Venture Capital and Private Equity Associations Quiz

Agenda

• The agenda covers topics related to private equity/venture capital
• Topics include: introductions to private equity/venture capital, investment process, financial aspects of venture capital investments, legal aspects of private equity investments, valuation of private equity investments, transaction structuring, fund remuneration, operations of private equity fund in portfolio companies, exits of funds, business angels, venture capital and private equity funds, and case studies.

Literature

• The literature section lists various books and articles related to venture capital and private equity.
• Includes works by P. Gompers, J. Lerner, S. Bloomfield, D. Podedworna-Tarnowska, M. Panfil, D. Klonowski, A. Metrick, A. Yasuda, S. Povaly.

Introduction to private equity/venture capital

• Venture capital and private equity are used interchangeably
• According to the EVCA, venture capital (VC) is professional equity co-invested with entrepreneurs to fund early-stage (seed and startup) or expansion ventures.
• Investors expect higher than average returns in high-risk investments.
• VC focuses on investments in new companies with potential high growth.
• Private equity is an investment in non-public companies made up of VC funds and buyout funds.
• NVCA defines private equity as VC + buyout/-Mezzanine investments.
• Mezzanine is a venture with increasing sales and profitable, needing more funds for expansion.
• Bridge is a venture needing short-term capital to reach stability.
• Acquisition/merger is a venture needing funds for acquisition/merger.
• Turnaround is a venture needing funds to become profitable.
• VC's origin dates back to ancient civilizations and funding expeditions like Christopher Columbus' voyage.
• Institutional sense, VC industry stemmed from managing high net worth families' wealth in the USA.
• VC, in its formalized meaning, is relatively new, emerging in the US from zero in the 1970s and growing to $5 trillion global assets.
• Characteristics of major issuers in the private equity market include a breakdown based on revenues and the reason they are seeking private equity.

Investment process

• The investment process is complex and varies by deal and fund.

• A successful VC deal is multistage.

• VC educates entrepreneurs who often confuse VC with other financing.

• Entrepreneurs may not have formal documentation or financial forecasts.

• The process of structuring and negotiating deals is difficult, especially for first-time VC recipients.

• Funds follow a common investment pattern that may differ in details based on the fund's structure.

• Components include approach by company, initial appraisal, meetings, examination, offer letters, accountant's investigation, legal stages, and closing.

• The investment process from the investee side includes determination, preparation, investors' preliminary consideration, preliminary offer letters, due diligence, investment committee proposal, issue of full offer, and formal acceptance.

• Legal stages include meetings between VC and VC's lawyers, meetings between the company and its lawyers, and completion meetings.

• Investment selection considers industry, field, technology, financing stages, size, and location.

• Pre-investment considerations include business plan, intellectual property, prior history, regulatory matters, and tax matters.

• Cross-border considerations are essential, as most markets are global, and VC generally expects companies to address international opportunities and threats.

Financial aspects of venture capital investments

• Rounds of financing/acquisition of funds start with commitments from investors.

• Investment stages include pre-seed, seed, first-stage, second and third stage, and pre-IPO financing.

• First-stage financing requires thorough market and competition familiarity, product understanding, and a strong management team.

• Pre-IPO financing is relevant to companies seeking public offerings, showcasing increasing sales and well-functioning marketing.

• Differences in financing stages include varying degrees of established feasibility and business development.

• Investment characteristics for each stage include aspects of the company's idea, team, plan, market understanding, marketing system (sales), and growth.

• Financing sources vary by stage and include individuals close to the entrepreneur, private investors, incubators, specialized funds, venture capital funds, institutional investors, and corporate investors.

• Key financing process aspects per stage include due diligence (from 3 to 6 months), managerial attention, and bridge financing for pre-IPO.

• Financial instruments in VC investments include loans (for agreed financing periods and amounts), and guarantees (written agreements for all or part of a third party's obligation, often related to loans). Equity and quasi-equity are also available for capital provision.

Valuation of private equity investments

• Valuation of each company needs precedent financial and strategic analysis.

• Financial analysis uses historical data to analyze efficiency and future condition of operations.

• Strategic analysis assesses entity strengths, weakness, opportunities, and threats in the environment.

• Methodology in valuation include price of recent investments (based on valuation of recent transactions), net assets (assessing underlying value of assets), discounted cash flows, and multiples (relative valuation based on similar companies).

• Discounted cash flows involve evaluating present value of expected future cash flows, the valuation of underlying business and not only the investment itself.

• Multiple methodologies are used, such as EV/EBIT, EV/EBITDA, and EV/S (enterprise value per revenues), and specific multiples (like EV/unique user or EV/number of subscribers).

• The choice of valuation method and the procedure of estimate fair value includes considering relevant factors to the investment, assumptions of future cash flows, risks, appropriate risk-adjusted rate, valuing the enterprise for surplus assets, excess liabilities, contingencies, and deducting financial instruments' ranking within the fund.

• FCFF vs. FCFE approaches to equity valuation are explained.

• Calculation of equity and enterprise value is according to model calculations for FCFE and FCFF (including required elements for the equations.

Transaction structuring. Fund remuneration

• Transaction structures on the venture capital market commonly use private placements
• Common securities include equity, debt, and warrants
• Equity securities: are common/preferred stock for companies.
• Debt instruments: are promissory notes/debentures, are often convertible subordinated debt.
• Subscription warrants: are rights to acquire equity, for later-stage ventures.
• Common advantages/disadvantages of equity-based structures include capital enhancements, credibility, no scheduled repayment, no personal liability, difficulty in funding, and dilution of ownership.
• Private placements and public offers differ in their costs and time frames.
• Fund compensation includes management fees (percentage of existing capital/assets) and carried interests (percentage of profits after investment return).
• Management fees have a set percentage and assessed base period.
• Sources for management fees calculation, includes capital commitments, actual capital investments, and managed portfolio value.
• Venture capital funds also often receive incentive payments based on fund profits.

Operations of private equity fund in portfolio companies

• VC funds are financial partners active in the capital market, offering know-how, expertise and connections, to help portfolio companies during developmental stages.
• Fund managers commonly have entrepreneurship experience in prior roles.
• There are differences in mindset between manager and entrepreneurial minds (see table).
• VC funds engage in activities that assist portfolio companies in the cycle.
• VC assists in constructing management boards that complement operational decisions.
• VC facilitates communications between portfolio companies, investors, and other stakeholders in the market.
• VC funds participate in management, operational improvement, and strategic growth initiatives.
• Additional activities to enhance company operations include recruitment, financial and fiscal optimization, and improvements in reporting and discipline, along with other assistance that can support development.

Venture capital and private equity worldwide and in Poland

• Venture capital and private equity associations (e.g., NVCA, EVCA, PPEA) represent the needs and interests of members, advocate for the sector, and provide networking and resources.
• These organizations aim to support industry development, share information, promote high professional standards, and maintain communication among members, institutional investors, entrepreneurs, policy-makers, and academics.
• Activities include lobbying, advocacy, professional development programs, research, and networking to grow the venture capital and private equity industry.
• Specific examples of international associations are listed within a detailed table.
• NVCA and PPEA are also examples of country-wide associations.

Exits of funds

• VC goals include selling companies at prices exceeding initial investments.
• Portfolio company outcomes vary (success rates).
• Exit types include IPO, acquisitions (by other firms or from competitors), trade sales and write-offs.
• Exit processes have structured stages of opportunity identification, evaluation, advisory, negotiations, and closing (that are also subject to review).
• The most common types of exits in US are acquisitions (M&A).
• Success rates and exit types vary depending on the metrics used to gauge success.
• IPO activities, success rates and different exit types are graphically displayed in charts using data sources.
• Various documents related to exit processes are used.

Business angels as an informal type of venture capital

• Business angels are private investors, often wealthy individuals, providing seed and startup capital to higher-risk ventures, while sharing their expertise, knowledge, and wisdom with the entrepreneur
• The concept of Business Angels dates back to the Golden Age of Greece that is modernized during the time of the well-heeled Broadway show investors
• I.C.R. survey suggests that only a small percentage of entrepreneurs are interested in VC-funded ventures, but significant portions of entrepreneurs are interested in Business Angel funding.
• Business angel characteristics compared to Venture Capitalists' characteristics are laid out in tables to highlight the differing approaches.