FEI Week 7 VC & PE Industry BPP BUSINESS SCHOOL BPP BUSINESS - - PowerPoint PPT Presentation

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FEI Week 7 – VC & PE Industry

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Capital Sources for New Ventures

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• 3 Fs : Founder/ Family/ Friends
• Most frequent source for startup businesses
• Angel Investors
• Wealthy individuals, typically fellow entrepreneurs,

willing to invest in the very early stages of a venture

• VC/ PE funds
• Fund managed by professional investment managers;

typically invests after business is somewhat established

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Angel Investors ‐ Definition

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• Wealthy individuals (net worth over $1 million)
• Cited by researchers as the most important source of capital

for startup firms

• Amount of capital provided by angels estimated to be 5 ‐ 11

times the amount provided by VCs

• Estimates vary, but reasonable assumptions are approx.:
• Provide capital to 50,000 companies
• 400,000 angels provide $50 billion in capital
• Account for 70% of capital for new ventures
• Angels invest their own money; VC/ PE raise funds

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Angel Investors ‐ Characteristics

• Diligence Process: “It’s about 70% just gut feeling and 30%

financial analysis.”

• Angels primarily assess the entrepreneur, not the business

plan; building trust between the entrepreneur and the potential angel is key.

• Often angel investors, especially lead angels, become co‐

founders, and very often an angel functions as a full or part‐ time employee.

• Angel investors value non‐financial benefits of new venture

investing more than VCs and general investors do.

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Angel Investors ‐ Characteristics

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“I’m not in it for a fast buck. Besides, it’s cheaper and more

fun than buying a yacht. I enjoy investing in companies and getting involved; it’s a real buzz.” Large percentage of angel investors are willing to accept a lower return in exchange for non‐financial benefits

• Socially benefiting products
• Fun to be part of the company
• Creation of local jobs
• Interacting with highly regarded investors
• Company committed to social ideals support
• Exciting investment ideas

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Difference: Angel Investors vs. VC/ PE

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Business Angels Venture Capital

Funding Sources Angel's own money Investor Number of deals per year 1 every two years 5-10 years Typical investment per year $25,000 - 250,000; Average $50,000 - 75,000 $1 million - $10 million; Average $4 million Company Stage Small, start-up, early stage Larger, expansion stage Geographic Focus Usually close to own location Usually nationwide; large payers international Industry Focus No focus, but prefer industries they know Often focus on specific indutries; or have dedicated indutry groups Source of deals Other angels, friends, business contacts Proposals submitted, other VC's Decision Maker Individual, experienced entrepreneur, personal, 50 years old Professionals, MBAs, committees, 40-year-

• lds

Analysis/ Due Dilligence Minimal, informal, subjective, judgement Extensive, formal, analytical, spreadsheet Investment Structure Simple, common stock Complex, Convertible Preferred Stock Role/ Involvement Hands-on Strategic, Board Seat Investment Time/ Horizon Longer, five or more years Shorter, three to five years Exit/ Harvest Strategy Less important, long-term investment horizon Important, IPO or sell company Return on Investment Expectation 20-30% but often don't have predetermined ROI expectation Expected 30-50% ROI

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VC vs. PE Definition

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Private Equity

• Asset class consisting of equity securities in operating companies

that are not publicly traded on a stock exchange

• Investment strategies in private equity include: leveraged buyouts,

venture capital, growth capital, distressed investments, and mezzanine capital

Venture Capital

• A subcategory of private equity; investments made, typically in

young, emerging, less mature companies, for the launch, early development, or expansion of a business

• Most often applied for new technology, new marketing concepts

and new products

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PE Investment Strategies

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Leveraged Buyout

• Acquisition of a company, business unit or business asset from the

current shareholder with the use of financial leverage

• Targets are usually mature companies, generating operating cash flow
• Sponsor provides part of capital required and raises acquisition debt
• Historically debt proportion of LBOs range from 60% ‐ 90%

Venture Capital

• Most suitable for businesses with large up‐front capital requirements,

which cannot be financed by cheaper alternatives, such as debt

• Usually associated with fast‐growing technology and biotechnology fields,

but it is also used for more traditional businesses

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PE Investment Strategies (cont.)

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Growth Capital

• Equity investments in relative mature companies looking to expand or

restructure operations, enter new markets or finance an acquisition

• Companies usually mature, generate revenue and operating profits, but

unable to generate sufficient cash to fund expansion or acquisition

• By selling part of the company to private equity, the owner can take out some value

and share the risk of the growth with partners

Distressed and Special Situations

• Investments in equity or debt securities of financially stressed companies,

comprising two sub‐categories:

• “Distressed‐to‐Control”/ “Loan‐to‐Own”, where the investor acquires debt in hopes to

emerge in control of the companies equity after a corporate restructuring

• “Special Situations”/ “Turnaround”, where investor is providing debt and equity to

companies undergoing operational or financial challenges

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PE Investment Strategies (cont.)

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Mezzanine Capital

• Subordinate debt or preferred equity that represents the most junior

proportion of the capital structure, that is senior to common equity

• Often used to reduce the amount of equity capital required to finance a

leveraged buyout or major expansion

• Allows small companies that don’t have access to the high‐yield market

to borrow additional capital beyond the level of traditional bank loans

• For the increased risk, mezzanine debt holder require a higher return for

their loan than secured or senior lenders

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PE Investment along Corporate Life Cycle

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Alternative Asset Classes

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Investment Time Horizon

7‐10 years 3‐7 years 1‐3 years Quar terly

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PE – Risk and Diversification

1) Long Term: 30 years; Short Term: 19 years; 2) Long Term: 24 years; Short Term: 16 years;

• Precise standard

deviation is difficult to measure

• But strong evidence of

risk reduction through asset allocation

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Private Equity – Portfolio Asset Allocation

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PE/ VC Industry Europe # of Players

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• Total of 1,696 active private equity and venture capital firms

in 2010

• 709 venture firms
• 505 buyout firms
• 74 growth firms
• 408 generalist firms
• 47 PE firms with offices elsewhere in the world made

investments in European companies

• 1,696 active private equity and venture capital firms

managing €523bn of capital from Europe

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PE/ VC Investments as % of GDP

Source: EVCA Year-Book 2011

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Funds Raised

Source: EVCA Year-Book 2011

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Funds Raised – Final Closing

Source: EVCA Year-Book 2011

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Funds Raised

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Challenges:

• 2010 saw no substantial fundraising recovery
• Uncertainty remained on the economic recovery in Europe
• LP’s were still assessing their strategies on private equity
• Fundraising increased just 13% to $20bn, far from the peak of

$112bn in 2006

• Commitments from pension funds and fund‐of‐funds, which

decreased dramatically in 2009, stabilized in 2010 at $2bn

• Banks commitments decreased from 19% of total funds in 2009

to 9% of total in 2010

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Investments

Source: EVCA Year-Book 2011

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Investments – VC by Sector

Source: EVCA Year-Book 2011

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Investments – Buyout & Growth by Sector

Source: EVCA Year-Book 2011

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Investments by size of company

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• 80% of companies attracted PE capital in 2010 were SMEs

(Small and Medium Enterprises)

• More than 3,900 SMEs were backed by PE houses,

attracted one‐fifth of the total PE investment in 2010

• 70% of SMEs attracted VC capital, 30% received buyout and

growth financing

• VC investment:
• Buyout investment:

90% in SMEs 20% in SMEs 60% in companies with more than 1000 employees

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Investments by # of employees

Source: EVCA Year-Book 2011

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Divestments

Source: EVCA Year-Book 2011

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Divestments by Exit Method

Source: EVCA Year-Book 2011

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Largest Private Equity Firms

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1. Goldman Sachs Principal Investment Area 2. The Carlyle Group 3. Kohlberg Kravis Roberts (KKR) 4. TPG 5. Apollo Global Management 6. CVC Capital Partners 7. The Blackstone Group 8. Bain Capital 9. Warburg Pincus

• 10. Apax Partners

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Legal Structure

PORTFOLIO COMP ANIES

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PE Partnership Structure

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• Invested Capital returned
• All profits up to an agreed level
• Known as the “preferred return” or “hurdle”
• Required GP (General Partner) to outperform less risky

investments

• Typically 8% compounded per annum on commitments

drawn down but not yet repaid

• 80% of profits in excess of the hurdle
• Usually, once GP has “caught up” preferred return

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Returns to Investors ‐ LP

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• Management Fee
• Around 1.5% for megafunds
• Typically 1.5% ‐ 2% for mid‐market buyout funds
• Up to 2.55% for venture funds and emerging market funds
• Carried interest
• Form of performance fee
• Typically 20% of fund’s net profits
• Only paid once investors have received a minimum return
• Return on co‐investment interest
• Transaction fees for corporate finance activities

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Returns to GP

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PE/ VC Industry Track Record

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—“If you examine all the major corporate scandals in the past 25 years, none of them occurred where a private‐equity firm was involved.”

— (Henry Kravis)

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• Small “workshop” board concentration of
• wnership and control
• Focus on exit/ short time horizon
• High power compensation, leading to self‐

selection of managers

• Alignment of incentives
• Expectations are not managed by financial

analysts

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PE Impact on Corporate Governance

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• Flexibility
• Compensation
• Carried interest
• Ability to create high

profile brand

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PE Can Attract Best T alent

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Corporate Venturing

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Corporate Venturing is when a large company invests in start-ups Corporates looking for quicker, cheaper and better sources of innovation than R&D, which often disappoints. In return, the startups they invest in benefit from their capital, expertise and connections.. Corporates get access to screening work at the entrance to the deal ‘funnel’ Setting up VC arms is a way to identify life-threatening changes from disruptive technologies to their business early Corporate VC tends to have a longer term outlook. Startups backed by firms are more likely to list their shares than those championed by conventional venture groups. A bank in Silicon Valley estimated last year that corporate VC yields three times the number of patents per dollar invested than in-house R&D

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http://www.economist.com/news/finance-and-economics/21633883-fear-being-displaced-startups-turning-firms-venture-capitalists-if

Corporate Venturing Investors

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Intel Capital France Telecom/Publicis/Iris Capital – digital start-ups €300m, March 2012 Google $100m 2009 GM $100m 2010 Merck – biotechs 2009 Innogy VC (RWE) €100m 2010 Challenge Up! (European arms of Intel, Cisco & Deutsche Telekom) – Internet Of Things