Vous êtes sur la page 1sur 47

Venture Capital and

Private Equity
Prof. Dimo Dimov
Reykjavik University
19 September 2014

Fundraising
The problem of
simultaneity
Capital
Specialized
intermediaries
Entrepreneurs
The venture capital cycle
Institutional
investors
VC firms
Entrepreneurial
firms
FUNDRAISING INVESTING
EXITING
RETURNS
I
n
n
o
v
a
t
i
o
n

a
n
d

m
a
r
k
e
t

o
p
p
o
r
t
u
n
i
t
i
e
s

A market gap exists
Institutional investors have money
Need diversification into different asset classes
Need to deliver consistent returns over time


Opportunities need money
New, innovative ventures
Growth or efficiency improvement of existing
businesses
UNCERTAINTY INFORMATION ASYMMETRY MORAL HAZARD
Bridging the gap
Institutional investors have money


Private equity firms
Deal selection skills
Deal management skills

Opportunities need money
UNCERTAINTY INFORMATION ASYMMETRY MORAL HAZARD
UNCERTAINTY INFORMATION ASYMMETRY MORAL HAZARD
Who are the institutional
investors?
Pension funds
Insurance companies
Banks
Corporations
Governments
University endowments
Foundations
Wealthy families or individuals
VC funds by source
0%
10%
20%
30%
40%
50%
US
Europe
Issues in fundraising
Education
Information
Tax
Regulatory
Public market
Education issues
Investment mentality formed by public debt or
equity markets
Investing in private equity requires a shift and
different expectations
VC nature and return profile
Natural cycles of ebbs and flows
Not knowing what they are getting into is a recipe
for disaster
Information issues
Information asymmetry (lemons vs. peaches)
Difficult to verify the quality of the counterparty
Need for specialized knowledge
Need for extensive access and research

Moral hazard
Difficult to keep track of how the money is used
Need for specialized knowledge
Need for extensive access and close monitoring
Tax issues
How the fund gains are taxed can have a significant impact on
the net return to investors
Large differences across countries (especially within EEA)
Double taxation
Differences across legal fund structures
Taking advantage of tax exempt status
Cross-border taxation
Permanent establishment exemptions from local tax many
countries do not have them
VAT on management and incentive fees
Capital gains taxation
In the US the rate has moved form 49.5% (1978) to 15%
(2003)
Regulatory issues
Some institutional investors are not free to invest funds as
they like, given their accountability to certain constituencies
Restrictions for alternative asset classes
Geographic restrictions for investments
Prudent man and safe haven rules
Barriers to the allocation of pension funds to venture capital
or securities of small or young companies
Requirement to register as investment advisers and
prohibition from receiving performance related
compensation or certain transactions
The nature of fundraising vehicles


Market issues
In the end, institutional investors are interested only if
private equity can deliver returns commensurate with
their risk
Vital role of exit opportunities
IPO opportunities are a critical factors
Active stock markets
Openness to listing new, growing companies
Returns and fundraising
-30
-20
-10
0
10
20
30
40
50
60
70
80
69-
75
76-
79
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
0
20000
40000
60000
80000
100000
120000
US Fundraising European Fundraising US Returns European Returns
Fund structures
A wide variety of structures exists across countries
Limited liability partnership (LLP)
Public-type mutual funds
LSVCC (Canada), VC Trusts (UK)
Joint stock companies (AG Germany, Austria,
Switzerland)
Evergreen investment funds
Corporations

Critical issues for fund
structures
Is there pressure to generate periodic cash
flows?
What are the reporting and accountability
requirements?
Can fund managers receive competitive
compensation (to attract and retain the best)?
Possibility of performance-based incentives to
align the interests of investors and managers

Advantages of LLP
structure
Avoidance of double taxation distributions flow
through and are taxed at the limited partners
Securities can be transferred to the limited partners
without tax liability until they are sold
Transfer of stakes and early withdrawals are
prohibited
Automatic dissolution at the end of its term
Brief history (USA)
First LLP introduced in 1959
LLP penetration grows from 20% (1977) to 80% (1994)

Overview of typical VC
fund
Typically structured as LLP
Fund investors are limited partners (i.e. prohibited from
active engagement)
VC firm manager(s) act as general partners and are
responsible for all investment decisions (subject to
some contractual limitations)
Fixed-term life, typically 10-12 years
Fees and compensation
Management fee, 2-3% of fund capital
Carried interest - 20-30% of excess returns
Strong incentive to increase the upside

Management fees: VC
2.0% 2.0% 2.0%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
Less than $100mn $100-249mn $250mn or More
Mean Median
Source: Preqin Private Equity Spotlight: September 2014
Management fees: buyout
2.0% 2.0% 2.0% 2.0%
1.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
Mean Median
Source: Preqin Private Equity Spotlight: September 2014
Holding period for
investments
0
1
2
3
4
5
6
7
2007 2008 2009 2010 2011 2012 2013 2014
YTD
Year of exit
Average Holding Period in Years
Source: Preqin Private Equity Spotlight: September 2014
Provisions in fund raising
(1)
Minimum size of investment
My differ for individual and institutional investors
Intended to limit the number of investors to avoid
regulatory oversight and reduce administration
costs
Explicit minimum and maximum fund size
Fund may be disbanded if minimum size is not
reached
Stipulations for whether and by how much
maximum size can be exceeded

Provisions in fund raising
(2)
General partner contributions
Plays the role of skin in the game
Generally 1%, but deviations for small or first-time
funds
Sometimes contributions made in promissory notes
rather than cash
Takedown schedule how the funds will be paid
Important since fund is invested over 2-3 years
Set amount to be disbursed at closing (10-33%)
Fixed schedule for future payments or at the GP
discretion
Stipulation of minimum and maximum period


GP commitments (2013/4
vintage)
0%
5%
10%
15%
20%
25%
30%
Proportion of Funds
Source: Preqin Private Equity Spotlight: September 2014
Provisions in fund raising
(3)
Fixed term
10 years + 2 years extension
Extensions may require explicit LP permission
Conditions for termination
Death or withdrawal of GP
Bankruptcy of fund
Dissatisfaction with GP (by majority of LP)


Provisions in fund raising
(3)
Dealing with delinquent LPs
Interest for late payments
Seizure or selling of stake in partnership
Waiver if due to regulatory requirements



Fund management restrictions
Need to limit moral hazard risks and preclude GPs
from deviating from their area of expertise. Done
through covenants:
Overall management of the fund
Activities of the GPs
Permissible types of investments
Overall fund management (1)
Limits to the size of investment in any one
company
Avoid salvaging poorly performing companies
Set as % of fund capital or fund assets

Limits on the use of debt
Preclude leveraging of the fund
May be set as % of fund capital or assets


Overall fund management (2)
Limits on co-investments with GPs other funds
Avoid salvaging investments by prior funds or
dressing their return performance
Set through advisory board (or other) review and
approval
Set through imposing same valuation or involving
independent investors at the same price
Limits on the reinvestment of profits
Management fees tied to assets under
management
May be set by date or when certain % of the capital
is invested

GP activities (1)
Ability to invest personal funds
Prevent cherry picking, uneven application of
effort, and escalation of commitment
Set limits on the size of investment in any
company or as % of GP net worth
Sale of partnership interest by the GP
May reduce incentive to monitor
Outright prohibition or by majority approval

GP activities (2)
Future fund raising
A new fund increases management fees and takes
attention away from the current one
May be limited by date or until a certain % of the
portfolio is invested
May be restricted to funds of non-overlapping size
or focus
Other actions by GP
May take attention away from the fund
May be limited by date or until a certain % of the
portfolio is invested
GP activities (3)
Addition of new general partners
Hiring junior partners to reduce burden
May require explicit approval
Other areas for consideration
Vesting schedule of GP interests
Division of the profits among the GPs (senior vs.
junior partners)
Types of investments
Restrictions by investment class
To justify the compensation (i.e. why should GPs
receive vastly higher compensation than public
fund managers)
Avoid investments in areas where the GPs have
no expertise (but hope to learn at the expense of
the LP)

Compensation issues (1)
Critical for aligning the interests of GPs and LPs. It is
difficult to monitor the fund after the LPs commit to it.
Carried interest (carry) large share of the
compensation depends on fund performance
Incentive for the GP to work hard
Important signal to the LPs
Management fees
Sizeable overhead of infrastructure and people
But funds under management grow much
quicker than the number of partners
Compensation issues (2)
Transaction and monitoring fees (for buyouts)
0.5-1.5% of transaction value
Paid by the acquired firm
Can be very significant
Consideration of capping the fees
By overall percentage
By refunding them to the LPs through reducing the
management fee
Clawback fees
Carried interest in paid out to the GPs with each
distribution.
Exiting the good deals early can lead to over-
distribution to the GPs
Need to ensure the GPs are not paid more than
they should
Depend on the negotiating leverage of the LPs
Particular types of LP
Special limited partner
Preferential conditions
Key to raising a first fund

Friend of the fund
Successful entrepreneurs backed in the past
Former GPs
Investments through special companion
(sidecar) fund

First-time funds
How to raise a fund without track record?
Identify investors who seek strategic benefits (e.g. state
fund or corporation)
Establish alliance with existing institution such as an
investment bank or private equity firm
Recruit a lead investor (special LP)
Contributes a significant portion of the fund
May provide seed funding to the partners for fund
marketing
In exchange for additional carried interest (e.g. 5%)
But can be very costly




Other players
Investment advisors (gatekeepers)
Fund of funds
Consulting firms
Placement agents
Investment advisors
Active since the early 1970s
Provide advisory services to some clients
Maintain discretionary control over the assets of other
clients
Setup
Separate accounts for large investors (dedicated
programs)
Pooling of smaller investors assets into fund of funds
Set fees
Fund of funds
Investing in other private equity funds
Pooling investments to provide diversification and
circumvent minimum investment sizes scaling UP
or DOWN
Increasing specialization e.g. high-tech, buyouts,
international, minority-managed, distressed, etc.
Access to top tier GPs
Fees
Management fee 1%
Carried interest typically 8%
Scaling LP contribution
Small
universit
y
$200M
endowme
nt
$250
million
Fund-
of-
Funds
$2M
Minimum
Massive
Buyout
Partners
$1 Billion
fund



$10M
Minimum
$5 million
buyout
allocation
$5 million
investment
UP
Deep
Pockets
Pension
Fund $5
Billion
Fund


$50M
Venture
Capital
allocation
$250
million
Fund-
of-
Funds
VC
Fund

$5-25M in
each of 15-25
VC funds
$25 million
investment
$5-25
million
investment
DOWN
Consulting firms
Help LPs make investment decisions
Monitor performance of funds and of the industry
as a whole
Examples: Cambridge Associates, Prequin
Placement agents
Represent GPs who are raising funds
Maintain close ties with leading LPs
Fees vary widely
0.5% for very large funds
As high as 3% for first-time funds
Upfront, nonrefundable fees
Share of carried interest
The LP landscape
Method Fees Staff
needs
Knowledg
e needs
Direct investing N/A Very
high
Very high Too difficult
Fund investing
w/o advisor
2% + carry High High Very difficult
Fund investing
with advisor
2% + carry +
fixed
High Medium Advisor
consults
and
introduces
Dedicated
program
2% + carry +
.75% + incentive
Medium Low Advisor
does the
work
Fund-of-funds 2% + carry + 1%
+ 8% carry
Low Nil Advisor
makes PE a
security
Source: Lerner, Hardymon, Leamon (2009)
Status ordering among
GPs
Top-tier GPs
Long history of good results
Command higher management fees or carried
interest
Performance tends to persist as they attract top
entrepreneurs
Bottom-tier GPs
e.g. first-time funds
Lower fees until proving themselves



Status ordering among LPs
Top-tier LPs
Long experience with private equity
No need to be educated
Desirable fund investors
Bottom-tier LPs
Lack experience in private equity
Need to be educated
Public LPs can be less desirable
Face regulatory pressures
Requirements to disclose performance