be issued to Round 1, Round 2 and option pool?
5/0.485=10.32; 5.32
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 TablesPage 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.
Before Financing After Intial 750,000 investment
Investor # of shares $ per share $ total%
ownership # of shares$ per share $ total
% ownership
Founders 1,625,000 $0.000 $0 100% 1,625,000 - $1,625,000 68.42%ONSET Ventures 750,000 $1.00 $750,000 31.58%Option Pool
Total For Round
Cumulative Total 1,625,000 $0.000 $0 100% 2,375,000 $1.00 $2,375,000 100%
Price Per Share$1
Pre-Money Valuation 1,625,000Cash Infusion 750,000Post-money Valuation 2,375,000
After Next Investment of $250,000
After Intial 750,000 investment After next 250,000 investment
Investor # of shares$ per share $ total
% ownership # of shares
$ per share $ total
% ownership
Founders 1,625,000 - $1,625,000 68.42% 1,625,000 - $1,625,000 61.90%ONSET Ventures 750,000 $1.00 $750,000 31.58% 1,000,000 $1.00 $1,000,000 38.10%Option Pool
Total For Round 250,000 $1.00 $250,000 9.52%Cumulative Total 2,375,000 $1.00 $2,375,000 100% 2,625,000 $1.00 $2,625,000 100%
Price Per Share$1 $1
Pre-Money Valuation 1,625,000 $2,375,000Cash Infusion 750,000 250000Post-money Valuation 2,375,000 $2,625,000
After option pool creation of 750,000 Shares
After next 250,000 investment After Option Pool
Investor # of shares$ per share $ total
% ownership # of shares
$ per share $ total
% ownershi
p
Founders 1,625,000 - $1,625,000 61.90% 1,625,000 - $1,625,000 48.15%ONSET Ventures 1,000,000 $1.00 $1,000,000 38.10% 1,000,000 $1.00 $1,000,000 29.63%Option Pool 750,000 $1.00 $750,000 22.22%
Total For Round 250,000 $1.00 $250,000 9.52% 750,000 $0.00 $0 22.22%Cumulative Total 2,625,000 $1.00 $2,625,000 100% 3,375,000 $1.00 $3,375,000 100%
Price Per Share$1 $1
Pre-Money Valuation $2,375,000 $2,625,000Cash Infusion 250000 0Post-money Valuation $2,625,000 $3,375,000
What if Mann is able to do a $3.5 million round at 2.5 times step up (ONSET invests $1 million in this
round)After Option Pool Raise 3.5 Million Total at 2.5 Step Up
Investor # of shares$ per share $ total
% ownership # of shares
$ per share $ total
% ownership
Founders 1,625,000 - $1,625,000 48.15% 1,625,000 - $4,062,500 34.03%ONSET Ventures 1,000,000 $1.00 $1,000,000 29.63% 1,400,000 $2.50 $3,500,000 29.32%Option Pool 750,000 $1.00 $750,000 22.22% 750,000 $2.50 $1,875,000 15.71%New VC 1,000,000 $2.50 2500000 20.94%
Total For Round 750,000 $0.00 $0 22.22% 1,400,000 $2.50 $3,500,000 29.32%Cumulative Total 3,375,000 $1.00 $3,375,000 100% 4,775,000 $2.50 $11,937,500 100%
Price Per Share$1 $2.50
Pre-Money Valuation $2,625,000 $3,375,000Cash Infusion 0 3,500,000Post-money Valuation $3,375,000 $11,937,500