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Venture Capital Industry

Venture Capital Industry. Business, Law, and Innovation. Lecture 4 Spring 2014 Professor Adam Dell The University of Texas School of Law. Macro View - Total U.S. Capital Markets. Private Equity is just a sliver of total capital markets, but it plays an important role in driving economy.

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Venture Capital Industry

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  1. Venture Capital Industry Business, Law, and Innovation Lecture 4 Spring 2014 Professor Adam Dell The University of Texas School of Law

  2. Macro View - Total U.S. Capital Markets Private Equity is just a sliver of total capital markets, but it plays an important role in driving economy For-Profit Capital Market by Segment Total = $48.4 trillion Private Equity = 2% Public Debt 19% LBO Funds $740B Bank Deposits 12% Equity Securities 31% Private Debt 35% VC Funds $260B

  3. Macro View - Hugely Important to Economic Growth As much as 18% of US GDP attributable to venture backed companies.

  4. Macro View – Sector Concentration...Why? IT is consistently over 50% of funds invested, but Healthcare has been growing in importance after tech/dotcom frenzy of 2000 as Baby Boomers age % Invested in Sectors of VC by Year Total = 100% Sector $94.8B $36.4B $22.1B $19.7B $22.4B $23.8B $25.7B 2006 Median Deal Size Information Technology $7.0mm Healthcare $8.0mm Business/ Consumer/Retail $5.7mm 4 Other $7.5mm Source: VentureOne

  5. Macro View • VCs invest in a limited number of sectors. • Most startups are not suited to be venture bets. • Not capital efficient, no home run potential • Other sources: credit cards / debt / friends and family $ / Small Business Investment Corporation (SBIC) & Small Business Administration (SBA) loans. • New Market = no incumbent, so a new entrant can capture the prize. • Massive Market = lots of room for winners and wiggle room. • Capital Efficient = doesn’t take a lot to get the business off the ground. J Curve

  6. Portfolio Theory of VC $100mm Fund, 20 bets, 2 big wins….up to $15mm in any given company Diversified investments within IT: Security Storage Networking Social Media Retail.com Mobile Advertising Total Write-off Get a little more than our $ back, but not worth the effort Home Runs Number of Successful Companies in a Cycle 0x-1x 2x-4x 5x-10x Return Multiple Expectation

  7. Portfolio Theory of VC: 20 bets: 2 HOME RUNS 18 WHATEVERS Of the 20 bets that a VC firm will make, in a normal distribution of returns (and considering the risks), 2 companies will generate the vast majority of the returns. But you never know which 2 they will be, so every investment has to have home run potential & be capital efficient. 7

  8. 1995-2000 Portfolio Outlook Crazy Time Everybody jumps into VC (hedge funds, private equity funds, grandpas) Drive prices up Drive returns down Total Write-off Home Runs Get a little more than our $ back, but not worth the effort Number of Successful Companies in a Cycle 0x-1x 2x-4x 5x-10x Return Multiple Expectation

  9. Macro View • Most VC Firms Loose Money • Yet a few great firms make all the $ • Kleiner, Sequoia, Benchmark, Accel • Impossible to Time the Market • Market Conditions • Public Markets • Customer’s willingness to buy / good vs. bad economy • If you build real value (regardless of market timing), you’ll probably make money.

  10. Portfolio Management – Fail Fast / Focus on Winners With limited capital, and the knowledge that the odds are stacked against success, a VC needs to know which companies are the “winners”…what do you do? Kill the losers. Get them to “fail fast” Be objective about which companies you continue to fund. Focus on the “winners” Every company that is not CF+ is on it’s way to going out of business..

  11. Skills of Top VCPE Investors Skill/Experience Description Personal Networks Strong personal networks enable investors to generate dealflow, be the first to learn about industry developments, help portfolio companies secure talent, and provide critical business development introductions. With large pipeline of deals and limited time and resources, must efficiently sift through potential investment opportunities. Critical to leverage technical knowledge and to prioritize opportunities based on anticipated return. Each Partner in a firm generally actively manages only around 5-10 investments at a time, depending on lifecycle, so must choose wisely. Selectivity & Specialization Investor generally sits on Board and serves as close advisor to CEO and management team. When company faces tough decisions (e.g., firing vs. making payroll in a down quarter), it is helpful for investor to be able to draw on personal experience and serve as advisor. Management Experience Important for investor to know lay of the land—key competitors, industry developments, technical specifications—to make informed decision about making investment, as well as how to manage development and exit. Industry Knowledge Unlike public companies, ownership and management are generally aligned because of shared economic interests, focused on an exit. It is in investor’s best interest to remain involved and watchful, guiding strategic decisions to create value. Focus on Value Creation

  12. ..and ;) • Salesmanship • Credibility / Integrity • Tolerance for Risk • Pattern Recognition • Curious…Looking for the next Big Thing

  13. It’s a Small Club: Ex. PayPal PayPal was a highly successful start-up founded in 1998 and sold in 2002 to eBay for $1.5B. The founders and top management have gone on to significant success and remain interconnected: Max Levchin Co-founder Peter Thiel Co-founder Roelof Botha CFO Jeremy Stoppelman VP Engineering Russel Simmons Engineer Founded web property: Started hedge fund, Clarium, & vc firm, Founders Capital. Personally invested in: Joined top VC firm Sequoia Capital in 2003 Co-founded successful internet site yelp in 2004 Involved with: Advised: Invested in YouTube in 2005—sold to Google for $1.6B Invested in: 13 Sources: Wikipedia, Sequoia Capital, PayPal, Facebook, LinkedIn, Slide, Thank You for Smoking, YouTube

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