Tenta

Question 1

Are new ventures are hard to finance? Why?

Answer 1

Yes.
Capital intensive.
Asymmetric information such as Moral hazard- the risk can be that they misallocate resources, and Adverse selection- The entrepreneur has more information than the investor and thus it can be hard to know if the company is good or bad.
Lack of tangible assets.

Question 2

Explain the three main activities of a VC?

Answer 2

Screening and selecting deals. (Venture capitalists devote a great deal of time into screening and selecting deals)

Financial contact and structuring investments. (Minimize principal-agent problem)

Add value to portfolio companies. (Monitor, board representation, strategy, certification ).

Question 3

Is staged financing relevant for a VC? Why?

Answer 3

Yes. Minimize the risk of the entrepreneur using all money and putting it in the same project. Gives a chance for monitoring. Not venture the portfolio companies money. Be careful with others’ investments. Build trust with the entrepreneur and the portfolio companies.

Question 4

How would you describe an entrepreneurial firm?

Answer 4

Risky with high rates of failures. Spurring innovation. Smaller companies. Years of negative loss. Lack of tangible assets

Question 5

List five potential sources of financing a venture?

Answer 5

Bank Loans (or family and friends). 
Angel investors
Government (or academic funds). 
VC
Corporate investments

Question 6

Describe the structure of a VC fund.

Answer 6

A venture capitalist (VC) is a financial intermediary (GP) that takes the capital of
investors (LPs) and invests it directly in portfolio companies (entrepreneurs).

The primary goal of a VC is to maximize the financial return by exiting
investments through a trade sale or an initial public offering (IPO),

VC funds usually have 10 year time frames and take a portfolio approach to investing

Question 7

What is the difference between a gross and a net return index?

Answer 7

What is the difference between a gross and a net return index?
Gross return index (SHE) does take management fees and carried interest into account. (Portfolio company level)

Net return index (CA) take management fees and carried interest into account. (Fund level)

Question 8

How do you understand that ”SHE is a conservative index”?

Answer 8

SHE look into the portfolio company level, hence the index look more broadly and needs to take more assumptions into consideration.

Question 9

Do the same GPs consistently outperform the market (Kaplan and Schoar, 2005)? What does this mean?

Answer 9

It is widely believed that the best GPs in venture capital consistently outperform other GPs.
This observation explains the strong preference of LPs to invest in top quartile funds or GPs.
”winners stay winners”

Question 10

Why do VCs, overall, rarely raise prices or quantity so as to clear the market?

Answer 10

To preserve long-run value of it franchise
Suppose carried interest is raised to 35%-then the firm would lose some of its (long-serving) LPs and be replaced by others

In order to increase quantity they will need to find as skilled workers as they have, which also will decrease the personal involvement of the VC fund overall, a large organization will tendto weaken the incentives for individual partners.

Question 11

Explain the trade-off between VC size and return.

Answer 11

Better General Partners (GPs) get larger, which is accompanied by increasing returns for
a while:
But at a fund size of roughly $200 million, the negative effect of size kicks in
and performance stops increasing with size,

At fund sizes greater than $500 million, performance clearly begins to decline
→ fund size is the enemy of performance persistence.

Question 12

List and describe the five main monitoring activities of a VC.

Answer 12

Board representation (influence the company in decision-making),
Human resources (hire fast and competent people that can bring sucess to the company),
Strategy (make a strategy so employees can see what goals to achieve etc. and monitor if employees actually follows the strategy).
Corporate governance
Matchmaking: match them with great partners

Question 13

How would you describe the significance or value of reputation in a VC world.

Answer 13

Reputable VCs are better networked, more likely to join syndicates of promising ventures
and thus secure lower valuation of investments.

Conventional wisdom suggests that VC investors rather invest in strong management (Jockey)
with an average business plan (Horse) than in average management with a strong business plan

They found that core business lines are remarkably stable (ideas stay relatively unchanged)
from birth to exit, whereas management changes are quite common.

Question 14

Under what situation can preferred stocks turn out to be extremly valuable? Why?

Answer 14

Preferred stocks can be used in situations with asymmetric information as a way for the entrepreneur to show confidence in their company’s business plan.

Question 15

Should an investor be compensated in the form of a higher expected return for holding any type of risk? Why?

Answer 15

Yes. The higher the higher the expected return, and the higher the expected reward.
An investor should be compensated for market/systematic risk, but not for firm specific/diversifiable risk

Question 16

What is the main idea (assumption) of CAPM, i.e., it is mainly related to the fact that CAPM is a one-factor model for the estimation of the cost of capital?

Answer 16

The CAPM assumes that there is only one source of risk that affects expected returns, systematic market risk – the sensitivity of the stock, security, company, or asset to the market

Question 17

Explain briefly what is alpha and beta in a VC world. Is VC’s beta the same as VC’s volatility?

Answer 17

Beta - the market risk for a portfolio, a higher beta is a higher systematic risk and therefore can yield a higher return-

Alpha - Alpha represents the unexpected portion of the return, i.e., a positive alpha is interpreted as skills of portfolio managers or as abnormal return.

Beta differs from volatility. Volatility measures total risk (systematic plus unsystematic risk), while beta is a measure of only systematic risk.

Question 18

Be able to choose between mutually exclusive alternatives and when the NPV rule does not agree with IRR.

Answer 18

Situations where the IRR rule and NPV rule may be in conflict:
1, Delayed investments
2, Nonexistent IRR
3, Multiple IRRs

Question 19

What is the weighted average cost of capital?

Answer 19

WACC = discount rate ( cost of capital) during steady-state period.

Question 20

Describe the main parties to an IPO transaction.

Answer 20

Underwriting syndicate, new investors and existing investors

Question 21

What are the key advantages and disadvantages of an IPO?

Answer 21

Advantages: Greater liquidity, the chance of receiving a lot of money
Disadvantages: The equity holders become more widely dispersed.
This makes it difficult to monitor management.
The firm must satisfy all of the requirements of public companies.
Takes a long time to be able to realize the sale.

Question 22

What is a ”road show” during an IPO process.

Answer 22

During an IPO, when a company’s senior management and its underwriters travel around promoting the company and explaining their rationale for an offer price to the underwriters’ largest customers, mainly institutional investors such as mutual funds and pension funds

Question 23

Which is the most important IPO puzzle? Describe and explain.

Answer 23

Underpricing: Due to information asymmetry IPO tend to set a underprice on the IPO to make sure that the first day is positive in return. The people with the most information would avoid overpriced, and the least informed will stay out of the IPO, forcing them to set an underprice.

Cyclicality: The number of issue are highly cyclical, good times lead to a lot of issues

Cost of an IPO: A typical spread is 7% of the issue price

Long run underperformance: After performing well immediately after the IPO firm tend to perform poorly during the next 3-5 years.

Question 24

What do you know about venture-backed IPOs versus non-venture backed IPOs?

Answer 24

VC have control right to make sure that the IPO happens at a good time, they also come with
a lot of experience from prior IPOs and may take the lead in going public.

Question 25

What are the five main remaining challenges for global VCs?

Answer 25

Exits:
IPOs have generated the most profitable exits for VCs, success of non-US VC-backed companies to exit via IPOs have been limited to a few: Israel, China, and India

The entrepreneurial ecosystem:
Well - functioning ecosystems: Skilled and trained bankers, lawyers, and so on, Qualified scientists, engineers and experienced managers and so on, Legal setting and regulatory procedures that facilitate business.

Law and corporate governance:
The relationship between legal systems and financial development, in particular regarding emerging economies. Those who control a corporation can use their power to divert corporate wealth to themselves, without sharing it with other investors

Country risk:
National-level political and economic risks: capital controls, financial crises, probability to seize corporate assets and so on, The different forms of country risk make any VCs worry about investment in emerging markets.

Cultural differences:
The importance of cultural factors and personal attitudes on an individual’s decision to become an entrepreneur, across countries

Question 26

What can be done to fix the problems of the VC market?

Answer 26

Different compensation models
Direct investment by company through subsidiary VC funds
Crowd funding?
Ventures backed by government - sponsored VCs (GVCs)

Question 27

Define risk

Answer 27

Risks threaten things that we value

Question 28

What are the differences between Normative, descriptive and prescriptive perspectives on risk?

Answer 28

Normative: Rational decision making, Risk = objective measures of outcomes
Making correct choices IF:
The DM is fully informed 
The DM is in touch with values 
The DM follows consistent rules 

The descriptive perspective:
The study of practical decision making 
Actual choices
Imperfect
Heuristic decision rules

Prescriptive:
Bridging the gap between normative and descriptive, using management tools, a combination between normative and descriptive.

Question 29

What is the meaning of “probability”? How do we use probabilities in risk management and why?
Give some examples.

Answer 29

Probability is a way to understand the likelihood that something occurs.

We can use probability to choose the options that is best for the company, probability can help you understand if you want to take risks to get a better outcome.

Question 30

Is VC performance persistent across funds (Kaplan and Schoar, 2005)?
Specify an empirical model that will answer this question.

Answer 30

They find strong evidence of persistence. 1% performance in prior fund → 54 basis points better performance in current fund.
”winners stay winners”
Kaplan & Schoars performance model shows that the IRR of Fund N, indeed are a significant predictor for the IRR of Fund N+1 and for the IRR of Fund N+2.

Question 31

List the advantages of the real options valuation approach.

Answer 31

Real options are created when costly decisions can be delayed. I.e switch from the highway to the back roads. The advantages of real options is that it gives us a make-believe world where everyone is risk neutral, and then use probabilities and decision trees to price our options and make a rational decision.

Real options for R&D:
Delay (the project, investment, etc.)
Expand
Extend
Abandon
Shrink
Switch

Question 32

WHY THE VC MARKET HAS PROBLEMS?

Answer 32

If there are only a certain number of worthy projects to finance, then a substantial increase in the amount of venture fundraising may increase the prices that are paid to invest in these companies.
These higher prices may ultimately affect the returns on investment in the industry

Question 33

List the four primary covenants in VC contracts:

Answer 33

Stage financing - VCs stage capital infusions in order to facilitate monitoring and reduce potential agency problems

Rights of first refusal - VCs typically insist on rights of first refusal, or pre-emptive rights, which give the VC the right to invest in subsequent rounds

Board rights - Corporate boards retain the responsibility for hiring and firing top management and ratifying major corporate decisions

Non-compete clauses - In early-stage ventures, much of the value is tied to the human capital of the entrepreneur. This can result in the entrepreneur having substantial bargaining power over the VC.