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Startup Financing > Venture Capital > Flashcards

Venture Capital Flashcards

1
Q

What are the two forms of Private Equity?

A 
Venture Capital: Financing of newly formed companies
Private Equity (narrow sense): Financing of established companies
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2
Q

What are the steps of the investment process?

A
  • Investment Origination
  • Investment Due Diligence
  • Investment Structuring
  • Investment Development
  • Investment Exit
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3
Q

Describe the structure of VC and PE financing

A

Investors fund portfolio companies

  • directly
  • through venture capital funds
  • through funds of venture capital funds (“fund-of-funds”)
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4
Q

How is a limited partnership (fund) organized?

A

Limited partners (investors):

  • no participation in management
  • liable to the extent of their investment

General partners (managers):

  • personally liable for debts of partnership
  • responsible for administering the fund

Compensation of the general partner:

  • management fee (2-2.5% of committed capital)
  • carried interest (20% of returns that exceed hurdle rate of 8%)
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5
Q

Which different types of funds regarding the influence of the investor on the investment policy are there?

A
  • government-dependent funds
  • dependent funds
  • semi-dependent funds
  • independent funds
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6
Q

Which legal documents are typically exchanged before an investment?

A

Screening: Confidentiality letter, Non-disclosure agreement (NDA)
Personal Meeting: Letter of intent (LOI)
Due Diligence, Investment Structuring: Term sheet (letter of intent prepared by VC firm to summarize all important financial and legal terms of transaction)

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7
Q

What are the most important VC investment decision criteria?

A
  • management team
  • market
  • products and services
  • financials
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8
Q

What are the 7 classes of additional investor rights?

A
  1. Information Rights
  2. Control Rights
  3. Management Covenants
  4. Milestone Agreements
  5. Cash Flow Rights
  6. Preemptive Rights
  7. Disinvestment Rights
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9
Q

What are the three types of control rights?

A
  1. Voting Rights: percentage of votes that shareholders have to affect corporate decisions
  2. Veto Rights
  3. Board Rights: membership in the supervisory board
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10
Q

What are the four types of Management Covenants?

A
  1. Affirmative Covenants: define correct behavior of the company’s management
  2. Non-compete clauses
  3. Vesting: founders forfeit granted shares or options under some specified conditions (e.g. leaving the company)
  4. Representations & warranties: company is required to make representations and warranties (good standing, ownership of IP, full disclosure of info)
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11
Q

What type of milestone agreements are there? What are the most relevant examples?

A

types:

  • financial nature
  • technical nature
  • conclusion of contracts

most relevant examples:

  • Earn-out: VC firm pays bonus if pre-defined criteria are met
  • Ratches: Ratchet-down / Ratchet-up agreements: If performance target is met, transfer of some number of shares from VC to management, else transfer from management to VC.
  • Staging: financing is provided incrementally and conditionally in several rounds
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12
Q

Name the two classes of cash flow rights

A
  • Liquidation Preference

- Antidilution Protection

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13
Q

Describe the different Liquidation Preference options

A

Basic structure:
VC firm receives its initial investment back before other investors receive any payments

Additional elements:

  • Preferred dividends: some percentage accrued on the preferred stock that will be paid to holders of preferred stock and paid before any dividend can be paid to holders of common stock
  • Cumulative preferred dividends: like preferred dividends but accumulated and added to the liquidation claim of the VC firm

Participating preferred stock:
VC first receives the par value of the preferred stock (plus possibly accumulated dividend) and then participate in the remaining payments with the common stock

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14
Q

Describe the different types of antidilution rights

A

General idea: protect VC shareholdings against share and price dilution

Type 1: Share dilution/percentage based dilution provisions
Intention: keep the percentage of the VC’s shareholding constant
Mechanism: Preemptive right

Type 2: Price dilution / price based dilution provisions
intention: adjust the price per share paid by the VC to a lower level when shares are sold at lower valuation in downround
Mechanisms: Full ratchet & weighted average ratchet
Full ratchet:
VC receives additional shares so that their average cost per share will then equal the lower price per share:
Free shares = original investment / conversion price - old shares // conversion price = new price
Weighted average ratchet:
VC receives additional shares so that their average cost per share equals the average price per share given to all investors:
Free shares = original investment / conversion price - old shares // conversion price = old price * (outstanding shares + (new investment / old price))/(outstanding shares + new shares)

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15
Q

Name the two types of preemptive rights

A
  • Right of First Refusal: if management negotiates a price and terms for a stock sale it has to make the same offer to VC
  • Right of First Offer: management must define minimum price and terms it will accept for the sale of stock to third parties -> VC has option to purchase at these options for designated time period
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16
Q

Name the 4 most important disinvestment rights

A

Tag-along right: Right of the VC firm to participate in any sale of stock by the management

Drag-along right: Requires management to sell their shares to a third party if VC firm sells its shares

Redemption right: Entitles the VC firm to sell the stock back to the company under defined terms

Registration rights: Entitles VC to force IPO

17
Q

What are 4 categories for companies during investment development?

A
  • potential write-off
  • living dead
  • on-track
  • high-flyer
18
Q

What are the two styles in relation to company performance and VC involvement?

A
  • high performance -> high involvement (prospect theory argument)
  • low performance -> high involvement (need for oversight argument)
19
Q

Name the different kinds of exit possibilities

A
  • Liquidation: bankrupcy -> VC has to write off investment
  • Buy Back: entrepreneurs repurchase VC firm’s stake
  • IPO: first sale of stock by a privately held company to the public
  • Trade Sale: purchase of company by another corporation
  • Secondary Sale: sale of VC’s stake to another financial investor
20
Q

What are the pros and cons of an IPO?

A 
\+ higher exit proceeds
\+ lower potential for conflicts
\+ higher reputation
\+ possible triggering of a takeover
\+ flexible investment reduction
\+ participation in future value creation of the portfolio company
  • limited to high flyers
  • strong dependence on stock exchange conditions
  • no full investment reduction possible
  • higher costs and time expenditure
21
Q

What is a Lock-up?

A

Agreement between underwriters and existing shareholders not allowing the existing shareholder to sell any shares for a specified period of time.

22
Q

What is a Grandstanding?

A

Young VCs take their companies public earlier in order to build a track record.

23
Q

What are the two main types of trade sales?

A
  • Horizontal integration: sale to a competitor

- Vertical integration: sale to a supplier / customer

24
Q

What are the pros and cons of a trade sale?

A

+ higher exit proceeds
+ immediate and complete exit possible
+ easier, quicker and cheaper compared to IPO

  • high potential for conflicts
  • limited number of potential buyers
  • obligation to accepted non-cash or payment by installments
  • obligation to grant guaranties
25
Q

What are the pros and cons of a Secondary Purchase?

A

+ possibility to exit event if portfolio company is still immature
+ low potential of conflicts
+ simple and quick transaction
+ rarely problems to identify relevant potential buyers

  • low potential for high returns
  • reservation of potential buyers
  • small number of market participants

Startup Financing (9 decks)

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