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Economics of Investment
Certain economic agents (individuals,
households and corporations) have excess
of income over their consumption (because
of their plan to defer consumption).
Certain other agents need more money than
they have (temporarily).
Intermediaries exist who bring together the
above two types for economic gains
(commissions, brokerage).
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Angels
HNWI
Hedge Funds
Households
Banks Venture
Capital
Mutual Funds
Funds
Corporates
Pension
Funds
Insurance Cos
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Angels Startups &
Private
Equity
VC Funds
Fixed Income
Hedge Funds
Securities
Banks
Mutual Funds Forex
Pension Funds
Insurance Cos Commodities
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Nature of these investors
Unconventional
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Target Companies
Startups
Early stage companies
Private companies in the scale-up phase
Pre IPO financing rounds
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Sources of Finance
Equity (common stock, preferred stock)
Loans: long term, short term
Lease finance
Inter corporate deposits
Bank cash credit and overdraft limits
Debentures
Fixed deposits
Grants from government agencies
Supplier credit and deferred payments
Credit cards
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Modes of Acquisition
Primary market:public issue, rights issue
(flotation costs)
Secondary market (listing costs)
Private placement (individual or institution)
Banks and mutual funds
Pension funds, insurance companies
Debenture issue
Fixed deposits
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How to compare various
sources ?
Holding period (Duration)
Repayment terms
Interest rate
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Net Present Value (NPV) of an
Investment
Horizon of interest: Typically 4 –5 years
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Example: Angel Investment
Three to five year horizon
No dividend / interest
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Discounting is the reverse of compounding
+ RV / (1.0 + r) 3
Where
r = Expected rate of return
CF i = Cash flow at the end of i th year
RV = Residual value of the asset
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Funds Requirements
Idea / Concept: USD 10K
Prototype: USD 50K
Product development: USD 0.5M – 2M
Organization building: USD 8M-10M
Scale up: USD 50M
IPO: Initial Public Offer
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Sources of Funds
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Cost of Equity
Angels would expect higher rate of returns
than VCs
Typical VC expectations is 40-50%
compounded annual return
Risk-return curve: New venture increasingly
reduces its risk as it goes through stages
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Angel Investors
High Net Worth Individuals
Successful serial entrepreneurs (also
parallel entrepreneurs)
Good knowledge of technology and
business acumen
Have country-specific preferences (NRI,
NRC)
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Examples…
James Clark (SGI to Netscape)
Prakash Bhalerao (Alopa Networks)
Kanwal Rekhi (Exodus Communications)
K.Chandrasekhar, B.V. Jagdeesh
Sabeer Bhatia (Hotmail Arzoo Navinmail)
Rakesh Mathur (Junglee to Purple Yogi)
Suhas Patil (Cirrus Logic)
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Made In India and Served from
India
N.S. Raghavan
Infosys
IIM Bangalore
Strand Genomics
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Made in USA and Served from India
Mahesh Murthy
Passionfund
TiE Angel Forum
Romesh Wadhwani
Indian School of Business (ISB)
Wadhwani Foundation
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Peculiarities of Angel
Investment
Quick decision-making
Uncle-nephew relationship
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Venture Capital Firms
VCs look for private equity for young
companies
Mezzanine VC firms
Scale-up VC firms
Technology / “Space” specific
Biotechnology
Networking
Chips and hardware
E Commerce
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Structure of a VC Firm
General partners 3-5 (themselves successful
entrepreneurs): put about 2-3% of the corpus
Limited partners (Pension funds, Retirement
plans): Put 97% corpus
Corpus = Fund, typically ranges between USD 50M
to 2B
Management fee is about 2-3 % per year
Funds about 5-30 new companies per year
Employs junior managers for due
diligence(associates)
After IPO/Acquisition, general partners keep 20% of
gains, limited partners get Principal+80%
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VC Firm’s Annual Throughput
10,000 qualified business plans
1000 meetings
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Role of the VC in the Portfolio
Company
Negotiate aggressive terms
Select strong co-investor
Help in constituting the Board of Directors
Assist in
Recruitment
Market validation
Strategic relationships
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Valuation: Bargaining Point
Causes of mismatch
Asymmetry of information
Ego
Greed
Factors that drive the valuation
Technology, ESOP rates, management
Orders in hand, scalability, brand strength
Patents and copyrights
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Difficulties in Valuing Start-up
Companies
Immediate earnings are negative
No past history
No comparable companies
No market prices
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VC Fund Raising Process
Introduction (phone call, e-mail, referral)
Submit business plan / executive summary
Presentation
Company visit
Due diligence (management reference
checks, customer calls, market analysis)
More meeting(s)
Term sheet
Legal / Closing
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Innovations in Financing Terms
Third party collaterals
SIDBI
USA Small Business Administration
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Some big names in India and
USA
Silicon Valley --Sand Hill Road Addresses
Kleiner Perkins
Sequoia Capital
Battery Ventures
India
Chrysalis Capital
Acer Technology Ventures
Westbridge Capital
Jump Startups
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Hedge Funds
Hottest and most talked about in the business
press
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Hedge Funds: Privileges and
Promises
Not scrutinized by SEC
Ask for long term commitment from
investors : 6 months to 2 years
Take simultaneous positions in securities,
commodities, Forex and Bond markets
Global (Transnational operations)
Promise absolute return irrespective of
market trends and movements
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Hedge Fund Strategies
Fixed Income Arbitrage
Equity market-neutral statistical arbitrage
Convertible Arbitrage
Merger Arbitrage
Distressed securities
Event-driven strategies
Macro investors
Sector-specific positioning
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Who can invest?
Accredited investors
Income of USD 200K/year
Net worth of USD 1 Million exclusive of house,
automobiles and other consumer durables
Fund of Funds
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Private Equity Investment
Large, profitable private limited or
deemed public companies who need
finance but don’t want to do an IPO
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Some deals in the last 6 months
Company Investor Investment Approx
USD mill Valuation
Progeon Citigroup 20 100
http://www.hedgefund.net
http://www.hedgefundmarketing.org/Ch
eat_Sheet.htm
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