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1、1Lecture 2:Venture Capital and Private Equity2Structure of Lecture1. Defining PE.2. Why PE investing?3. PE and VC Funds Types.Operations.Alignment of interests.The VC cycle and process.3Turning into4Defining P/E and V/CPrivate Equity:Investments in private and public companies consisting of equity t
2、hat is not quoted on any public / official stock exchange. Venture Capital:Investments that are made to finance new businesses, early developments or expansion.5PE in the Investment HierarchyAlternative InvestmentsTraditional InvestmentsCashBondsListed equities6PE vs. Public Equity Investments Priva
3、tePublicLiquidityLowHighInvestment horizonsLongShort to mediumActive involvementOftenRarelyMarket efficiencyLowHighResults publishedNoYesRegulatory oversightLowHigh7Size of investment universe. # of Listed Companies# of Unlisted CompaniesCompanies listed on JSE: 500.SA Businesses of all sizes: many
4、10,000s? By #, not % of economy.8Drivers of Investment in PEPE higher risk, higher return.Portfolio investing risk reduction per individual investment.Reduces required rate of return for investing in risky assets.Flow of funds to private equity growth of international and small cap PE markets (US an
5、d Europe).9Getting in at the bottomCompanies with greatest growth potential often not listed (not corporates).TimeProfitsTrack RecordS-CurveIPO / listing10SA Private Equity in ContextUKSAUSASource: 2004 KPMG / SAVCA PE Survey (2002 data) 11Reasons for Investing in PE1. Diversification.2. Higher retu
6、rns possible.3. Active investment - unlocking of value.4. Inefficient market and undervaluation.5. Other: Economic growth, ”empowerment” etc.12Investing in a PE Fund1.Long time horizons.2.Risk-return profile and risk tolerance.3.Correlations between funds and listed equities.4.Intra-Fund correlation
7、s.5.Choosing high quality funds (with good underlying investments, monitoring systems and structures).6.Track records.7.Diversification across funds.13US Venture Capital Partnership ReturnsVersus Public Market ReturnsFunds Formed 1969-2001 (quarterly returns)Database Source: VentureXpert database fr
8、om Thomson Venture EconomicsInvestment Data Source: The MoneyTree Survey by PricewaterhouseCoopers/Thomson Venture Economics/NVCAOverall Source: Thomson Venture Economics14Correlations: PE Fund Sectors15Constraints to Institutional Investment in Private Equity1. Regulatory restrictions.2. Low liquid
9、ity.3. Lack of regulation of unlisted entities.4. Lack of historical data.5. Risk / return trade-off.6. Valuation difficulties. 16 Types of PE Financing1. Seed Financing2. Startup Financing3. First Stage Financing.4. Second Stage Financing.5. Mezzanine Financing.6. Buyout FinancingV/CDevelop-ment17P
10、rivate Equity Funds1.Types1.Role Players1.Fees and Split of Returns.2.Duration.18Types of Private Equity Funds1. Independent Funds.Listed, e.g., Brait, , Venfin, Cycad.Unlisted: e.g., Ethos (RMB), HBD.2. Captive Funds.E.g., Investec, Nedbank Corp. PE.3. Government Captive Funds E.g., Khula, IDC, Ums
11、ombomvu etc.19Makalani20SA Venture Capital IndustrySAVCA/KPMG Private Equity and Venture Capital Survey 200321 General PartnersThe “fund managers” investment decisions and active involvement.Marketing to both entrepreneurs / business owners and potential investors (“limited partners”).Objective: Inc
12、rease personal wealth by managing other peoples money in active direct investments. 22 Limited PartnersThe passive investors.In US mostly pension funds and some HNWI, in SA mostly corporate (captives).Objectives: Exposure to alternative asset class.Maximise returns.Minimise risk.23 Entrepreneur or I
13、nventorOwner/s or shareholders of the unlisted business, or generator of the business idea.Objectives: Obtain financing for business / idea.Minimise finance cost (equity sacrifice).24Risk Reward Structure2000, Entrepreneurial Finance, Smith and Kiholm SmithChapter 14Organizational Structure of Ventu
14、re Capital InvestmentPortfolio CompaniesValue creation Generate deal flow Screen opportunities Harvest investments Negotiate deals Monitor and adviseGeneral PartnersVenture Capital Fund Pension plan Endowments Life insurance companies Corporations IndividualsLimited PartnersEffort and 1% of capitalA
15、nnual Management Fee 2-3%Carried Interest 20-30% of Gain99% of Investment CapitalCapital Appreciation 70-80% of GainInvestment Capital and EffortFinancial Claims25Investments, Returns and RewardsTimeInitial CommitmentDrawdown1234Investment132Cumulative Limited Partners InvestmentRealisationTime = 0L
16、imited PartnersGeneral Partners426The VC J-CurveTimeReturns (IRR)Reasons:1. Fees (2.5%) regardless of performance.2. Good managers terminate bad investments early.3. “Dogs die before winners run.”27Fund DurationTypically around 10 years.Investors capital in theory locked up for that period.Can have
17、an extended contingency “cash-out” period.Fund startsPublic Equity Market10 Year Fund LifeFund EndsContingency Extension28A typical P/E investor? 29Conflicts of InterestManagement vs. Investment Partners.General Partnersvs. Limited Partners.30Owners/Managers vs. InvestorsInformation Asymmetry owners
18、 / managers oversell positives and downplays negatives.Build this into valuation process.Incentive issues once investment made, management make selfish operating decisions (risk for possible short-term gain).31Solutions: Performance IncentivesManagement Stock Ownership required (tie-in).Equity type
19、PE investor holds preferred stock and management ordinary stock (higher ranking).Employment contract penalties for poor performance.32Solutions: Direct Control MechanismsBoard membership general partners.Controlling or largest outside shareholding.Contingent financing (depending on performance).Othe
20、r mechanisms: on-going supervision, inspection and approval.33Positive CovenantsContractual agreement - things the company must do, such as:Maintain insurance.Audited financial statements.Maintain certain ratios (working capital).34Negative CovenantsContractual agreement - things the company may not
21、 do, such as:Limitation on dividends.Not pledge assets to other lenders.Cannot be acquired.Cannot dispose of significant assets without prior approval.Cannot issue additional debt or senior debt.35GP vs LP: Overall Fund Management1. Limit to size of investment in specific firm.Why? GPs may attempt t
22、o salvage poorly performing investment with more resources or take risky big bets.Disproportionate gain from increasing risk at expense of diversification.36GP vs LP: Overall Fund Management2. Limits to use of debt.Why? GPs may attempt to increase variance of portfolio returns through debt (excessiv
23、e gearing).Also limits to guarantee of debt of investment companies (indirect borrowing).Restrictions to term of debt (short-term only).37GP vs LP: Overall Fund Management3. Co-investments with other / earlier PE funds.GPs may try to salvage investments in earlier funds using current fund. 4. Profit
24、 Reinvestments.Fees may be based on assets under management incentive for GPs not to pay out.But further reinvestment may benefit both parties approval needed.38GP vs LP: Activities of Investors1. Limit to GPs personal investments per portfolio firm.GPs may devote excessive effort to their investmen
25、ts. 2. Limits to sale of partnership interests by GPs in specific firms.Reverse of above: reduces GP incentive to montiro and manage specific investment.39GP vs LP: Activities of Investors3. Restrictions to future fund raising.Increases fees to GPs, but neglecting LPs investments. Often: certain % of current funds invested before new capital may be raised. 4. Minimum time spent on investments.5. Limits to adding less experienced new GPs.6. Forfeit of share of profits when GP leaves.