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com
 Economics of Investment
 Certain economic agents (individuals,
households and corporations) have excess
of income over their consumption (because
of their plan to defer consumption).
 Certain other agents need more money than
they have (temporarily).
 Intermediaries exist who bring together the
above two types for economic gains
(commissions, brokerage).

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 Angels
HNWI

Hedge Funds
Households

Banks Venture
Capital
Mutual Funds
Funds
Corporates
Pension
Funds
Insurance Cos

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 Angels Startups &
Private
Equity
VC Funds

Fixed Income

Hedge Funds
Securities
Banks
Mutual Funds Forex
Pension Funds
Insurance Cos Commodities

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Nature of these investors
Unconventional

Make highly risky investments

Deal with difficult Asset Pricing and Valuation

Are free of regulatory issues

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Target Companies
Startups
Early stage companies
Private companies in the scale-up phase
Pre IPO financing rounds

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Sources of Finance
Equity (common stock, preferred stock)
Loans: long term, short term
Lease finance
Inter corporate deposits
Bank cash credit and overdraft limits
Debentures
Fixed deposits
Grants from government agencies
Supplier credit and deferred payments
Credit cards

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Modes of Acquisition
Primary market:public issue, rights issue
(flotation costs)
Secondary market (listing costs)
Private placement (individual or institution)
Banks and mutual funds
Pension funds, insurance companies
Debenture issue
Fixed deposits

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How to compare various
sources ?
 Holding period (Duration)

 Repayment terms

 Interest rate

 Other strings attached

 Pledges and collaterals

 Finance marketing costs and lead

time

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Net Present Value (NPV) of an
Investment
 Horizon of interest: Typically 4 –5 years

 Expected future cash flows: Dividends, interests

 Residual value at the end of horizon: Market

price

 Risk-free rate of return: Government bonds

 Risk premium: Investor dependent

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Example: Angel Investment
 Three to five year horizon

 No dividend / interest

 IPO Price is the residual value

 Risk-free rate of return: 5 % (Bonds, Treasury bills)

 Risk premium: 20-40% (Early stage investment)

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 Discounting is the reverse of compounding

NPV = CF1 / (1.0 + r) + CF2 / (1.0 + r) 2 + CF3 / (1.0+r) 3

+ RV / (1.0 + r) 3
Where
r = Expected rate of return
CF i = Cash flow at the end of i th year
RV = Residual value of the asset

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Funds Requirements
Idea / Concept: USD 10K
Prototype: USD 50K
Product development: USD 0.5M – 2M
Organization building: USD 8M-10M
Scale up: USD 50M
IPO: Initial Public Offer

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Sources of Funds

Idea / Concept: Personal savings

Prototype: Loan from friends and
relatives
Incubation: Angel / Early stage fund
Organization building: VC, first round
Scale up: Second round / growth/ scale up
funds
IPO: Investment bankers, underwriters

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Cost of Equity
Angels would expect higher rate of returns
than VCs
Typical VC expectations is 40-50%
compounded annual return
Risk-return curve: New venture increasingly
reduces its risk as it goes through stages

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Angel Investors
High Net Worth Individuals
Successful serial entrepreneurs (also
parallel entrepreneurs)
Good knowledge of technology and
business acumen
Have country-specific preferences (NRI,
NRC)

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Examples…
James Clark (SGI to Netscape)
Prakash Bhalerao (Alopa Networks)
Kanwal Rekhi (Exodus Communications)
K.Chandrasekhar, B.V. Jagdeesh
Sabeer Bhatia (Hotmail Arzoo Navinmail)
Rakesh Mathur (Junglee to Purple Yogi)
Suhas Patil (Cirrus Logic)

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Made In India and Served from
India
N.S. Raghavan
Infosys
IIM Bangalore
Strand Genomics

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Made in USA and Served from India
Mahesh Murthy
 Passionfund
 TiE Angel Forum

Romesh Wadhwani
 Indian School of Business (ISB)
 Wadhwani Foundation

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Peculiarities of Angel
Investment
 Quick decision-making

 Low level of funds

 One-two days a week of commitment –

after all they are putting their own money
on the table!!

 Uncle-nephew relationship

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Venture Capital Firms
VCs look for private equity for young
companies
Mezzanine VC firms
Scale-up VC firms
Technology / “Space” specific
 Biotechnology
 Networking
 Chips and hardware
 E Commerce

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Structure of a VC Firm
 General partners 3-5 (themselves successful
entrepreneurs): put about 2-3% of the corpus
 Limited partners (Pension funds, Retirement
plans): Put 97% corpus
 Corpus = Fund, typically ranges between USD 50M
to 2B
 Management fee is about 2-3 % per year
 Funds about 5-30 new companies per year
 Employs junior managers for due
diligence(associates)
 After IPO/Acquisition, general partners keep 20% of
gains, limited partners get Principal+80%

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VC Firm’s Annual Throughput
10,000 qualified business plans

1000 meetings

400 company visits

25 new investments

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Role of the VC in the Portfolio
Company
Negotiate aggressive terms
Select strong co-investor
Help in constituting the Board of Directors
Assist in
 Recruitment
 Market validation
 Strategic relationships

Pursue liquidity aggressively

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Valuation: Bargaining Point
Causes of mismatch
 Asymmetry of information
 Ego
 Greed
Factors that drive the valuation
Technology, ESOP rates, management
Orders in hand, scalability, brand strength
Patents and copyrights

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Difficulties in Valuing Start-up
Companies
 Immediate earnings are negative

 No past history

 No comparable companies

 No market prices

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VC Fund Raising Process
Introduction (phone call, e-mail, referral)
Submit business plan / executive summary
Presentation
Company visit
Due diligence (management reference
checks, customer calls, market analysis)
More meeting(s)
Term sheet
Legal / Closing

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Innovations in Financing Terms
Third party collaterals
 SIDBI
 USA Small Business Administration

Flexible, milestone-based equity conversion

options and release of funds in tranches

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Some big names in India and
USA
Silicon Valley --Sand Hill Road Addresses
Kleiner Perkins
Sequoia Capital
Battery Ventures
India
Chrysalis Capital
Acer Technology Ventures
Westbridge Capital
Jump Startups

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Hedge Funds
Hottest and most talked about in the business
press

Started by ex-Wall Streeters

Quantum Fund : George Soros

LTCM: Long Term Capital Management (Myron

Scholes and Robert Merton, 1997 Economics
Nobel)

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Hedge Funds: Privileges and
Promises
Not scrutinized by SEC
Ask for long term commitment from
investors : 6 months to 2 years
Take simultaneous positions in securities,
commodities, Forex and Bond markets
Global (Transnational operations)
Promise absolute return irrespective of
market trends and movements

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Hedge Fund Strategies
Fixed Income Arbitrage
Equity market-neutral statistical arbitrage
Convertible Arbitrage
Merger Arbitrage
Distressed securities
Event-driven strategies
Macro investors
Sector-specific positioning

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 Who can invest?
Accredited investors
 Income of USD 200K/year
 Net worth of USD 1 Million exclusive of house,
automobiles and other consumer durables

Hedge fund typically limits to 99 investors and

has minimum investment of USD 100K – 500K

Fund of Funds

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Private Equity Investment
Large, profitable private limited or
deemed public companies who need
finance but don’t want to do an IPO

Examples: Patni Computers,

Persistent Systems Limited

Deal is usually in tens of crores

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 Some deals in the last 6 months
Company Investor Investment Approx
USD mill Valuation
Progeon Citigroup 20 100

Glenmark Pharma CDC Capital 10.3 74

TV Today ICICI Ventures, GE 1.5 25

Capital
Patni Computers General Atlantic 108 530
Partners, GE Capital
Strand Genomics Westbridge Capital 4.6 9.5
Partners
References
 Google!!

 Indian Venture Capitalist Association

 http://www.indiavca.org/

 Joseph G. Nicholas, “ Investing in Hedge

Funds”, Bloomberg Press, 2000

 http://www.hedgefund.net
 http://www.hedgefundmarketing.org/Ch
eat_Sheet.htm

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