Raising Venture Capital

by Pearce, Rupert; Barnes, Simon

• ISBN13: 9780470027578
• ISBN10: 0470027576
• Edition: 1st
• Format: Hardcover
• Copyright: 2006-05-16
• Publisher: WILEY

Summary

Offering a deep insight into the venture capital deal-making process, Raising Venture Capital also provides valuable introduction to the subject. The book is practical in focus but based on sound academic theory, research and teaching materials gathered over the last 4 years at Tanaka Business School.Part one covers the history of the venture capital industry, shows why entrepreneurs need venture capital finance, and looks at how venture capitals raise and structure their funds. It also covers valuation methods for venture capital investments, and portfolio management.Part two illustrates how successful entrepreneurs raise finance from venture capitals, and gives details on how to approach venture capitals, how to choose the right venture capital firm, and how venture capitals and entrepreneurs work together after the deal is done.Part three gives a blow-by-blow account of the structure of a venture capital deal.

Author Biography

RUPERT PEARCE joined Inmarsat in 2005 as Group General Counsel. Inmarsat is the world’s leading mobile satellite communications provider and recently underwent a $1,500 million leveraged buy-out by Apax and Permira and subsequent $3,000 million IPO on the London Stock Exchange. Inmarsat is now well-established in the FTSE 250. Prior to joining Inmarsat, Rupert was a General Partner at Atlas Venture, the leading transatlantic venture firm, responsible for corporate finance, mergers & acquisitions and special situations. He also served as Atlas Venture’s European COO. Prior to Atlas Venture, Rupert was a partner at the international law firm Linklaters, specializing in corporate finance, mergers & acquisitions, technology and private equity. Rupert has therefore experienced private equity and venture capital transactions from the perspectives of investor, adviser and member of management. As a founder of Out-Take Limited, an on-line publisher, he has also dabbled in entrepreneurship.
Rupert holds a First Class MA in Modern History from Oxford University and won the 1995 Fullbright Fellowship in US Securities Laws, studying at Georgetown Law Centre, Washington DC.

SIMON BARNES is Director of the Entrepreneurship Centre, and Deputy Director of the Full Time MBA programme at the Tanaka Business School, Imperial College London. He teaches electives in new venture creation and venture capital finance on the MBA, MSc Finance and MSc Health Management as well as courses for the faculty of Imperial College’s science and technology departments. His research at Imperial focuses on technology entrepreneurship and venture capital, with an emphasis on the development of university spin outs and technology ventures. Simon has six years of hands on experience in the venture capital industry, first with the transatlantic firm Atlas Venture and most recently with GIMV Venture Capital where he invested in early stage biotechnology companies. He has been a board director of several VC backed ventures, and lived through two M&A transactions at board level.
Simon received a first class honours degree and a PhD from The University of Cambridge. He holds an MBA with Distinction from the Tanaka Business School, Imperial College London, and was the winner of the European MBA Business Plan of the Year Competition in 1998.

Table of Contents

Preface	xiii
Part I The Business of Venture Capital	1	(48)
Entrepreneurs and Venture Capitalists	3	(6)
Introduction	3	(1)
Entrepreneurs and business creation	3	(1)
Why entrepreneurs need external capital	4	(2)
Venture capitalists	6	(1)
How to read this book	7	(2)
Other People's Money	9	(6)
Introduction	9	(1)
The fund-raising cycle	10	(1)
Relationship with LPs	11	(1)
Identity of the LPs	11	(2)
Conclusions	13	(2)
The Limited Partnership	15	(10)
Introduction	15	(1)
The primacy of a limited partnership	15	(2)
Facets of a limited partnership	17	(2)
Partnership terms	19	(3)
Life	19	(1)
Capital commitments	20	(1)
GP management	20	(1)
Profit share	21	(1)
Investment restrictions	21	(1)
Transaction costs and fees	21	(1)
Further funds	22	(1)
Transfer of LP interests	22	(1)
Conclusion: The venture capital business in a nutshell	22	(3)
The Competitive Environment	25	(6)
Introduction	25	(1)
Capital competition	25	(3)
Vintage years	25	(1)
Sector and geography	26	(1)
IRRs and cash-on-cash metrics	27	(1)
Deal competition	28	(1)
Conclusions	28	(3)
The VC's Investment Model	31	(18)
Introduction	31	(1)
Fundamentals of VC risk	31	(2)
Extreme caution over the act of investment	33	(5)
Focus on proprietary deal flow	33	(1)
Early exclusivity	34	(1)
Due diligence	34	(1)
Drip-feed approach to investment	35	(1)
Syndication	35	(1)
Internal investment process	36	(2)
Exit obsession	38	(1)
High reward for high risk	39	(1)
Downside risk management	40	(5)
Tranching of investments	41	(1)
Price protection	41	(2)
Follow-on capability	43	(1)
Information and veto rights	44	(1)
Special exit rights	45	(1)
Dynamic capital allocation	45	(1)
The human element	46	(2)
Conclusions	48	(1)
Part II Accessing Venture Capital	49	(50)
Introduction to Part II	51	(2)
Is Venture Capital the Right Option?	53	(6)
Introduction	53	(1)
What do I want my business to become?	53	(1)
Can my business match those ambitions?	54	(1)
How much capital does my business require?	54	(1)
Do I want to control my business for a long time?	55	(1)
What kind of life do I want to lead?	56	(1)
Am I comfortable with an exit?	56	(3)
Choosing a VC Firm	59	(6)
Introduction	59	(1)
Substantial long-term resources	59	(2)
Long and relevant experience	61	(1)
A leader, not a follower	62	(1)
Scaling the business	62	(1)
Powerful proprietary networks	62	(1)
Portfolio community	62	(1)
International capability	63	(1)
Additional skills leverage	63	(1)
Successful reputation	63	(1)
Personal chemistry	63	(2)
The Entry Point	65	(6)
Introduction	65	(1)
Which qualified access route?	65	(2)
A personal contact	66	(1)
A portfolio company contact	66	(1)
Industry gurus	66	(1)
Professional advisors	66	(1)
Professional intermediaries	66	(1)
Cold calling	67	(1)
Generating a qualified access point	67	(2)
Portfolio company access	67	(1)
The great and the good	68	(1)
Personal contacts	68	(1)
Communicating the initial message	69	(1)
What is the VC firm looking for?	69	(1)
Conclusion	70	(1)
The Investment Process	71	(10)
Introduction	71	(1)
Phase one -- initial engagement with the VC firm	72	(2)
The kick-off meeting	72	(1)
The initial presentation	73	(1)
Phase two -- preliminary due diligence to term sheet	74	(2)
Preliminary due diligence	74	(1)
Term sheet negotiations	75	(1)
Phase three - from term sheet to completed investment	76	(4)
Final due diligence	76	(1)
Legal documentation	77	(2)
Syndication	79	(1)
Special situations	79	(1)
Internal approvals	80	(1)
Afterwards	80	(1)
Preparing for the Investment Process	81	(18)
Introduction	81	(1)
Timing	82	(1)
Timing the approach	82	(1)
Raising enough funds	82	(1)
Valuation	82	(6)
Introduction to valuation	82	(2)
Valuation bases -- the entrepreneur's perspective	84	(1)
Valuation bases -- the VC's perspective	85	(1)
Why value is important	86	(1)
Conclusions for an entrepreneur	87	(1)
Choosing an investor	88	(1)
Grooming the business	88	(4)
Revisiting timing and value assumptions	89	(1)
Ensuring management stability	90	(1)
Spring cleaning	91	(1)
Transaction structure	92	(3)
Transaction logistics	95	(3)
Confidentiality	95	(1)
Non-solicitation	96	(1)
Preparing for site visits	97	(1)
Poison pills	97	(1)
Conclusion	98	(1)
Part III The VC Term Sheet	99	(130)
Introduction to Term Sheets	101	(20)
Purpose	101	(1)
What is a term sheet?	101	(1)
Why have term sheets at all?	102	(2)
Risk management	102	(1)
VC policy	103	(1)
Deal syndication	103	(1)
What happens to a term sheet?	104	(1)
Methodology of Part III	104	(17)
Pro forma term sheet	106	(15)
Business Valuation	121	(2)
Investment Structure	123	(2)
Syndication	125	(4)
Introduction to syndication	125	(1)
Reward for syndicate leadership	126	(1)
The entrepreneur's response	127	(2)
Investment Milestones	129	(10)
Introduction to investment milestones	129	(2)
Milestone definitions	129	(1)
Milestone waivers	130	(1)
Attractions for the VC firm	131	(1)
Attractions for the entrepreneur	132	(2)
Protected committed funding	132	(1)
Guaranteed subscription price	133	(1)
Fund-raising without milestones	133	(1)
Areas to watch out for	134	(5)
Sizing each tranche	134	(1)
Careful drafting of milestones	135	(1)
Syndicate decision-making	135	(1)
Enforcement teeth	136	(1)
Negotiation approaches	137	(1)
Earn-ins and ratchets as an alternative	137	(2)
Corporate Governance	139	(8)
Introduction to corporate governance	139	(1)
VC board representation	139	(3)
Composition of the board	139	(1)
Nominations to the board	140	(2)
Board process	142	(2)
Regularity and quorum	142	(1)
Committees	142	(1)
Board veto rights	143	(1)
Shareholder information	144	(1)
Shareholder veto powers	145	(2)
Equity Participation	147	(22)
Introduction to equity participation	147	(1)
Voting rights	147	(3)
Introduction to voting rights	147	(1)
Attractions of voting rights to the VC firm	147	(2)
Attractions for the entrepreneur	149	(1)
Voting rights -- areas to watch out for	149	(1)
Dividend rights	150	(2)
Introduction to dividend rights	150	(1)
Attraction of dividend rights to the VC firm	150	(1)
The entrepreneur's response	151	(1)
The preference cascade	152	(10)
Preference shares	152	(2)
``Double-dipping'' preferred shares	154	(3)
``High watermark'' preferred shares	157	(2)
The best type of preference?	159	(1)
Application of the preference	159	(2)
Legal considerations	161	(1)
Redemption features	162	(3)
Attractions of a redemption feature to the VC firm	162	(1)
Events of default	163	(1)
Default	163	(1)
The decision-making process	163	(1)
Legal issues	164	(1)
Alternatives to redemption	164	(1)
Conversion rights	165	(4)
Voluntary conversion rights	165	(1)
Compulsory conversion rights	166	(1)
Adjustment to conversion rights	167	(2)
Share Incentives	169	(6)
Introduction to share incentives	169	(1)
Sizing of incentive programmes	170	(1)
Who bears the dilution?	171	(1)
Ratchets	172	(3)
Share Vesting	175	(10)
Introduction to share vesting	175	(1)
Attractions of vesting to the VC firm	175	(1)
The entrepreneur's response	176	(2)
Vesting - areas to watch out for	178	(7)
Pace and level of vesting	178	(2)
Good/bad leaver provisions	180	(1)
Acceleration on exit events	181	(2)
Treatment of vested shares	183	(1)
Repurchase mechanics	184	(1)
Pre-emption Rights on Securities Issues	185	(6)
Introduction to share issue pre-emption rights	185	(1)
Attractions of share issue pre-emption rights to a VC firm	185	(1)
The entrepreneur's response	186	(1)
Areas to watch out for	186	(5)
What triggers pre-emption rights?	187	(1)
Reference terms of pre-emption	188	(1)
Partial pre-emption?	188	(1)
Who gets pre-emption rights?	189	(1)
Pre-emption top-ups	189	(1)
Administration of pre-emption rights	190	(1)
Anti-dilution Rights	191	(12)
Introduction to anti-dilution rights	191	(2)
Full ratchet anti-dilution	191	(1)
Weighted average anti-dilution	192	(1)
Mechanism of action	192	(1)
Attraction of anti-dilution to a VC firm	193	(1)
The entrepreneur's response	194	(2)
Fundamental unfairness	194	(1)
Limitation of anti-dilution in practice	194	(1)
Shareholder double advantage	195	(1)
Pay to play	196	(2)
What is ``pay to play''?	196	(1)
Determining the amount to pay	196	(1)
Consequences of not paying...	197	(1)
New developments	198	(1)
Areas to watch out for	198	(5)
Carve-outs	198	(1)
Pricing considerations	199	(1)
Proxies for value	199	(1)
Price benchmarks	200	(1)
Who squeezes who?	200	(1)
Differential pricing	200	(1)
Syndicate dangers	201	(2)
Provisions Relating to Share Transfers	203	(16)
Introduction to share transfers	203	(1)
Transfer restrictions	203	(2)
General restrictions	203	(1)
IPO restrictions	204	(1)
Mandatory sales	205	(1)
Transfer pre-emption rights	205	(4)
Nature of pre-emption	206	(1)
Partial pre-emption?	206	(1)
Who gets pre-emption rights?	207	(1)
Pre-emption top-ups	207	(1)
Buyer of last resort	208	(1)
Administration of pre-emption rights	208	(1)
Exclusion of certain transactions	208	(1)
Drag-along rights	209	(5)
What are drag-along rights?	209	(1)
Why is drag-along needed?	209	(2)
Drag-along implementation	211	(1)
Further issues to consider	212	(1)
Enforcement of drag-along rights	213	(1)
Tag-along rights	214	(5)
Introduction to tag-along rights	214	(1)
Nature of tag-along rights	214	(2)
Partial tag-along?	216	(1)
Timing of subsequent sale	216	(1)
Different classes of shares	216	(1)
Who gets tag-along rights?	217	(1)
Pre-emption top-ups	218	(1)
Administration of pre-emption rights	218	(1)
Exclusion of certain transactions	218	(1)
Deal Management Terms	219	(10)
Introduction	219	(1)
Conditions precedent	219	(3)
VC firm's strategy	220	(1)
Entrepreneur's strategy	220	(2)
Exclusivity	222	(3)
VC firm's strategy	222	(1)
Entrepreneur's strategy	223	(2)
Cost reimbursement	225	(4)
VC firm's strategy	225	(1)
Entrepreneur's strategy	226	(2)
Financial assistance	228	(1)
Index	229