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Chapter 14Chapter 14Entrepreneurial Finance, Smith and Kiholm Smith
Venture CapitalVenture Capital
Historical Development of Venture Capital as an Institution
Venture Capital New Commitments
$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
$40,000
$45,000
$50,000
Mill
ion
s o
f D
olla
rs
19
69
19
71
19
73
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75
19
77
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79
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81
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83
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85
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91
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93
19
95
19
97
19
99
Year
Venture Capital New Commitments
Sources: Statistical Abstract of the U.S. (various issues), Venture Economics Investor Service, Sahlman (1990).
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Pe
rce
nt
of
To
tal
19
78
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
Year
Sources of Venture Capital Funds
Foreign Investors
Individuals
Corporations
Endowments
Insurance Companies
Pension Funds
Sources: Statistical Abstract of the U.S. (various issues), Gompers and Lerner (1996, 1997).
Sources of Venture Capital Funds
Organizational Structure of Venture Capital Investment
Portfolio Companies–Value creation
– Generate deal flow – Screen opportunities– Harvest investments
– Negotiate deals– Monitor and advise
General Partners
Venture Capital Fund
– Pension plan– Endowments– Life insurance companies
– Corporations– Individuals
Limited Partners
Effort and 1% of capital
Annual Management
Fee 2-3%
Carried Interest 20-30% of Gain
99% of Investment Capital
Capital Appreciation 70-80% of Gain
Investment Capital and
Effort
Financial Claims
Summary of Terms: Venture Capital Limited Partnership Agreement
Venture.com VC Fund, L.P. (the “Fund”)
Terms and ProvisionsPurposeGeneral PartnerLimited Partnership InterestsGeneral Partner’s InvestmentMinimum for ClosingPayment of SubscriptionsTerm Allocation of Profit and LossDistributionsService FeeOrganizational ExpensesConflicts of InterestOther Restrictions and Limitations
Summary of Terms:Venture Capital Limited Partnership
Agreement
0%
5%
10%
15%
20%
25%
Pe
rce
nt
of
tim
e
So
liciti
ng
Bu
sin
ess
Se
lect
ing
Op
po
rtu
niti
es
An
aly
zin
g B
usi
ne
ss P
lan
s
Ne
go
tiatin
g D
ea
ls
Dir
ect
ing
an
d M
on
itori
ng
Co
nsu
ltin
g
Re
cru
itin
g M
an
ag
em
en
t
Ass
istin
g in
Ou
tsid
eR
ela
tion
ship
s
Exi
ting
Activity
Allocation of Venture Capitalist Time
Source: Zider (1998)
Allocation of Venture Capitalist Time
The Venture Capital Investment Process
Development of Fund Concept
Secure Commitments from Investors
Generate Deal Flow
Closing of FundFirst Capital Call
Screen Business
Plans
Evaluate and Conduct Due
Diligence
Negotiate Deals and
Staging
Additional Capital Calls
Invest Funds
Distributing Proceeds– Cash – Public Shares
– OtherHarvesting Investment– IPO– Acquisition
– LBO – Liquidation
Value Creation and Monitoring
– Board service– Performance evaluation and review– Recruitment management
– Assist with external relationships– Help arrange additional financing
Year 0
2-3 years
4-5 years
2-3 years or more
7-10 years plus extensions
Key Covenant Classesof Venture Capital Limited Partnerships
Overall Fund ManagementInvestment in a single firmUse of debtCoinvestment by Venture Capitalist’s Other FundsReinvestment of profitsActivities of General PartnerPersonal investing in portfolio companiesSale of interest by General PartnerFund-raisingOutside activitiesAddition of General PartnersTypes of investmentsRestrictions on asset classes
Based on Gompers and Lerner (l997).
Key Covenant Classes of Venture Capital Limited Partnerships
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