Venture Capital

1. Public market (Major segment):

   Established markets operate with fixed rules and minimum transparency requirements, offering tradable securities while ensuring anonymity between buyers and sellers.

   a. Stock Market

   b. Bond Market

2. Private Market (Major segment):

   bilateral contract ensures tight interaction and alignment between the buyer and seller throughout the entire transaction process, from initiation to completion.

   a. private equity

   1. Venture Capital: early stage

   2. Private Equity: later stage

   b. Private Debt

1. Financial Intermediary: A VC invests investors' capital directly into portfolio companies, typically acquiring a minority stake, often involving combined investments from multiple VCs

2. Involved in Private Companies: VC invests exclusively in private companies, typically taking a minority stake. Once invested, these companies can't be quickly traded publicly, resulting in no immediate liquidity

3. Active Post - investment: A VC takes an active role in monitoring and helping the companies in his portfolio

4. Defined Time Horizons: A VC aims to maximize financial returns by exiting investments via a sale or IPO, typically holding investments for 3-6 years, with a focus on liquidation preference

5. Company Growth Strategy: VCs fund the growth of young companies, not acquiring existing ones, aiming for capital gain rather than dividends

1. Seed

2. Start Up

3. Expansion

4. Bridge

5. MBO / MBI

During the seed phase, a product concept is formulated, followed by a thorough market analysis, and foundational developments are initiated to shape the venture.

During the startup phase, the company is established, efforts focus on bringing the product to maturity, and a strategic marketing concept is devised.

In the expansion phase, production commences, and the focus shifts to entering the market or securing financing to fuel growth.

Preparation of IPO or sale to investor

Takeover by existing management (MBO) or by external management (MBI)

• Seed - phase:

  • Financing: own fund; public subsidies; venture capital

  • Problem: Assessment of product and market, professionalism

• Start Up- Phase:

  • Financing: own fund; public subsidies; venture capital

  • Problem: Mistrust of investors, Search for management staff and personnel

• Expansion-phase:

  • Financing: Private equity & debt financing

  • Problem: Search for outside investors Creation of market position and Image

• Bridge-phase:

  • Financing: Debt, Stock, Private Equity

  • Problem: Increasing competition, Organizational problems

• MBO/MBI-phase:

  • Financing: Debt, Stock, Private Equity

  • Problem: Financial Strength of Management , Dynamics of the management team

1. Demographig patterns and relationships:

   • will finance anywhere

   • expect to play an active role in ventures financed

2. Investment record:

   • investment range from 100k - 500k

3. Venture preference:

   • Companies less than 5 years old

   • services, software, natural ressources

4. Risk reward expectations to the basis of 5 year capital gain

   • Start up = 10x the investment

   • Under 1 year old = 6 x the investment

   • 1-5 years old = 5 x the investment

   • over 5 years old = 3 x the investment

• 1,25- 3% Annual fee measured by the investment

• 15-25% of the capital gains

1. Investors

   • Provide capital

2. Venture Capital and private equity firms

   • Identify and screen opportunites

   • Transact and close deals

   • monitor and add value

   • raise additional funds

3. Portfolio companies

   • Use capital

A Fund of Funds (FoF) is an investment strategy where a fund invests in multiple other investment funds rather than directly in stocks, bonds, or other securities. This approach diversifies investments across a range of underlying assets, offering investors a broader exposure while potentially mitigating risks. FoFs are commonly used in hedge funds, private equity, and mutual funds

1. An efficient mechanism to access various asset classes/venture funds: A Fund of Funds (FoF) provides investors with a streamlined way to tap into a variety of asset classes or venture funds.

2. Access to high performing managers: One of the primary benefits of an FoF is that it can grant investors access to top-tier fund managers.

3. Diversification: Diversification is a core principle of investment to mitigate risk. By investing in multiple funds, an FoF inherently spreads the risk across various assets, strategies, and management styles.

4. Research and proactive relationship development: FoFs often have dedicated teams that conduct thorough research on potential target funds. This research ensures that the FoF is investing in funds that align with its strategy and risk profile.

1. Accelerators

2. Angel list

3. Peer investor

4. Banks

5. serial entrepreneurs

6. Corporate spinouts

• Adv:

  • Large volume of vetted opportunities,

  • best suited for seed investors

• Dis:

  • Overcrowding – the best start-ups

    are funded prior to demo-days

  • For some start-ups, valuation can

    get inflated very quickly

Adv:

• Access to opportunities

• No geographic barriers

Dis:

• Stimulates herd mentality of stock

  market

Adv:

• Speedier DD in trusted relationships

Dis:

• Lame horses can be parlayed as

  great opportunities

Adv:

• Can provide some level of prescreening based on fund criteria and fit

Dis:

• Caveat emptor: All clients who pay $ 300 per hour look great!

Adv:

• Can mitigate risk

• May have skin in the game

Dis:

• Senior lenders have first lien on assets

Adv:

• Well-vetted ideas

• Recognition of challenges

Dis:

• May not have any skin in the game

Adv:

• Potential for joint development

• Co-investments

Dis:

• Market size may be limited

• Patents may have limited shelf life

• Can't raise enough initial angel/VC funding (less founding)

• Wasting too much money at early stages (wasting money)

• Company doesn't begin with the best people (wrong people)

• Doesn't produce something people want (no market)

• Hires too many people too quickly (to many people)

• Hires the wrong people, or people with the wrong skills (wrong skills)

• Beaten out by a competitor (Competitor)

  ————————————————————————————————-

Extra:

• Not able to successfully monetize the idea

• Doesn't produce a working product in a timely manner (no timing)

1. Deal Flow & Preliminary Check:

   • The inspection of submitted documents involves a standardized quick-check and a high-level review. This process culminates in a first meeting with the investment manager

2. LOI & Detailed Assessment:

   • The agreement on the term-sheet encompasses an exclusivity agreement and a detailed examination of investment criteria. This is followed by high-level transaction structuring and an initial indication of venture valuation.

3. Due Dilligence:

   • The business plan review includes market and competitor analysis, leveraging expert knowledge from the network. This assessment leads to venture valuation, a management presentation, and HR due diligence

4. Investment Committee:

   • The presentation of the investment proposal involves a discussion on the investment, followed by a majoritarian voting process before the final investment decision. This culminates in a recommendation for negotiation.

5. Structuring & Closing:

   • The process entails agreement on the contract draft, leading to the signing of contracts with notarial documentation. This is followed by the payout and the initiation of value enhancement programs.

• Agreement on content of contract, without involving expensive lawyers

• Documentation of serious interest of both parties

• Determination of cost allocation (esp. if founders negotiate with several VCs in parallel)

Basics:

1. Price per Share:

   Original Purchase Price (OPP); Aggregate Purchase Price (APP)

2. Capitalization Table & Employee Stock Option Program (ESOP):

   Might include shares owned by previous investors (angels and VCs of earlier rounds)

The Charter:

1. Charter = Certificate of Incorporation; filed with the state in which the company is incorporated

2. Dividends

   Alternative: Payment-In-Kind (PIK) however forced dilution of common stock

3. Liquidation Preference

   Tells an investor where he stands in the capital structure hierarchy (“waterfall”), ≠ pari passu

4. Anti-Dilution

   Protect investors in case of down rounds (future investments are done at a lower price per share); Weighted average versus “Full-Ratchet”

Investor right agreement:

1. Lock-up

   Lock-up of insider stock after IPO; Frequently 180 days

2. Management and Information Rights

   Provides the investors with access to information about the company, such as budget and audited; financials at pre-agreed periods of time

• tells an investor where he stands in the capital structure hierarchy (“waterfall”), ≠ pari passu

• Occurs if the company is sold, merged, or shut down (“deemed liquidation event”)

• Some investors insist on preferences in excess of their original investment (“2X” or “3X”)

• Forces investors to continue investing pro rata in future rounds or see their preferred stock converted to common

“In der Venture-Capital-Branche kann "Pay to Play" eine Klausel in Investitionsverträgen sein, die besagt, dass Investoren in späteren Finanzierungsrunden weiter investieren müssen, um ihre ursprünglichen Rechte und Privilegien zu behalten.”

• Protect investors in case of down rounds (future investments are done at a lower price per share)

• Weighted average versus “Full-Ratchet”

  
  

  “Die "Weighted Average"-Methode bietet einen ausgewogenen Schutz für bestehende Investoren, ohne die Gründer und anderen Aktionäre übermäßig zu benachteiligen.

  Die "Full-Ratchet"-Methode bietet maximalen Schutz für Investoren, kann aber für die Gründer und anderen Aktionäre nachteilig sein.”

• Promise of equity in exchange for founding, employment, or consultancy roles.

• Equity can vest based on milestones, time elapsed, or specific events (e.g., liquidation).

• Common scheme: Four-year vesting period.

• One-year "cliff" followed by monthly increments.

• A period during which assets or securities cannot be sold or transferred.

• Often used post-IPO, preventing company insiders from selling shares for a set duration.

• Ensures stability and prevents market flooding with large volumes of a security.

• Gives the investors in earlier rounds the right of first refusal to invest pro rata to their initial

  investment in follow-on rounds

“Gibt den Investoren aus früheren Runden das Vorkaufsrecht, entsprechend ihrer anfänglichen Investition anteilig in nachfolgenden Runden zu investieren.”

• "Tag-Along Right" allows investors to sell shares alongside founders.

• If a founder sells, investors can sell at the same terms.

• Protects minority shareholders and ensures equal sale conditions

Usually stipulates that, if a majority of preferred shareholders want an exit through sale or

liquidation, then the remaining preferred and common stockholders must either agree to go along or to be dragged along in the process

1. Acquisition

2. IPO ( Initial Public Offering)

3. Private exchanges

4. Redemption

”+” : - Speed

- Reduced regulatory challenges

“-” : - Takes two to tango

- Founders or any other investors cannot retain partial ownership

Pros:

• Larger valuation in stronger market conditions

• Can use stock for acquisitions

Cons:

• Company need to achieve growth rates higher than average

• Expensive process

Pros:

• Rapid liquidity

• Higher valuations

Cons:

• Awareness and demand of the companies

  needs to be high

• Value is determined by public-market like

  speculation

Pros:

• Ability to recover at least some capital,

  assuming the company has some cash in

  hand at the time of redemption

Cons:

• Dependent on the company’s ability to

  redeem

• Payouts could be stretched over time,

  further reducing the IRR

Rt = (Pt + Dt) / Pt-1 – 1, where R = return, P = portfolio value or price, t =

period, and D = dividend.

For multi-period returns, multiply the periodic returns to arrive at the

Compound return = (1 + R1) * (1 + R2) * … * (1 + RN) – 1

To translate multi-period returns into annualized returns use the

following formula: Annualized return = (1 + compound return)(1/T) – 1

• An annualized return calculation is an industry-standard procedure for computing asset returns

• it is used for stocks, bonds, and bank deposits.

• This procedure is reasonable for calculating returns of the whole VC industry; however it doesn’t seem to be reasonable when applied to a single VC fund as these funds may have vastly different amounts of capital invested in different years of the fund.

Example:

• An LP commits $11M to a fund (for simplicity: no carries, no fees)

  • Year 1: The fund calls $1M at the beginning of the year and returns $2M at the end of the year

  • Year 2: The fund calls $10M at the beginning of the year and returns $6M at the end of the year

  • Compound return: (1+1)*(1-0.4) – 1 = 20%

  • Annualized return: (1.2)(1/2) – 1 = 9.5%

  • However, obviously the total return is negative: - $11M + $2M + $6M = $-3M Need to weigh each dollar equally

  • Compute the Internal Rate of Return

    
    

    $6M = $1M * (1+IRR)2 + $8M * (1+IRR)

    IRR = -31%

• Cannot be compared to time weighted returns

• Compounding of periodic returns (IRR assumes reinvestments)

• Difficult to make risk adjustments (only one IRR throughout investment lifecycle)

• Realized vs. unrealized investments (low IRR in the first years of a fund)