Lecture 19

Question 1

when was the first VC firm founded?

Answer 1

1946; American Research and Development Corp (ARDC)

Question 2

Who was ARDC founded by?

Answer 2

Georges Doriot; Karl Compton; Ralph Flanders

Question 3

What is the small business investment act of 1958?

Answer 3

first step towards professionally managed VC industry; allows us small business administration license (SBA) to license private “small business investment companies”

Question 4

the relaxation of investment rules for us pension funds in 1979 did..

Answer 4

large inflows from these investors to VC finance; participation by pension funds hastened participation for other institutional investors; beginning of modern VC era and Silicon Valley

Question 5

which two sectors have VC investments been concentrated in?

Answer 5

health care and IT (communications, semiconductor, software, and hardware)

Question 6

what are some common characteristics of VC contracts?

Answer 6

preferred stocks; anti-dilution provisions; covenants and control terms; employee terms; staging of capital commitments

Question 7

In virtually all VC deals, which kind of security does the VC firm own?

Answer 7

preferred stocks

Question 8

What are the two key features of preferred stock that make it attractive to VC?

Answer 8

Liquidation preference over common stocks (senior to common); Redemption (force liquidity event)

Question 9

what are anti-dilution provisions?

Answer 9

protect vc against future finnacing rounds at lower valuation than valuation at current round

Question 10

if a portfolio company raises additional funding at a price below the prior round VC’s price what happens if there’s anti-dilution provisions?

Answer 10

VC’s conversion price of convertible preferred stocks is lowered to protect against dilution

Question 11

the goal in VC deals is to structure contracts that..?

Answer 11

allocate control to the party that has more benefits and expertise using it

Question 12

what are the three types of control rights?

Answer 12

voting rights; board representation; protective provisions (some actions required approval of VC)

Question 13

describe employee terms

Answer 13

compensate employee’s for taking risk and hard work; provide incentives to encourage superior performance; retain talent in company

Question 14

describe staging of capital commitments

Answer 14

VC’s fund companies in multple rounds (seed, start up, early stage, expansion); rounds tend to be shorter in high tech industries and for smaller sums

Question 15

what is the dual roles of staging capital commitments?

Answer 15

control mechanism and option to abandon

Question 16

describe the control mechanism:

Answer 16

entrepreneur has to come back to VC for funding at several points

Question 17

Describe the option to abandon:

Answer 17

allows investor to monitor firm and shut it down if success probabilities are poor

Question 18

what are the assumptions of contracting approach to start up finance?

Answer 18

entrepreneur and venture capitalist maximize their own objective ssubject to contractual constraints

Question 19

what are some motivations for collaboration for entrepreneur?

Answer 19

build successful business; raise money to fund venture; maintain value and control of company; get expertise and contacts to grow company; share risks with investors; financial reward if venture works out

Question 20

what are motivations for VC to collaborate?

Answer 20

max financial returns to justify risk and effort involved in funding company; ensure firm is using capital in best possible way; participation in later financing rounds; achieving liquidity (exit); building reputation

Question 21

what are cash flow rights?

Answer 21

fraction of portfolio company’s equity value that different investors and management have claim to

Question 22

what are the liquidation cash flow rights?

Answer 22

when value of venture is low, cash flow rights go to senior claims

Question 23

what is similar to required repayment of principal

Answer 23

after some time, liqudation cash flow rights provision gives VC right to demand that firm redeem vc’s claim, typically at liquidation

Question 24

what are automatic conversion provisions for VC’s?

Answer 24

security held by VC’s automatically converts to common typically during IPO