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Venture Capital
Santa Clara University School of Law
Kornegay, Robert F.

Venture Capital Outline
Professor: Rob Kornegay

General

Venture Capital→ a type of private equity capital typically provided to early stage, high potential, growth companies in the interest of generating a return through an eventual realization event such as an IPO or trade sale of the company.

i. Associated with
1. job creation
2. the knowledge economy
ii. used as a proxy measure of innovation within an economic sector or geography
iii. most attractive to new companies with limited operating history. new companies are
1. too small to raise capital in the public markets and
2. too immature to secure a bank loan or complete a debt offering

VC Investments→ generally made as cash in exchange for shares in the invested company

i. Companies→ usually high technology, biotechnology and ICT industries
ii. Investment Money →comes from institutional investors and high net worth individuals
1. the money is usually pooled together in dedicated investment firms
a. private pension funds
b. university financial endowments
c. foundations
d. insurance companies
e. pooled investment vehicles (mutual funds)

VC firms→ typically comprised of small teams with technology backgrounds (scientist, researchers) or those with business training or deep industry experience.

i. Duties of VC Firms →
1. to identify novel technologies that have the potential to general high commercial returns at an early stage.
2. take a role in managing entrepreneurial companies at an early stage
a. this adds skill to the company as well as capital
i. this may help the VC firm realize much higher rates of return.

VC Capitalist→ a person or investment firm that makes venture investments who is expected to bring managerial and technical expertise as well as capital to their investment
VC Fund→ to a pooled investment vehicle that primarily invests the financial capital of third party investors in enterprise that are too risky for the standard capital markets or bank loans.

i. Often a LP or LLC

Benefits of VC→control over company decision & ownership

i. in exchange for the high risk that venture capitalists assume by investing in smaller and less mature companies, venture capitalists usually get significant control over company decisions and significant portion of the company’s ownership (and value)

Company Qualities VC looks for before investing

i. Before investing VC looks for company with
1. Innovative technology
2. Potential for rapid growth
3. Well thought through business model
4. Impressive management team
ii. 98% of opportunities presented to VC firm is rejected b/c of lack of the above qualities

Impediments to an investment

i. Ensuring that the core intellectual property is in fact owned by the company
1. ensuring that all parties involved with the development of the technology (engineers, consultants, employers) assign over their rights to the IP to the new company
ii. cutting out on all of the extravagant operating expenses so that the initial investment lasts longer
1. minimize the number of geographical facilities
2. minimizing the number of employees
3. minimize the salaries of the employees hired
iii. revising the business plan to determine the d time needed before the company is profitable
iv. assessing a more realistic pre-money valuation

Alternatives to venture capital

i. Angel investors→individual persons more willing to invest in highly speculative opportunities or may have a prior relationship with the entrepreneur
ii. “bootstrapping” → founders provide their own financing until they reach a point where they can credibly approach outside capital providers like venture capitalist or angel investors
iii. Debt→ in industriees where assets can be securitized effectively because they reliably can generate future revenue streams or have a good potential for resale in case of foreclosure
iv. Off shore funding →provided via specialist venture capital trusts which seek to utilize securitization in structuring hybrid multi market transactions via an SPV (special purpose vehicle)
1. SPV→ a corporate entity that is designed solely f

the money has been raised, the fund is said to be closed and the 10 year lifetime begins.
2. Partial closed fund
a. Some funds have partial closes when one half (or some other amount) of the fund has been raised
iv. Vintage year
1. generally refers to the year in which the fund was closed and may serve as a means to stratify VC funds for comparison

Six stages of financing offered in the venture capital

i. Seed money →low level financing needed to prove a new idea
1. often provided by angel investors
ii. start up → early stage firms that need funding for expenses associated with marketing and product development
iii. First round→ early sales and manufacturing funds
iv. Second round→working capital for early stage companies that are selling product, but not yet turning a profit
v. Third round → mezzanine financing, this is expansion money for a newly profitable company
vi. Fourth round →bridge financing, is intended to finance the “going public” process

Compensation

Venture capitalist are compensated through “two and 20” arrangements (management fees and carried interest)

i. Management fees →annual payment made by the investors in the fund to the fund’s managers to pay for the private equity firm’s investment operations
1. typically the general partners receive an annual management fee equal to up to 2% of the committed capital
ii. Carried interest→a share of the profits of the fund (typically 20%), paid to the private equity fund’s management company as a performance incentive
1. the remaining 80% of the profits are paid to the fund’s investors.
a. Some venture partners are able to command carried interest of 25- 30% on their funds