Class 9 - Choice of financing and institutionnal relations Flashcards
what is the framework in capital markets
The law sets the standards The legal (laws) and regulatory framework of the stock markets and capital markets is binding on the parties
Public and mandatory rules
the law is binding on the parties
you want the rules to be standardized as much as possible
the law will decide the rights and obligations of the different parties and you cannot really create other structured in public markets
what is the framework in private markets
The contract is the law of the parties
The specific legal framework for VC investments is almost non-existent …
except for limited partnerships (LPs)
laws are based on a contract. theres no legal framework. the law will define what is a LP, but not what the LP needs to do.
limited partnerships ;
Limited liability for investors, and
Suitable for non-taxable investors
Retirement funds
University endowment funds
in LPs, theres no taxes so no double taxing
they can reinvest the full amount received
Structuring a limited partnership
A contract…
Negotiated by mutual agreement …
Between investors and fund managers
There is no model, but there are “standards”
The limited partnership agreement aims to reduce agency costs
Three aspects of limited partnerships
Fund structure
Restrictions in fund management
Remuneration of managers
what is the fund structure of a lp
GP - fund manager
The general partner limits his liability by constituting himself as a joint-stock company, GP is taxable
create a company to haev some osrt of limited liability
LP - investors
Limited liability, and
The limited partnership does not pay taxes
A « closed-end » fund
Minimum and maximum size
the capital is fixed
the fund will raise capital and then will close the fund and start investing.
vc fund will not receive new capital until theres a second round of financing
vc fund will target 5 years or less but in the LP agreement the life is extended to 10 years au cas ou ca prendrait plus de temps
Funds are raised as they are invested …
… but investors have no choice but to subscribe
the fund is raised as it is invested.
gp will call and say ok now we need to first 10m of the 100m commited. they dont keep the cash if they have no investment in mind
“Defaulting Limited Partners”
« Most contracts have provisions for defaulting limited partners who fail to meet their capital commitments. »
(page 74)
if the investor cant give the money, way to recup the money fo hte other investors
Once committed, investors must follow the parade!
Agency problem
On the one hand…
Limited partners may not interfere in the management of the fund
On the other hand…
The “Carry” (20% of the upside) is assimilated to an “option” (management options)
the law of the LP says you cant interfer with the management of the fund
so you need to have ways to constraint the management
the fee of the gp is structured as an option ce qui peut etre tricky pcq augmente les couts doption
carry :
Goal: alignment of interests
Problem: the manager has no downside risk (no downside risk)
so manger may be tempted to take more risk, so there has to be restrictions
Limit to the amount to be invested in a single firm : need for diversificaiton.
Limit in the use of financial leverage
Limit to co-investments between funds managed by the same manager. would concentrate too much capital in a single firm
Limit to reinvestment of profits. when u sell an investment, you return the money to the investors, if they want they can comit it again
Limit to co-investment by the general partner
Limit to monetization of the general partner’s participation. canot sell it when he wants
Limit on raising new funds imposed on the general partner
Limit to the delegation of the general partner’s responsibilities
Remuneration of managers
Management fees: 1.5% - 2.5%, per annum
« Carry » : 15 % - 25 % (and more)
How can we justify such a generous “carry”?
by comparing what the management of stock and bonds do vs vc fund do
manager of stock invest close to the index et seulement une petite partie fait autre chose que le bench donc cest comme si le manager investi juste 10%
vc fund manager investi tt le fond dune maniere funky donc veulent plus
Sometimes GPs negotiate fees payable to the VC fund by the firms in which they invest (called
« transaction fees »)
What is the problem that “transaction fees” can pose for investors in a venture capital fund?
its a burden imposed on the firm, its a disadvantage for the invesotors, il paye les 2-20% et en plus les transactions
clawback
GPs can distribute the gains as they are realized and end up receiving more than 20% of the total capital gain
Explain the objective pursued by the “Claw back” in the remuneration of the manager.
a la fin du fonds, le gp doit rembourser les investisserus si jamaisil a recu plus que 20% du upside en totalité du fonds (et pas deal by deal
ecst pour eviter que le gp ait plus que le 20% de carry qui était proposé
sil fait 20% sur chaque deal successful et a la fin du fonds ya un echec, en cumul il aura plsu que 20%
Negotiation of limited partnership agreement : what is the golden rule
if the investor wants a specifi term and condition, if hes big enough he will have is way. le gp peut pas vrm imposer une rule si le gros investisseurs veut pas
valuation model for preferred shares
option pricing model
(Fundamentally) a common share is a call option with an exercise price of 0
A VC preferred share is a portfolio of options
pref shares protects downside and gives more say in the management of the company
those features have a value
series of options
if the firm is worth 100
the call is worth 100
and thus if you have 25%, your call is worth 25
comited capital ; 100
invested capital : 80 pcq 20% de lp fees over 10 years
investmend is 6M$,
the 1,5 is the fee
so the LPS bear the cost of mgnt
but they benefit from the shares
common shares dot line
pref shares the plain line : 0-72 they have more then 1/3 then the company
once u reach the 4x you no longer have the upside of the company and you have common shares
aller voir metrick p.294, calcul exam
