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

19

75

19

77

19

79

19

81

19

83

19

85

19

87

19

89

19

91

19

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

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g

Re

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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