1. Venture Capital and Private Equity Session 2
Professor Sandeep Dahiya
Georgetown University

2. This Course
No easy answers – Boot Camp (Up to 100+pages of reading before class!!)
Main Perspective
Key aspects and practices of industry
How these key features are a response to the difficult environment
Constant comparison of the US and European experience

3. We will follow the “Venture Capital Cycle”
Investing Capital
Exit
and returning capital
Fund raising

4. Course Road Map What is Venture Capital - Introduction VC Cycle
Fund raising
Investing
Exiting
Time permitting – Corporate Venture Capital (CVC)

5. Some Important Terms VC firm general partner (GP) VC fund
limited partner (LP)
committed capital
early-stage, mid-stage, late-stage fund, multi-stage fund
raised, closed
vintage year
capital call = drawdown = takedown 5

6. Quick Overview of Venture Capital
Institutional Investors (Pension Funds/ Endowments etc)
Fund of Funds (FOF)
Individual Investors
Family Offices
Limited Partners
(LP) € € €
VC FUND
(Partnership Agreement)
Advice € +
Advice
VC Fund Management Company
Portfolio Company 1
General Partner
(GP)
Portfolio Company 2
Portfolio Company 3 …

7. (Partnership Agreement)
Concerns for LPs
Institutional Investors (Pension Funds/ Endowments etc)
Fund of Funds (FOF)
Individual Investors
Family Offices
Limited Partners
(LP) € € €
Hand over money for 10 years – No control once committed!!!
Hard to get out mid-way
VC FUND
(Partnership Agreement)
Restrictions on size of fund, size and type of investment, and use of debt
Restrictions on co-investments with earlier funds
Pre Agreed “Take Down” Schedule – will give money when “Capital Calls” are made
Fund Life restricted to 10 years (may be extended by additional 2 years)
Compensation Structure of GP!

8. (Partnership Agreement)
Compensation of VCs
Management Fee (2% of Committed Capital)
How do GPs get compensated?
Carried Interest (20% of Profits)
Reputation
Signal
VC FUND
(Partnership Agreement)
Advice
VC Fund Management Company
General Partner
(GP)

9. (Partnership Agreement)
Exit and Distribution
Institutional Investors (Pension Funds/ Endowments etc)
Fund of Funds (FOF)
Individual Investors
Family Offices
Limited Partners
(LP) € € €
VC FUND
(Partnership Agreement) €
Advice € +
Advice
VC Fund Management Company
Portfolio Company 1
General Partner
(GP)
Portfolio Company 2 €
Portfolio Company 3 …

10. Who are the LPs?
Historically, just under half of all committed capital comes from pension funds.
The next two largest groups are financial institutions and endowments/foundations, each with about 1/6 of the total.
Individuals/families and corporations make up the remainder, and are more fickle than the other types.

11. Fund Raising Process Private Placement Memorandum 1. Executive summary
2. Firm and Fund investment philosophy
3. Investment Professionals and Advisory Committee
4. Summary of GP/LP terms and agreements
5. Investment track record and prior fund performance
6. Legal and tax matters
7. Inherent related investment risks
8. Accounting and reporting standards

12. Time Line For Fund Raising
FUND VINTAGE YEAR
2000
1997
Announcement – Plans to raise a $100 Million Fund
1998
Commitments of $25 Million
1999
Commitments of $75 Million
2000
First Investment of $15 Million
Fund CLOSING YEAR

13. Time Line Investment and Distribution
Final Year
2009
2000
Total investment $15 Million PLUS
2 Million for Management fees
2001
Investment of of $65 Million
PLUS
2 Million for Management fees
2008
Distribution of $120 Million
Still $ 2 Million for Management fees
2009
Distribution of $160 Million Still $ 2 Million for Management fees
Capital Call/
Draw Down
Of $17 Million

14. The key terms in VC partnership agreement
Compensation structure
Management fees
Carried interest
Covenants
Activities of the fund
Activities of the individual General Partners 14

15. Fees: definitions Annual management Fees Level:
Basis: committed capital or net invested capital
lifetime fees = The total amount of fees paid over the lifetime of a fund
investment capital = committed capital - lifetime fees
invested capital = cost basis for the investment capital of the fund that has already been deployed at a given point
Net invested capital = invested capital - cost basis of all exited and written-off investments 15

16. Example
ABC Ventures has raised their $100M fund, ABC Ventures I, with management fees computed based on committed capital. These fees are 2 percent per year in the first five years of the fund, then fall by 25 basis points per year in each of the subsequent five years. The fees will be paid quarterly, with equal installments within each year.
Problem
Given this description, what are the lifetime fees and investment capital for this fund?

17. ABC Ventures

18. Carried Interest: definition
Definition: % of the realized fund profit, defined as cumulative distributions in excess of carry basis, that gets paid to GPs
Level
Basis: committed capital or investment capital
Timing
Priority return
Catch-up
Claw back

19. Example
Sunny Bird Ventures is considering two alternative carry structures for its SBV II.
25% carry with a basis of all committed capital
20% carry with a basis of all investment capital
Committed capital = $ 250 M
Management fees = 2.0% of committed capital every year
Fund duration = 10 years
Suppose total cumulative distributions for 10 years = $400 M. How much carry would GP get under 1 and 2?
What is the breakeven amount of distributions that makes GP indifferent between structure (1) and (2)?
Lifetime fees = 10 * 2% * $250 = $50M
Investment capital = $250 - $50M = $200M
(1): ( )*0.25 = $37.5M
(2): ( )*0.2 = $40M
With investment capital as carry basis, carry kicks in faster and is more valuable.
With higher carry level, carry is also more valuable.
(b)
(X-250)*0.25 = (X-200)*0.2
X = ( )/(0.05) = 450
With total exits greater than $450M, GP prefers higher carry level with greater carry basis. 19

20. Example Break Even Distribution  450 MM
25% carry with a basis of all committed capital
20% carry with a basis of all investment capital
Committed capital = $ 250 M; Management fees = 2.0% of committed capital every year ; Fund duration = 10 years
2% of 250 = 5MM for 10 years Life Time Fees= 50 MM
Invested Capital = =200
Suppose total cumulative distributions for 10 years = $400 M. How much carry would GP get under 1 and 2?
Profit basis = =150 Carry = 25%x 150=37.5
Profit basis= = 200 Carry=20% x 200= 40
Break Even Distribution  450 MM
Lifetime fees = 10 * 2% * $250 = $50M
Investment capital = $250 - $50M = $200M
(1): ( )*0.25 = $37.5M
(2): ( )*0.2 = $40M
With investment capital as carry basis, carry kicks in faster and is more valuable.
With higher carry level, carry is also more valuable.
(b)
(X-250)*0.25 = (X-200)*0.2
X = ( )/(0.05) = 450
With total exits greater than $450M, GP prefers higher carry level with greater carry basis. 20

21. Carried interest Carried interest timing
Contributed capital = invested capital + management fees that have been paid to date
For a fully-invested and completed fund, contributed capital = investment capital + lifetime fees = committed capital
Carried interest timing
Return all call carry basis (committed or investment capital) first (25%)
Return all contributed (or invested) capital plus priority return first (45%)
Return only part of contributed/invested capital
Often distinguishes between realized and unrealized investments
Fair value test (14%)
Other (16% of sample) 21

22. Carried Interest (cont’d)
Priority return: For some funds, some minimum rate of return (called priority return or hurdle rate) must be achieved by LPs before GPs receive carried interest
45% of VC funds have a priority return
More common among late-stage funds than early-stage funds
Catch-up: Once this threshold return is achieved, there is often a catch-up period during which GPs receive disproportionately high ratio of profit until the aggregate profit is split according to the carry rule (e.g., 20:80).
Priority with catch-up affects timing of cash flows, but not the eventual aggregate profit split if there are sufficient exits
This is much more common
Priority without the catch-up, on the other hand, permanently affects the eventual aggregate profit split
PRORITY and CATCH UP EXAMPLE  100 ; 108; 2; 10 (80/20)

23. ONSET Ventures Fund Name Vintage Year Committed IRR Capital Fund LP
PAGE 20-21
Fund Name Vintage Year Committed IRR
Capital Fund LP
ONSET $5M
ONSET I $30M % %
ONSET II $67M % %
ONSET III $100M

24. Return Definitions (1)
(IKV)
Internal rate of return (IRR) = a rate of return that implies an NPV of 0 for a given cash flow stream
Value multiple (TVPI)* = Total Value Paid In= investment multiple = multiple of money =
Value multiple =
Realized Value multiple =
Unrealized value multiple = 24

25. 5 steps to calculating value multiples
There are 3 components that contribute to value multiples: Total (cumulative) distributions to LPs, value of unrealized investments, and contributed capital.
Calculate distributions to LPs each year.
Distributions to LPs = total distributions - carry
Sum them to date to get total distributions to LPs
Get value of unrealized investments (after exits) = portfolio value (before exits) - total exits in year t. This is an estimate value of illiquid investments and not a market/transaction value.
Calculate contributed capital = invested capital + fees to date.
Calculate

26. 5 steps to calculating IRRs for LPs
As LPs, there are 3 components that contribute to your net cash flows: fees, new investments, and distributions.
Calculate fees
Calculate distributions to LPs
Distributions to LPs = total distributions - carry
Calculate net cash flows = Distributions to LPs - new investments - fees
For the IRR of a fund that is T years into its life and is still alive, the value of unrealized (i.e., remaining) investments at the end of year T is counted as if it is a positive cash flow. This is an estimate value of illiquid investments and not a market/transaction value.
Cash flow if final year of IRR calculations = Distributions to LPs - new investments - fees + portfolio value of remaining unrealized investments
IRR(year 1,…, year X) = IRR(CF1, …, CFT)

27. The IRR is not perfect Cannot be compared to time-weighted returns
Compounding of periodic returns
Realized vs. unrealized investments
Difficult to make risk adjustments

28. Performance Notice it was not paid out 88 Committed Capital 100
Management Fee 2%
Year 1 2 3 4 5 6 7 8 9 10
Management Fee 2
Investments 20
Notice it was not paid out
Carrying Value
And/or distributions ( very rare at this stage) 40
Cash Flows to LPs
-22 18
IRR
-18.2%
Multiple
0.90 x (40/44)
Committed Capital
100
Management Fee 2%
Year 1 2 3 4 5 6 7 8 9 10
Investments 20
Carrying Value
Plus some distributions (some possible at this stage)
176
IRR
49%
Multiple
2.0 x
Cash Flows to LPs
-22
154 88
Management Fee 2
Investments 20
Remaining Value plus distributions 40
200
Cash Flows to LPs
-22 38
198
Committed Capital
100 2%
Year 1 3 4 5 6 7 8 9 10
IRR
30%
Multiple
4.0 x

29. Example of a J-curve

30. Some Basics How is return of a fund measured?
Consider a fund that raised 100 million – Drew down 50 million at start of year 1 and Year 2. Distributed 100 million at the end of year 7 and 80 million at the end of year 10. 1 2 3 4 5 6 7 8 9 10
-50
-50
100 80
IRR=7.87%
Multiple 1.8x
What if 100 was distributed at the end of Year 5 instead of Year 7?
What is distribution?
What is the IRR when the Fund was 4 years old?
How does the VC get paid?

31. CalPERS – Performance Review of Private Equity Investments
Fund Description
Vintage Year
Capital Committed
Cash In
Cash Out
Cash Out & Remaining Value
Net IRR
Footnote
Investment Multiple
Footnote2
RV/Cash In RV
Permira U.K. Venture III
1991
12,700,000
13,262,655
37,161,145
37,428,531
31.1
2.80x
2.02%
0.27
Hellman & Friedman Capital Partners II
100,000,000
87,335,732
239,071,996
239,128,430
22.5
2.70x
0.06%
0.06
Welsh, Carson, Anderson & Stowe VI, LP
1993
50,000,000
97,922,237
100,214,581
12.9
2.00x
4.58%
2.29
Blackstone Capital Partners II, L.P.
1994
75,000,000
78,946,963
170,188,559
176,592,301
37.4
2.20x
8.11%
6.40
FS Equity Partners III, L.P.
164,794,231
164,813,795
16.4
0.03%
0.02
Green Equity Investors II, L.P.
72,453,008
151,988,178
13.9
2.10x
0.00%
0.00
Aurora Equity Partners I, L.P.
25,000,000
27,227,117
33,799,938
37,078,086
7.7
1.40x
12.04%
3.28
TPG Partners VI, L.P.
2008
855,000,000
162,853,206
261,044
127,551,734
-26.8
N/M
0.80x
78.16%
127.29
Bridgepoint Europe IV, L.P.
406,373,559
56,266,433
40,177,347
-48.4
0.70x
71.41%
40.18
Candover 2008 Fund, L.P.
39,629,686
25,528,038
462,069
18,295,919
-19.0
69.86%
17.83
CVC Capital Partners Asia Pacific III, LP
150,000,000
52,426,802
344,567
34,904,220
-27.6
65.92%
34.56

32. VC Industry Historical Performance
Cumulative Vintage Year Performance
Fund Year
Sample Size
Pooled Average
Maximum
Upper Quartile
Median
Lower Quartile
Minimum
1990 21
28.47
74.94
29.29
14.25
0.31
-7.63
1991 17
19.39
61.34
25.25
14.10
4.43
-0.57
1992 27
36.43
116.35
38.89
13.34
11.00
-17.13
1993 42
37.32
98.55
38.90
12.37
0.75
-25.01
1994 36
47.00
107.72
43.90
23.75
3.03
-47.88
1995 49
59.49
220.09
61.14
19.27
2.38
-36.14
1996 39
84.26
454.91
94.47
37.73
1.19
-13.59
1997 65
48.16
295.97
59.56
19.97
-0.58
-21.63
1998 78
17.23
721.01
10.48
1.91
-3.10
-44.77
1999
109
-4.18
140.02
-4.95
-12.54
2000
124
1.44
21.98
1.95
-1.89
-5.77
-37.35
2001 63
5.45
26.94
6.47
1.03
-3.51
-20.68
2002 18
-1.79
13.72
1.63
-1.11
-3.65
-13.83
2003 19
4.60
18.43
8.71
1.88
-0.65
-10.74
2004 26
4.07
81.86
4.63
0.41
-4.08
-13.77
2005 22
7.57
54.43
6.82
3.08
-3.46
-18.65
2006 43
4.75
21.50
6.37
-0.71
-5.97
-35.25
2007 23
14.29
80.48
18.63
2.37
-4.15
-16.84
2008 16
6.38
29.15
16.50
4.90
-7.25
-22.00
2009 12
11.55
45.30
10.55
5.26
-9.11
-42.44
2010 5
-15.18
2.71
-4.24
-22.30
-32.29
-57.79

33. Review of Important Terms
VC firm
General partner (GP)
VC fund
Limited partner (LP)
Capital call = drawdown = takedown
Committed capital
Early-stage fund, late-stage fund, multi-stage fund
Vintage year
Management Fees
Carried interest

34. Basics of Fund Performance
Simple calculations have ignored fees/expenses to be paid
We shall see a more realistic example in Key Ventures

35. Key Ventures Size is $250 million, life 10 years
Management Fee 2% collected at start of each year. (2%x250 = 5 million each year)
Lifetime fees = 10x5=50 million
Investment Capital = x5= 200
Assume 4 equal take downs (200/4=50)
Assume gross return is 25%
10% of portfolio value is distributed every year starting in Year 4 (end of year).
No carry till the entire 250 million is returned to investors – Carry is 20%

36. Key Ventures
288.3x(1.25)
Fund Liquidated
x(1.25)
50+50x(1.25)
0.10x(360.4)
Year 1 2 3 4 5 6 7 8 9 10
Management Fee
Investment
50.00
0.0
Estimated Portfolio Value
50.0
112.5
190.6
288.3
360.4
405.4
456.1
513.1
577.2
649.4
730.5
Distributions
36.0
40.5
45.6
51.3
57.7
64.9
Cumulative Distributions
76.6
122.2
173.5
231.2
296.1
1026.7
Distribution to Key Ventures
9.2
146.1
Cumulative Distributions to Key Ventures
155.3
Distribution to LPs
55.7
584.4
Cumulative Distributions to LPs
286.9
871.3
Portfolio value after capital returned
324.3
364.9
410.5
461.8
519.5
Contributed Capital
55.0
110.0
165.0
220.0
225.0
230.0
235.0
240.0
245.0
250.0
Invested Capital
100.0
150.0
200.0
Cash Flow to Key Ventures
5.0
14.2
NPV for Key Ventures (at 12% discount Rate) 82
Cash Flow to LPs
-55.00
31.04
35.54
40.61
46.31
52.72
50.71
584.43
IRR for LPs
20.14%
To Make LPs Whole: = 18.8
Available for Sharing: = 46.1
GP carry : 0.2x46.1=9.2
LP Share : =55.7

37. Key Ventures
Year 9
=46.1
20% of 46.1=9.2
=55.7
50+50*(1.25)
*(1.25)
Year 1 2 3 4 5 6 7 8 9 10
Management Fee 5 5 5 5 5 5 5 5 5 5
Investment
50.00
50.00
50.00
50.00
288.3
0.0
220.0
200.0
5.0
-55.00
0.0
0.0
405.4
456.1
513.1
577.2
40.5
45.6
51.3
57.7
76.6
122.2
173.5
231.2
364.9
410.5
461.8
519.5
230.0
235.0
240.0
245.0
200.0
5.0
35.54
40.61
46.31
52.72
0.0
0.0
Estimated Portfolio Value
50.0
112.5
190.6
360.4
649.4
730.5
Distributions
0.0
0.0
0.0
36.0
64.9
730.5
Cumulative Distributions
36.0
296.1
1026.7
Distribution to Key Ventures
0.0
9.2
146.1
Cumulative Distributions to Key Ventures
0.0
9.2
155.3
Distribution to LPs
36.0
55.7
584.4
Cumulative Distributions to LPs
36.0
286.9
871.3
Portfolio value after capital returned
50.0
112.5
110.0
100.0
190.6
165.0
150.0
324.3
584.4
0.0
Contributed Capital
55.0
225.0
250.0
200.0
14.2
50.71
250.0
Invested Capital
50.0
200.0
200.0
Cash Flow to Key Ventures
5.0
5.0
5.0
5.0
146.1
NPV for Key Ventures 82
Cash Flow to LPs
-55.00
-55.00
-55.00
31.04
584.43
IRR for LPs
20.14%

38. HOME WORK 1
Accel VII – ANSWER ALL STUDY QUESTIONS

39. Yale University Investments Office August 2006

40. A Clear Philosophy Focus on Equities--public or private.
Avoiding market timing.
Focus on inefficient markets.
Pick investment managers rather than investments.
Focus on incentives.

41. An Unconventional Mix

42. Picking the Pickers…
Source: Yale Endowment Report 2010

43. Can PE returns be compared to other asset classes?
Strong Track Record
year return of 14.6%:
4.1% above S&P 500
4.7% above all universities
Can PE returns be compared to other asset classes?

44. Private Equity is an Important Element
Investor since 1973.
Repeated investments in partnerships formed by a select group of organizations.
Emphasis on value-added strategies.
Focus on incentives.
How easy it is to invest in top PE funds?

45. But Worries About Future
Recent fund influx:
Private pension funds in 1980s.
Public pension funds in 1990s.
Private equity pool--from $4B in 1980 to ~$300B in 2004.
“Virtual overhang.”

46. Implications of fund Influx
Alteration in incentives.
Relaxation of covenants.
Concerns about within-fund compensation.
Quality of deals.

47. But ... Good returns during last fund influx. Inter-quartile spreads:
3% in public equities.
12% in private equity.
Private equity small relative to potential: $1:$30.

48. Swensen’s Dilemma Is private equity still viable for Yale?
If so, where?
If not, what other asset classes should they pursue?
How far can it go in pursuit of returns?
How dangerous is it to be different?

49. Yale Investment Office 2008
Domestic Equity 10%, Bonds 4%!!!
Private Equity 20%
Real Assets 29%
Beat S&P 500 in every year since 2002 by Wide margins!! Endowment size $22.8 billion
But what about 2009!

50. Future of Swensen Model
On December 16, President Levin delivered a message to Yale’s faculty and stated that : “Our best estimate of the Endowment’s value today is $17 billion, a decline of 25 percent since June 30, 2008.” President Levin’s estimate incorporated returns on marketable securities through October 31 and projections of write downs on illiquid assets. Based on marketable security returns through December 31 and illiquid asset projections, the estimated investment decline remains at 25 percent
Salary and hiring freeze instituted (Endowment had provided 37% of Yale’s operating budget in 2008!)
Context –Domestic Equity fell 30%, Foreign Equity fell 47%
2010 Yale Endowment had 8.9% return
Endowment assets went up from 16.3 Billion to 16.6 Billion