Mahendra Ramsinghani - The Business of Venture Capital

1 Cover

2 Title Page THE BUSINESS OF VENTURE CAPITAL THE ART OF RAISING A FUND, STRUCTURING INVESTMENTS, PORTFOLIO MANAGEMENT, AND EXITS THIRD EDITION Mahendra Ramsinghani

3 Copyright

4 Dedication

5 Foreword

6 PrefaceWHY SHOULD YOU READ THIS BOOK? AND WHO AM I TO WRITE THIS BOOK? WHAT SHOULD YOU KNOW ABOUT THIS BUSINESS OF VENTURE CAPITAL? NOTES

7 Acknowledgments

8 Part One: The Making of a VC 1 The Business of Cash and CarryINTRODUCTION: AN OPERATIONAL PRIMER ROLES, RESPONSIBILITIES, AND COMPENSATION NOTE 2 Why Choose a Career in VC CREATIVE CONSTRUCTION INTELLECTUAL STIMULATION MENTOR CAPITALISTS ASYMMETRICAL REWARDS NOTES 3 Attributes of Successful VCs STRONG AWARENESS OF TECH TRENDS ABILITY TO PICK WINNERS OPTIMISM, PATIENCE, AND STABILITY ABILITY TO LEARN AND GROW AN INHERENT BIAS FOR ACTION 4 Welcome to the Land of Ad-Venture ROLES AND RESPONSIBILITIES OF A VC INTERNSHIPS AND CAMPUS RECRUITMENT THE FELLOWSHIP OF INVESTORS ADJACENT ENTRY POINTS GETTING LUCKY — WHEN OPPORTUNITY MEETS A PREPARED MIND NOTES 5 Developing Your Investment Career BUILDING YOUR STRENGTHS BEWARE: BIAS AND PSYCHOLOGY NOTES 6 A Business Where Enemies AccumulateCHALLENGES OF A VC CAREER VC CAREER AS A CALLING NOTES 7 Generational Transfer and Succession MANAGING SUCCESSION - NOW MY WORK IS DONE THE ART OF LETTING GO NOTE

9 Part Two: Raising Your Venture Fund 8 LP Universe PENSION FUNDS ENDOWMENTS AND FOUNDATIONS SOVEREIGN WEALTH FUNDS FINANCE AND INSURANCE COMPANIES FAMILY OFFICES AND HIGH-NET-WORTH INDIVIDUALS CORPORATE OPERATING FUNDS COMPARISON OF LIMITED PARTNERSHIPS NOTES 9 LPs of Choice: Fund of Funds ADVANTAGES OF A FUND OF FUNDS FUND OF FUNDS INVESTMENT STRATEGIES 10 How LPs Conduct Fund Due Diligence PRIMARY AND SECONDARY INVESTMENT CRITERIA FUND SELECTION CRITERIA NOTES 11 Defining Your Fund's Investment Strategy MARKET OPPORTUNITY COMPETITIVE ADVANTAGES CASE STUDY: SOLO GP GOES INSTITUTIONAL CASE STUDY: OVERSUBSCRIBED FIRST FUND — HOW A $30M FUND ENDED UP WITH OVER $100M IN COMMITMENTS CASE STUDY: STARTING ALL OVER… CASE STUDY: WHO HAS TIME FOR THIS? I DON'T NEED NO LPS ANYMORE… NOTES 12 Investment Team Diligence EVALUATING FUND MANAGERS TEAM DYNAMICS: STABILITY, SKILL SET, AND ALIGNMENT NOTES 13 Fund Size and Portfolio Construction NOTES 14 Performance Analysis INDIVIDUAL PERFORMANCE AND ATTRIBUTION PUBLIC MARKET EQUIVALENTS FUND-LEVEL PERFORMANCE MEASURING REALIZED RETURNS SELF-SELECTION BIAS: GIANTS AMONG MIDGETS NOTES 15 Terms of Fund Investment KEY TERMS FUND FINANCIAL TERMS FUND GOVERNANCE TERMS WHAT INSTITUTIONAL LPs SEEK OFFERING SWEETENERS TO ATTRACT LPs: A DOUBLE-EDGED SWORD MOST NEGOTIATED LP–GP TERMS WHY LPs TERMINATE EXISTING RELATIONSHIPS NOTES 16 The Venture Firm's Ethos, Culture, and Values ETHOS CULTURE AND VALUES GOVERNANCE OF THE FIRM NOTES 17 Raising Your First Fund FIRST STEPS TARGETING LPs MARKET TIMING FIT WITHIN THE LP's CURRENT PORTFOLIO NOTES 18 The Fundraising Roadshow OVERVIEW: THE FUNDRAISING PROCESS GETTING IN THE LP DOOR LOCKING YOUR ANCHOR INVESTOR SELL, SELL, SELL SHOULD YOU WAREHOUSE PORTFOLIO COMPANIES? YOUR BIGGEST FUNDRAISING RISKS, AND HOW TO MANAGE THEM NOTES 19 Why LPs Seek First-Time Funds CREATIVITY, HUNGER, AND PERFORMANCE RANKING EMERGING MANAGERS A FUTURES OPTION NOTES 20 Sourcing Investment OpportunitiesOVERVIEW: THE SOURCING PROCESS PROACTIVE SOURCING NETWORK-BASED SOURCING ACCELERATORS ANGEL NETWORKS COMMERCIALIZING UNIVERSITY RESEARCH CORPORATE RESEARCH TRADE CONFERENCES INVESTOR PITCH SESSIONS THE AGONY OF MISSED OPPORTUNITIES NOTES

10 Part Three: Building Your Portfolio 21 Due Diligence Cheat Sheet NOTE 22 Diligence THE CHECKLIST MANIFESTO TAILORING DILIGENCE BY STAGE CHECKLISTS — USEFUL BUT SELDOM USED NOTES 23 Management Team Diligence: Assessing the IntangibleOVERVIEW VALUES AND INTEGRITY CAN THE COMPANY ATTRACT GIANTS? CAN THE CEO EXECUTE? LAMBS VERSUS CHEETAHS SERIAL ENTREPRENEURS VERSUS FIRST-TIME ENTREPRENEURS BIAS AT WORK: SEEKING ATTRACTIVE MEN BACKGROUND CHECKS: FALSE MBAS AND CRIMINAL HISTORIES VARIOUS APPROACHES TO MANAGEMENT DILIGENCE NOTES 24 Market, Product, and Business Model Analysis EVALUATING THE PRODUCT ASSESSING THE BUSINESS MODEL NOTES 25 Terms and Conditions Apply THE SPIRIT OF THE TERM SHEET NEGOTIATION STRESS POINTS 26 Structure of the Term SheetOVERVIEW CONVERTIBLE LOANS AND SAFE KEEPING TERM SHEETS SIMPLE SAMPLE SUMMARY TERM SHEET NOTES 27 Buy Low, Sell High VALUATION METHODS AND OTHER VOODOO ARTS THE DRIVERS OF VALUATION COMPARABLE VALUATIONS OF SIMILAR INVESTMENTS (COMPS) DISCOUNTED CASH FLOW METHOD LIQUIDATION PREFERENCE ANTIDILUTION PROTECTIONS GOVERNANCE AND CONTROL: PROTECTING YOUR SECURITIES EXIT-RELATED PROVISIONS OTHER IMPORTANT TERMS SYNDICATING INVESTMENTS MILESTONE-BASED FINANCING: RISK MITIGATION OR DISTRACTION NOTES 28 The Closing Process

11 Part Four: The Art of Value Creation 29 Serving on Boards OVERVIEW LEGAL REQUIREMENTS OF BOARD SERVICE SELF-EDUCATION: PREPARING FOR YOUR BOARD ROLE ROLES AND RESPONSIBILITIES OF A BOARD MEMBER NOTES 30 Board Culture and Orientation TOWARD A BETTER BOARD CULTURE ON-BOARDING CHECKLIST NOTES 31 Let Me Know How I Can Be Helpful: Value Creation GOOD GOVERNANCE AS THE FIRST STEP TOWARD VALUE CREATION THE CEO'S PERSPECTIVE ON VENTURE CAPITALIST VALUE ADD NOTES 32 Challenges in the Boardroom CEO TRANSITIONS BEST PRACTICES IN MANAGING CEO TRANSITIONS PERFORMANCE CHALLENGES ALIGNMENT ON EXIT BOARD EVALUATION NOTES

12 Part Five: Exits: Liquidity Events and Champagne 33 Exit Strategies EXIT OPTIONS PRECONDITIONS FOR AN EXIT NOTES 34 AcquisitionsTHE PRIMARY PATH TO AN EXIT PUTTING THE COMPANY UP FOR SALE DEAL KILLERS NOTES 35 Initial Public Offering THE IPO PROCESS: THE LONG AND WINDING ROAD STEPS TO AN IPO IPO UNDERPRICING AND DUTCH AUCTIONS POST IPO: SHOULD VCs STAY ENGAGED? NOTES 36 Secondary Sales NOTES

13 Index

14 End User License Agreement

1 Chapter 1 Exhibit 1.4 The Advantages of Shorter Holding Periods. Exhibit 1.5 Fund Portfolio Returns.

2 Chapter 4 Exhibit 4.1 Entry Points in Venture Capital.

3 Chapter 8 Exhibit 8.3 Alternative Investments. Exhibit 8.4 Yale Endowment's Asset Allocation. Exhibit 8.5 Sovereign Wealth Funds — A Growing Opportunity for Venture.Exhibit 8.8 Comparing the LP Universe.

4 Chapter 9Exhibit 9.2 Fund of Funds Strategies: A Comparison.

5 Chapter 10Exhibit 10.2 Fund Selection Criteria.

6 Chapter 11Exhibit 11.1 Drucker's Seven Sources for Innovative Opportunity.Exhibit 11.2 Variations on a Theme: How Strategy Differs in Venture Firms.Exhibit 11.5 Switch Ventures.Exhibit 11.6 Growth of Base 10 Ventures.

7 Chapter 12Exhibit 12.2 Sample Format: Assessing Alignment of Interest.Exhibit 12.3 Complementary Skills in a Venture Firm.

8 Chapter 13Exhibit 13.1 Factors Determining Fund Size.Exhibit 13.2 Portfolio Assumptions.Exhibit 13.3 Ownership Assumptions.Exhibit 13.4 Portfolio Construction.Exhibit 13.5 Exit Values.Exhibit 13.6 Exit Range Assumptions and Distribution Waterfall.Exhibit 13.7 Fund Size and Gains.

9 Chapter 14Exhibit 14.1 Sample Format: Individual Performance.Exhibit 14.2 Do VC Funds Outperform Public Markets?Exhibit 14.3 Sample Fund Performance: Stand-Alone Format.Exhibit 14.4 Sample Fund Performance: Benchmarked Format.Exhibit 14.5 Performance Analysis: Slicing the Data a Hundred Different Ways. ...Exhibit 14.6 Sample Fund Performance: Benchmarked Format.Exhibit 14.7 Measuring What Matters.Exhibit 14.8 The Best versus the Worst: IRR Performance Variance i...Exhibit 14.9 IRR Performance Variance in Venture Funds.

10 Chapter 15Exhibit 15.1 Key Fund Terms.Exhibit 15.2 Most Negotiated Terms in a Fund.Exhibit 15.3 Financial and Governance Terms.Exhibit 15.4 Fund Management Fee Vesting Scenarios.Exhibit 15.5 Presenting Waterfall to Investors.Exhibit 15.6 Industry Best Practices: GP–LP Terms Summary.Exhibit 15.7 Most Negotiated Terms in Order of Priority: LPs and GPs Views.