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Questions and Answers

According to the document, what is a primary effect of 'pump and dump' practices on industries?

They accelerate the natural evolution of industries.

They cause industries to become more profitable and efficient.

They distort the basic economics of industries and cause artificial development. (correct)

They promote stability and long-term growth in industries.

Based on the document, what is the primary source of capital for the US VC market?

Foreign direct investment

Pension funds (correct)

Individual investors

Corporate investments

What does the document define as a 'Unicorn'?

A startup that has achieved profitability within its first year.

A startup that achieves an IPO within 1 year.

A startup with a valuation of 1 million USD.

A startup with a valuation of 1 billion USD. (correct)

According to the document, what percentage of unicorns are estimated to be losing cash?

90% (A) Signup and view all the answers

According to the document, what is the primary role of pension funds in the context of unicorns?

They act as the primary source of subsidies, contributing to the formation of monopolies. (A) Signup and view all the answers

According to the document, what is a typical outcome for Limited Partners (LPs) in the venture capital ecosystem?

They often lose money both before and after companies go public. (A) Signup and view all the answers

According to the document, how do VCs typically profit even when startups fail?

Through the 2 and 20 fee structure. (A) Signup and view all the answers

Based on the document, who bears the most risk in the venture capital system?

Normal people (B) Signup and view all the answers

According to the document, what percentage of VCs have outperformed the stock market since 2000?

10% (C) Signup and view all the answers

According to the document, what is a typical allocation of IPO shares to institutional investors?

90% (B) Signup and view all the answers

What is the primary purpose of a liquidation preference?

To guarantee investors receive a return on their investment before other shareholders. (A) Signup and view all the answers

In a scenario where an investor has a liquidation preference of 1 and the company sells for 150,000 Euros, how are the proceeds typically distributed?

Investors receive 100,000 Euros and founders receive 50,000 Euros. (A) Signup and view all the answers

What does 'multiples' of liquidation preference refer to?

The factor by which the initial investment is multiplied to determine the amount returned to investors before other shareholders. (D) Signup and view all the answers

If an investor has a 3x liquidation preference on a 100,000 Euro investment, how much is returned to them first from the sale proceeds?

300,000 Euros (A) Signup and view all the answers

What is the main difference between 'no participation' and 'preferred participation' for investors with a liquidation preference?

In 'no participation,' the investors do not receive any proceeds after their liquidation preference is met, while 'preferred participation' investors receive additional proceeds from the remaining funds. (B) Signup and view all the answers

In a company sale of 500,000 Euros, with an investor who has a 3x liquidation preference on 100,000 Euros and preferred participation, what is the amount the investor is entitled to?

400,000 Euros (A) Signup and view all the answers

What does the term 'preference stacks' in the context of investments usually mean?

Multiple investment rounds with layered liquidation preferences are all included in the calculation. (A) Signup and view all the answers

What is likely to happen if a company sells for less than the total liquidation preference amount owed to investors?

Investors will receive the entire sale amount and the founders will receive nothing. (B) Signup and view all the answers

Why might VCs (venture capitalists) ask for multiples of liquidation preference?

To minimise risk in early-stage investments. (C) Signup and view all the answers

Which of these options best describes the meaning of 'liquidation preference'?

Investors receive preferential payouts from the sale of the company prior to other shareholders. (B) Signup and view all the answers

Study Notes

Pump and Dump

Startups are becoming unprofitable due to cashing-out shell operations
Huge investments by Softbank have impacted Silicon Valley
"Pump and dump" practices disrupt natural industry evolution, creating artificial and inaccurate growth patterns

Who Pays for This?

Unprofitable companies often use pension fund money
Pension funds contribute 65% of capital to US venture capital (VC) markets
90% of VCs fail to keep pace with stock market returns since 2000
Institutional investors typically acquire 90% of initial public offering (IPO) shares

Unicorns

Unicorns are startups valued at $1 billion USD
90% of unicorns experience substantial cash losses
Unicorns are essentially subsidized monopolies funded by pension funds

Who is Winning Here?

Venture capitalists (VCs) benefit from "fee streams" (2% and 20% fees)
Startup founders and employees bear the majority of the risk
Professional fund managers generally gain from the system

Term Sheets Matter

Unicorn startups may undergo several rounds of VC funding, but valuation subsequently decreases
VC-funded companies often achieve large sell-offs with seemingly great accomplishments for the company, but founders/employees may gain little
The reason for this phenomenon lies in "liquidation preference"

Liquidation Preference

Investors often initially invest a specific amount in a company (e.g., 100,000 Euros) in return for a percentage of the company's shares
If the company is sold for a higher value than the initial investment, the investor profits from the difference (e.g., selling price - investment cost).
This initial investment is protected, meaning investors get their initial investment first, even if the founders have received a lesser profit from the proceeds after paying investors.
Essentially, investors are prioritized in a liquidate scenario.

Multiples + Participation

VCs frequently seek "multiples" of liquidation preference due to risk
Investors contribute capital to acquire a percentage of the company (e.g., 50% for 100,000 Euros).
A company's sale price will determine how much the investors receive.
VCs often prioritize themselves to receive greater profit from multiple funding rounds

Preference Stacks

"Preference stacks" are used in multiple investment rounds across various startups and companies.
An initial round (e.g. FFF at 100k Euros) and subsequent rounds (e.g., B rounds with millions USD) may involve different levels of priority for investors.
Often, later investors are prioritized and early investors might not receive any profit if the company's sales are not profitable.

Why Founders Accept This

VCs often employ aggressive tactics to acquire investments in startups
Founders may have no better alternatives
Startup incubators may fail to disclose these practices to new startup founders

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