Class 8 - Choice of financing and institutionnal relations Flashcards
What can be said about the match between the capital market and the financing of innovation?
the preferred exit is an IPO because the stock market usually pays the highest price
someone who wants to take over the company will pay a premium over the stock market price but usually
the stock market is the place to get the highest price, and it allows for liquidity so vc fund would wait for the stock to settle at a higher price before selling it
the second best way is to sell to another company
VC funds would invest in companies with the intent to bring it public, usual best way to realize the highest return on the investment. generally speaking the stock market has buyers that are willing to pay the highest price because they have a lot of liquidity and diversification which helps the companies to be fully valued
vc fund managers make the investment to bring it to market or for the company to be sold in a consolidation play (M&A). the exit depends on the type of company they invest in. theres specifi requirement for a company to be attractive to the stock market. the stock market is very liquid so thats why the vc fund managers prefer that way : they want to exit when they want et profiter de la liquidité du marché
IPO or acquisition ?
generally speaking, higher when u bring the company to market. depends on factors tho, it will vary depending on the state of the market. some times are better to bring a company to market.
even in m&a the multiples have an impact pcq si toi tu es value a un high multiple tu vas pouvoir acheter une compagnie a un plus petit multiple et créer de la valeur a cause de ton princing favorable dans le marché
gross value multiples vary si tu es investisseur dans la premiere ronde vs 2e et 3e
making 2x investment in 6 months is good but in 5 years is not good. if you invest late in the company, you can have a gross value mutliple that is late but a realized return that is high because you are able to go out faster
What is exit a function of?
Metrick reports that the number of IPOs is a function of market conditions … and that it can vary widely from year (good) to year (bad)
the new issue market is cyclical, if things in the stock market are good, the new issue market is very good. and when its bad, the new issue market is very bad. cest plus cylique.
you face the risk of not being able to exit the investment because you cant bring the company to market because of bad market conditions
Metrick points out that the large number of exits at multiples between 0 and 5 justifies the use of financing structures based on preferred shares (page 132)
Investment process : what are the terms and conditions
Company / VC dynamics
The best companies want to partner with the best VCs
Large VCs see the best (the most) investment opportunities
when a vc makes an investment, he wants the upside and some level of control in order to reduce the agency costs so hes gonna do it through investing in preferred shares that will give him a higher percentage of vote than the percentage he owns
also gives downside protection
the best vcs will partner with the best companies (they have a reputation with the market and IB so they are perceived as being good partners so the best companies will want to seek those investors
and has the company gros it needs more investments thus you want your partner to be able to commit that capital
small vc funds as to establish their track record and have enough ressources
VC investment criteria
Market Test
Never obvious!
Management Test
Intuition or experience?
when a vc fund invest in a company, they want the company to have huge potential in term of size
thats why they do a market test. its also important for when the company goes to market. in order to attract investors in the stock market, the company has to attain a certain size and in order to be a large company you have to have a big market potential
management test ; u invest with people, some put more emphasis on management and others less so but its important. it varies from funds because they can be replaced so vc investors always keep the right to replace management of the company
Management or business plan?
Kaplan, Sensoy, and Stromberg
In the case of firms having completed an IPO, changes in management were more frequent than changes in the activity of firms
(Mentioned in Metrick, p. 139-140)
is it the jockey or the horse? is it the managemnt that is important or the company?
Why wouldn’t VCs be content to own common stocks?
founders are at the mercy of the vc funds, but vc funds want to founders to be fully motivated, hence they want them to own a sufficient % of shares
there might be differences between vc funds but its basically standard.
the vc fund want the upside os they want fully participating shares so they own common share. however they want more control than waht common shares give them so they will invest in shares with specific terms and conditions reserved to them that gives them rights.
they have preffered shares that give them advantages over the rights of the common shareholders
VCs don’t settle for common stocks
: vc shares are voting, dividend paying shares. they are not the typical preffered shares.
How do VCs protect their downside?
they protect their downside with the preferred shares because they have the priority over the founders.
they are also voting shares and rights that give them more than a voting stock so they can have a certain control
Terms and conditons…
to protect the downside
“Liquidation preference”
when a vc fund invest, they have prefered shsares and ask for a liquidation preference. if they pay10M of a 100 M company, and the company is sold at 50 000 at the end, they will have their 10M instead of 10% of 50M
sometimes they ask for a liquidation preference of 2X their intial investment. they would get 20M technically.
so preferred shares for vc investors is costly for common shareholders
antidilution protection
when vc invest, they expect to have other round of investment.
the follow up investments are done at a higher price then the previous one because the company has grown in value. as you go through the growth of the company the price is going up.
however, if theres a downround, meaning that the value of the company goes down after the first round, they keep a antidulition protection
the price they payed will be reduced at the new price now. if you initially payed 100 and now its 50, they would receveive twice the number of shares.
“Redemption rights”
when a perfered share is redeemed by the issuer. it can happen that the company is sold and thers a redemption right, and the holder of the preffered shares can force the new owner to buy back the shares at a price equal to the original price.
“Right of first refusal”
first refusal : the right for the initial investor (1st round) has the right to participate in the follow up round. if they think its favorable to make the investment at the 2nd round, they have the right to participate
co -sale : if one of the founders sell its part of the company, the vc fund has the right to sale their shares. if theres a transfer they want to be able to sell also
How do VCs ensure control of the firms in which they invest?
vc want control. they will do so with the terms and conditions with their preferred shares
“Voting rights”
the voting right of the shares they own will give them the possibility to choose the members of the board and the way to control a company is through the board.
so they want enough voting rights to be able to control the company through the board of directors
even if they are preffered shares they have voting rights and they have a special right to select 2 members of the board
the pref shares are convertible. the vc fund as the right to convert their shares to comon shares n order to sell them in the stock market
“Matters requiring investor director approval”
droit de veto pour les board members mis par le vc
prescribe a number of deicisons that have to be done with the consent of the vc. les board members ont un droit de veto
How do VCs ensure eventual liquidity for their investments?
the exit of the investment by the vc fund
terms and conditions To ensure liquidity :
1. mandatory conversion (right that the vc funds have to convert the pref shares to comon shares when the company becomes public.
)
if the company goes publc at 5x the initial investment, when the compnay goes public the pref shares will be automatically converted to comon shares
when u bring a company to market you have to have a clean capital structure, thats why theres a mandatory conversion pour que ce soit plus facile. you have to clean up the capital structure and eliminate the specific classes. the clause allows for the clean up and makes the company more attractive
- “Qualified Public Offering”
the mandatory conversion will quick in if its a qualified public offereing, meaning if they do 5x their initial investment - “Registration rights”
when a compnay is brought to market, the shares that are qualified to trade on the stock market are the shares having been sold to the new shareholders via the prospectus. the shares have to be qualified to be tradable and the qualification is done via the prosepectus.
the registration of the shares owned by the founders and the vc are not necessarily qualified and registered so you may not be able to trade them.
so when you go to market you have to mention that ALL shares will be tradable and can be sold on the stock market. so all sahres need to be registered.
- “Right of Co-sale”
when a founder sells comon shares, the investor has the opportunity to sell to the new buyer their shares first or at the same time.
