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Venture Capital Business, The Conception ........................................................................... 2 Venture Capital Business From Time to Time ....................................................................... 3 Venture Capital Business and its Differences ....................................................................... 4 Venture Capital Business, The Mechanism ........................................................................... 4 Venture Capital Business, Profile and Logic of The Deal ..................................................... 6 Reference ................................................................................................................................. 7
Venture Capital Business
The fact that venture capital does not need a collateral for the funds invested. then venture capital business is one of the sources of funds for small investor that does not have access to formal financial services because lack of collateral (hard asset) and credit worthiness. Without these strategy available in hands. they could offer sources of fund without those limitations. Venture Capital Business Page 2 . this is where the high return on investment is rationalized within the venture capital firm. The very basic nature of Start-up Company is that they do not have a large number of collateral and they lack of credit worthiness. but this myth is busted in Bob Zider paper.Daymas Ryan Dipo Daymas Ryan Dipo 19009141 Mid-Term Exam Venture Capital Business 13 May 2012 Venture Capital Business. Venture capital is different from banks in terms that they are willing to take more risk. “How Venture Capital Works” stated that historically. this is how they are going to realize the profit gained from growing such start-up. There’s several myth that states venture capital invest in good ideas and good people. In addition. in exchange for high return on investment. and thus. venture capital business is a financial service company that invests its money in high risk start-up businesses with no collateral. bank needs to charge higher interest rate that of course is impossible because of government regulations. With this definition in mind. Exit strategy is usually done via initial public offering (IPO) and management buyout/leveraged buyout. The nature of venture capital that needs high return on investment makes them selective in choosing their start up. a certain thing that formal banks could not do because of government imposed regulation that regulates on how much the maximum interest rate they should charge to a loan. venture capital invest in good industries. The Conception Viewed from its very basic function. the most important thing that venture capital firm in selecting a start-up is an exit strategy. The reason is that growing a business within high-growth industries is much easier than in low-growth one. when this nature is met with bank criterion. makes this business fills the gap between formal financial firms (bank) with micro finance. This is where the venture capital steps in. venture capital would not be able to reap the capital gain.
The demand for internet company was very high at that time. infrastructure. a good industry to begin with. so that it could be easier to manage or crate growth. Following the story. The outcome is quite miserable. Venture Capital Business Page 3 . entrepreneurs. United Kingdom and Israel started to become the center of venture capitalist in 1990s. The problem was. Ebay. This failure lead to the birth of new financial entity called private equity. there are Amazon. General Georges Doriot. in the early 2000s tha internet boom finally go bust. in the 1970s there were many new venture capital businesses around the world trying to do the same thing as ARDC does. Google. Despite of this scenario. This success created a new incentives for other investors to invest their money on venture capital business. creating more incentives to investor to invest their money. that is. as well as stock and some start ups. wiping down the start up company as well as venture capitalist. but operates focusedly on buyouts and bridge financing. that is when its $70. many of those company failed because the lack of expertise. Facebook.Daymas Ryan Dipo Venture Capital Business From Time to Time Venture capital can be traced back from its origin. some venture capitalist still proved its impressive return on investment. As the boom and bust cycle needed for venture capital to work emerges. in this case internet boom. Following ARDC success. several venture capital success story has flourished over the news. in the history of private equity that started in 1930s. All of them were an internet start up at their time. they did not have the correct funding mechanism that could contain all the risk that existed. The latter (Facebook) is now opt for IPO that revise its valuation to more than $100 Billion. However.000 investment in equity of Digital Equipment Corporation. In the past year. making this sector to become more attractive to investors. ARDC opened up many investors eyes with its success story. not all off the countries that imitated US Venture capital were failed. At that time. and etc. The first seed money invested happen in the World War II as some wealthy family invested their money in young company and hired professional to evaluate them. become $350 million within 14 years time periods. and the most important. The road for venture capital seems brighter when ARDC (American Research and Development Corporations”. a company established by Harvard Business School faculty member. a firm that share basic nature of venture capital.Nowadays venture capitalist always see an opportunity. there was a problem in financing in United States and United Kingdom as they wanted to provide funding for small caps company.
the maximum interest rate that they could charge is limited. if converted into bank’s interest. and is used to finance the research and development before the commercial operation. To put it into another perspective. risk free rate plus risk premium of the business covering all the risk. protection for their own money. At this stage. The deal in the money invested on start-up is usually to divide the money given into several stages which is: Seed. This nature. with a tight government regulation on bank. Early stage. would sum up to 58% annual compound interest. that is. venture capital usually expect ten times return on capital for five years in return of one to two years of financing. However. that is.35% per year over the investment horizon. this stage implies that the start-up is able to begin operation. The Mechanism Venture capital get its money from investors. Seed stage venture capitalist usually will participate in later stage as its expansion. the capital provided at this stage is often modest. Each of these entities put small amount of their portfolio into high risk investment that expected to generates a return of 25% . but is offset by the advantages it will create such as attract talented people. and university endowment. but rationalized by venture capitalist perspective of very high risk profile. this stage is the first stage of venture capital financing. according to Bob Zider. in terms that venture capital offer source of funding without the need of collateral. but not yet in the stage of commercial operation. Bank and other financial institution needs collateral when lending their money. In start ups perspective. either private or institutional. venture capital is different from another formal financial institutions. when this requisition is not met.Daymas Ryan Dipo Venture Capital Business and its Differences Unlike bank. this source of fund is extremely expensive. costs usually increase with a vast amount of growth. Formative stage is where venture capitalist includes in their financing the seed and early stage money Venture Capital Business Page 4 . financial firms. Institutional investor often comes from pension funds. bank would opt to charge higher interest rate. A very expensive source of financing. insurance companies. is offset by high return on investment needed by venture capital. and the pay structure on venture capital that has no such caps. Venture Capital Business. and thus could not offset all the risk that emerges from a new start up company. however.
venture capitalist usually uses several method to value them. Venture Capital Business Page 5 .e.Daymas Ryan Dipo Later stage includes third stage. There is several formula used in relative valuation. expansion stage. CF is the expected cash flow generated at year n n is the time in years before the future cash flow occurs. In DCF. or FV adjusted for the delay in receipt. i. the interest rate expressed as a deduction at the beginning of the year instead of an addition at the end of the year. In this stage. The other tools to measure the value of a start-up is to use relative cash flow. In this method venture capitalist compare the start-up with another start-up that has been operating to set a benchmark. then venture capitalist could not calculate the price/earnings and EPS growth. venture capitalist discount future cash flow generation by some amount of rates. which reflects the cost of tying up capital and may also allow for the risk that the payment may not be received in full. which usually is their cost of capital or expected return. Most used is Discounted Cash Flow Valuation (DCF) and Relative Valuation. if the company has not been operating. one of them is PEG ratio (Price to earnings growth ratio) which is: Where: Price/Earning is market Price divided by earning per share Annual EPS growth is year to year growth of the earning While PEG ratio is quite easy to use. i is the interest rate. In assessing the valuation of a start-up. venture capitalist could value the start up with the following formula: Where: DPV is the discounted present value of the future cash flow (FV). d is the discount rate. that is to provide capital needed for going public The idea here is that capital is given to several stages to protect the investors against the vulnerability to risks. capital is provided after commercial manufacturing and sales but before IPO. which is. This stage could be the bridge that finance a start-up to fill the IPO. which is i/(1+i). With DCF valuation. there are some limitations. and mezzanine stage.
at 1980s they invest at energy industry and then moved to genetic engineering. that is. Profile and Logic of The Deal From the statistic point of view. because it gives them the flexibility to go through exit opportunities. and software companies.Daymas Ryan Dipo Venture Capital Business. with this way. telecommunications. these venture capitalist creates boom and bust cycle along its way. venture capital businesses usually invest in a good industries. Investing in a high growth start-up company is favorable for venture capitalist. Venture Capital Business Page 6 . Downside protection is the contract that gives provision to venture capitalist to get the first claim of the start-up in case of bankruptcy. This is because bankers usually keep looking for a high growth issues because of their nature that is easy to sell (IPO) The deal used for these venture capitalists is consisted of downside protection and favorable upside contract if the start-up is winner. While continuously searching for good industries. venture capitalist could reduce the risk. take internet boom for example. so in the event of liquidation. industries that have high growth and competitive advantage compared to another industries. specialty retailing. according to Bob Zider. The trend for venture capital is. multimedia. a venture capitalist could add up its portion of investment in a start-up company with lower price than market price. Upside provisions could be done if the start-up is proved to be a success. computer hardware to CD-ROMs.
CFA Publication. Brown and Company. Pearson Education Limited. Josph W. Peter. Private Equity. Little. 1999 Crisp. Bartlett. 2000. Venture Capital Business Page 7 . Bruno. Kenney. Levin. Winning Angels. and Entrepreneurial Transactions. Madison Books. Bob. Structuring Venture Capital. “Note on Venture Capital.Daymas Ryan Dipo Reference Solnik. 2011.” Harvard Business Review November 1998: 9. Global Investments Sixth Edition. Martin.” International Encyclopedia of the Social and Behavioral Science” 2000: 10. “How Venture Capital Works. Fundamentals of Venture Capital. Jack S. 2001 Zider.