Chapter 14

Entrepreneurial Finance, Smith and Kiholm Smith

Venture Capital
Historical Development of
Venture Capital as an Institution
Venture Capital New Commitments
$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
$40,000
$45,000
$50,000
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Year
Venture Capital New Commitments
Sources: Statistical Abstract of the U.S. (various issues), Venture Economics Investor Service, Sahlman (1990).
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
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Year
Sources of Venture Capital Funds
Foreign Investors
Individuals
Corporations
Endowments
Insurance Companies
Pension Funds
Sources: Statistical Abstract of the U.S. (various issues), Gompers and Lerner (1996, 1997).
Sources of Venture Capital Funds
Organizational Structure of
Venture Capital Investment
Portfolio
Companies
Value creation
Generate deal flow
Screen opportunities
Harvest investments
Negotiate deals
Monitor and advise

General Partners
Venture Capital Fund
Pension plan
Endowments
Life insurance companies
Corporations
Individuals
Limited Partners
Effort and
1% of
capital
Annual
Management
Fee 2-3%
Carried
Interest 20-
30% of Gain
99% of Investment
Capital
Capital Appreciation
70-80% of Gain
Investment
Capital and
Effort
Financial
Claims
Summary of Terms:
Venture Capital Limited Partnership Agreement
Venture.com VC Fund, L.P. (the Fund)
Terms and Provisions
Purpose
General Partner
Limited Partnership Interests
General Partners Investment
Minimum for Closing
Payment of Subscriptions
Term
Allocation of Profit and Loss
Distributions
Service Fee
Organizational Expenses
Conflicts of Interest
Other Restrictions and Limitations
Summary of Terms:
Venture Capital Limited Partnership
Agreement
0%
5%
10%
15%
20%
25%
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Activity
Allocation of Venture Capitalist Time
Source: Zider (1998)
Allocation of Venture Capitalist Time
The Venture Capital Investment
Process
Development of Fund Concept
Secure Commitments
from Investors
Generate Deal Flow

Closing of Fund
First Capital Call
Screen
Business
Plans
Evaluate and
Conduct Due
Diligence
Negotiate
Deals and
Staging
Additional
Capital
Calls
Invest
Funds

Distributing Proceeds
Cash
Public Shares
Other
Harvesting Investment
IPO
Acquisition
LBO
Liquidation
Value Creation and Monitoring


Board service
Performance evaluation and review
Recruitment management
Assist with external relationships
Help arrange additional financing

Year 0
2-3 years
4-5 years
2-3 years
or more
7-10 years plus extensions
Key Covenant Classes
of Venture Capital Limited Partnerships
Overall Fund Management
Investment in a single firm
Use of debt
Coinvestment by Venture Capitalists Other Funds
Reinvestment of profits
Activities of General Partner
Personal investing in portfolio companies
Sale of interest by General Partner
Fund-raising
Outside activities
Addition of General Partners
Types of investments
Restrictions on asset classes
Based on Gompers and Lerner (l997).
Key Covenant Classes of Venture
Capital Limited Partnerships