Venture Capital and Private Equity Session 3

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Venture Capital and Private Equity Session 3

• Professor Sandeep Dahiya
• Georgetown University

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Course Road Map

• What is Venture Capital - Introduction
• VC Cycle
• Fund raising
• Investing
• VC Valuation Methods
• Term Sheets
• Design of Private Equity securities
• Exiting
• Time permitting Corporate Venture Capital (CVC)

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Accel Partners VII
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Accel Partners High Level Questions

• How are VCs compensated? How does the
  compensation structure of VCs differ from CEOs or
  Fund managers
• Why do we observe the partnership structure?
• Why do GPs need to put down 1?
• Why not take down the entire capital at one go?
• Why do we see the various restrictions on size
  and co-investment in previous deals?

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Accel Partners More General Issues

• How do Management Fee and Carry interact with
  Fund size?
• 20 million fund with 2 partners(2.5 Mgmt fee)
• 400 million fund with 4 partners (2.5 Mgmt fee)

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Accel Partners VII

• Would you invest in Accel Partners VII
• Would David Swensen invest ?
• How they done in the past?
• How are they likely to do in the future?

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Accel Partners Now

• Did close Fund VII with 30 carry
• Accel VIII mother of all funds 1.6 BILLION
  proposed in 2000 scaled back to 950 million
  later
• Accel IX 400 million
• Accel X 520 million
• Now in London, China and India
• No Idea how the funds are doing but was Series A
  investor in FACEBOOK.

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VC Method For Valuation

• Professor Sandeep Dahiya
• Georgetown University

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Quick Review of Valuation Methodologies

• DCF
• Estimate FCF (EBIATDep-CapEx-?NWC)
• Estimate WACC
• Estimate Terminal Value (Perpetual growth g)
• Discount FCF and TV to get Enterprise Value
• Multiples Based
• Choose a set of Peers/Comprables
• Choose the multiple(s) e.g. EV/EBIT, P/E
• Estimate Median/Average Multiple
• Apply to target

Please Read Note on Valuation in Private Equity
Settings
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VC Method

• Flavor of both DCF and Multiples but is
  different.
• FCF is highly uncertain
• WACC is almost meaningless
• Multiples are hard to get by
• Most firms will NOT survive
• A few firms would have incredible growth

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VC Method-Implied Valuation

• Information you would almost always have
• I Amount being raised from VC
• X- Number of Shares currently owned by
  entrepreneur
• Information that requires judgment call
• R VCs required return (IRR) usually between
  25 to 80
• T Time to exit (When VC gets money back)
• V Value of the company at time of exit
• Numbers you need to calculate
• F Fraction of company VC would need to get the
  return
• Post-Money Valuation Value of company after
  funding is received
• Pre-money Valuation - Value of company before
  funding is received
• P Price per share.
• Y Number of shares to be issued to the VC

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An Example

• Hoya.com is asking for 5 million, Projected
  income in year 5 is 4 million and expected exit
  multiple is 25x. Company currently has 1 million
  shares all owned by the entrepreneur. What share
  of company would a VC require today if VCs
  required return is 50?

Exit Value of Hoya.com 4 x 25 100
million Exit Value of VC has tobe 5x(150)5
37.97 million Fraction of Company Needed
37.97/10037.97 Implied POST MONEY
Valuation5/0.379713.17 million Implied PRE
MONEY Valuation 13.17-58.17 million Let us
assume Y is the number of new shares that must be
issued to the VC, X are the existing number of
shares Y/(XY) F 37.97 algebraic
manipulation yields Y 612,091 shares. Price per
share 5,000,000/612,091 8.17
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Same Example Alternative Approach

• Hoya.com is asking for 5 million, Projected
  income in year 5 is 4 million and expected exit
  multiple is 25x. Company currently has 1 million
  shares all owned by the entrepreneur. What share
  of company would a VC require today if VCs
  required return is 50?

Exit Value 4 x 25 100 million POST MONEY
VALUATION 100/(150)5 13.169 million PRE
MONEY VALUATION 13.169 5 8.169
million Since 1 million shares outstanding Price
per share 8.17 Alternatively VC must get
5/13.17 37.97 of the company Let us assume Y
is the number of new shares that must be issued
to the VC, X are the existing number of
shares Y/(XY) F 38 algebraic manipulation
yields Y 612,091 shares. Price per share
5,000,000/612,091 8.17
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VC Valuation Problem Set

• Hoya.com is asking for 5 million, Projected
  income in year 5 is 4 million and expected exit
  multiple is 25x. Comapny currently has 1 million
  shares all owned by the entrepreneur. What share
  of company would a VC require today if VCs
  required return is 30?

Exit Value 4 x 25 100 million Value of VCs
5 million investment at 30 5(1.30)5
18.6 million VC would ask for 18.6/100 18.6
of the firm!
How many shares if VC needs 50 return (would ask
for 38 of the firm). X original number of
Shares, Y new shares Y/(XY) 0.38, since X 1,
Y0.612
How many shares if VC needs 30 return (would ask
for 18.6 of the firm). Y X(F/1-F)
1(0.186/1-0.186) Y 0.2285 million shares
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Multiple Rounds/ Exit Dilution

• Imagine that you need 15 of the company at the
  exit to get your mandated return.
• Simple case 100 shares would want 15 shares
• What if along the way company issues another 50
  shares (option/new investor) what happens to your
  stake?
• New total shares 10050 150
• You interest 15/150 10!! you have been
  diluted
• You would insist on more than 15 today to end
  with 15 eventually how to figure that out
• Expected dilution 50/150 0.333
• Fraction needed today Final ownership/(1-Dilutio
  n)
• 15/(1-0.333) 22.5 implying 22.5 shares today
• Checkgtgtgt at the end 22.5/150 15

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Example Contd.

• Hoya.com is asking for 5 million, Projected
  income in year 5 is 4 million and expected exit
  multiple is 25x. What share of company would a VC
  require today if VCs required return is 50?
• Need to reserve 15 of the firm in terminal year
  for the option pool for mangers.

VC still needs to get 5 million(1.5)5 37.97
million Only 85 million available after the
option pool VC would want 37.97/85 44.67 of
the company AT EXIT. 5 million for 44.67 of the
company imply Post money valuation of 5/0.4467
11.193 million and pre-money valuation of 11.19
-56.193 million New Shares to VC 5/6.1930.807
million shares
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Another Approach (easier).

• Hoya.com is asking for 5 million, Projected
  income in year 5 is 4 million and expected exit
  multiple is 25x. What share of company would a VC
  require today if VCs required return is 50?
• Need to reserve 15 of the firm in terminal year
  for the option pool for mangers.

VC still needs to get 5 million(1.5)5 37.97
million At Exit Firm is Still Worth 100
Million VC still needs 37.97/100 37.97 of the
Firm AT TIME OF EXIT! However what VC needs TODAY
is higher since extra shares would be issued to
the Option Pool causing dilution
VC Current Ownership 0.3797/(1-0.15) 44.67
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Multiple Rounds of Financing

• Hoya.com is asking for 5 million, Projected
  income in year 5 is 4 million and expected exit
  multiple is 25x. What share of company would a VC
  require today if VCs required return is 50?
• Need to reserve 15 of the firm in terminal year
  for the option pool for mangers. Would need
  another 3 million at the beginning of year 3
  round 2 investors require 30 return

Round 2 investor need 30 on its 3 million i.e.
3(1.30)3 6.59 million Amount available after
option pool is 85 million implying 6.59/85
7.75 Round 1 still needs 38 million to generate
50 but only has (100-6.59-15) million to get it
out of implying initial stake
38/(100-6.59-15)0.485 or 48.5 stake.
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Multiple Rounds of Financing

• Hoya.com is asking for 5 million, Projected
  income in year 5 is 4 million and expected exit
  multiple is 25x. What share of company would a VC
  require today if VCs required return is 50?
• Need to reserve 15 of the firm in terminal year
  for the option pool for mangers. Would need
  another 3 million at the beginning of year 3
  round 2 investors require 30 return

Round 2 investor need 30 on its 3 million i.e.
3(1.30)3 6.59 million Final value is still 100
million, Thus Round 2 investor need 6.59 of the
company AT EXIT Implying that at time of
investment it needs to own Round 2 VC need
0.659/(1-0.15)7.75 Round 1 still needs 38 at
the time of EXIT implying initial stake
0.38/(1-(0.06590.15))0.485 or 48.5 stake. What
is the Post and Pre Money Valuation at round
1? How many shares need to be issued to Round 1,
Round 2 and option pool?
5/0.48510.32 5.32
Round 1 1x0.485/(1-0.485) 941,748 Round 2
1.941748x0.0775/(1-0.0775)163,128 Option Pool
(1.9420.163)X0.15/(1-0.15) 371,448
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Tomorrow

• How Do VCs Evaluate Investments
• Term sheet for Trendsetter