Angel Investors, VCS, Hedge Funds and Private Equity Investors

Angel Investors, VCs, Hedge Funds and Private Equity Investors
Professor Rajendra K. Lagu Department of Electrical Engineering
e-mail: rklagu@ee.iitb.ac.in Webpage: http://www.ee.iitb.ac.in/~rklagu
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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HNWI
Angels
Households
Hedge Funds
Banks
Mutual Funds Corporates Pension Funds Insurance Cos
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Venture Capital Funds
Angels
VC Funds
Startups & Private Equity

Fixed Income
Hedge Funds Securities Banks Mutual Funds Pension Funds Insurance Cos
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Forex
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
How to compare various sources ?

Holding period (Duration) Repayment terms Interest rate Other strings attached Pledges and collaterals Finance marketing costs and lead time
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
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)
NPV of an Asset (Stock, Bond) Discounted Cash Flow Analysis

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
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) Hunt in packs
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
Venture Capital Firms

VCs look for private equity for young companies Mezzanine VC firms Scale-up VC firms Technology / Space specific

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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%
VC Firms 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

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
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
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)
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
Hedge Fund Strategies

Fixed Income Arbitrage Equity market-neutral statistical arbitrage Convertible Arbitrage Merger Arbitrage Distressed securities Event-driven strategies Macro investors: EIC Analysis 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
Private Equity Investment

Large, profitable private limited or deemed public companies who need finance but dont 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 USD mill Approx Valuation
Progeon
Glenmark Pharma TV Today
Citigroup
CDC Capital
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10.3 1.5 108 4.6
100
74 25 530 9.5
ICICI Ventures, GE Capital Patni Computers General Atlantic Partners, GE Capital Strand Genomics Westbridge Capital Partners
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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/Cheat_Sheet.htm

Angel Investors, VCS, Hedge Funds and Private Equity Investors

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Angel Investors, VCs, Hedge Funds and Private Equity Investors

Professor Rajendra K. Lagu Department of Electrical Engineering

e-mail: rklagu@ee.iitb.ac.in Webpage: http://www.ee.iitb.ac.in/~rklagu

Venture Capital Funds

Startups & Private Equity

Nature of these investors

Are free of regulatory issues

How to compare various sources ?

Net Present Value (NPV) of an Investment

Residual value at the end of horizon: Market price

Example: Angel Investment

NPV of an Asset (Stock, Bond) Discounted Cash Flow Analysis

CF i = Cash flow at the end of i th year

Made In India and Served from India

Made in USA and Served from India

Peculiarities of Angel Investment

Venture Capital Firms

Biotechnology Networking Chips and hardware E Commerce

VC Firms Annual Throughput

Role of the VC in the Portfolio Company

Pursue liquidity aggressively

Valuation: Bargaining Point

Difficulties in Valuing Start-up Companies

VC Fund Raising Process

Innovations in Financing Terms

Flexible, milestone-based equity conversion options and release of funds in tranches

Some big names in India and USA

Hedge Funds: Privileges and Promises

Hedge Fund Strategies

Who can invest?

Private Equity Investment

Some deals in the last 6 months

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