Venture capital and the finance of innovation / Andrew Metrick.

Format:

Book

Author/Creator:

Metrick, Andrew.

Contributor:

Charles R. Anderson Endowment Fund.

Language:

English

Subjects (All):

Venture capital.

Technological innovations--Finance.

Technological innovations.

Physical Description:

xxiv, 568 pages : illustrations ; 24 cm

Place of Publication:

Hoboken, NJ : Wiley, [2007]

Summary:

Of all the skills that make a successful venture capitalist, finance may not be high on your list. But it should. Why? Because a grasp of the essentials of finance can make the difference between investing with discipline or with blind hope. Think only of the disastrous performance of the VC industry in the post-2000 years for a cautionary example of what happens when investment discipline breaks down.

In Andrew Metrick's Venture Capital and the Finance of Innovation, future and current venture capitalists will find a useful guide to the principles of finance and the financial models that underlie venture capital decisions. Assuming no knowledge beyond concepts covered in first-year MBA courses, the book will familiarize you with: The relationship between risk and return in venture capital, Historical statistics on the performance of venture capital investments, Total Valuation-the data and methods used to value a high-growth company, Partial valuation-how to analyze the special features of VC transactions such as convertible preferred stock, participating preferred stock, payment-in-kind dividends, and liquidation preferences, A framework for modeling investment in "research and development", The relationship between strategy and finance, Cutting-edge techniques such as Monte-Carlo analysis, real options, binomial trees, and game theory. Comprehensive yet accessible and supplemented by free online spreadsheet models that provide "reality checks" for many types of transactions, Venture Capital and the Finance of Innovation arms you with the financial models and tools you need to become a successful venture capitalist.

Contents:

Part I VC Basics

Chapter 1 The VC Industry 3

1.1 What Is Venture Capital? 3

1.2 What Do Venture Capitalists Do? 9

1.3 The History of Venture Capital 10

1.4 Patterns of VC Investment in the United States 15

1.4.1 Investments by Stage 15

1.4.2 Investments by Industry 17

1.4.3 Investments by U.S. Region 18

Chapter 2 VC Players 21

2.1 Firms and Funds 21

2.2 The Limited Partners 27

2.3 VC Partnership Agreements 29

2.3.1 Management Fees 29

2.3.2 Carried Interest 31

2.3.3 Restrictive Covenants 37

Appendix 2.A EarlyBird Ventures I 42

Appendix 2.B Talltree Ventures IV 43

Appendix 2.C Owl Ventures IX 44

Chapter 3 VC Returns 45

3.1 Industry Returns 45

3.1.2 A Gross-Return Index 47

3.1.3 A Net-Return Index 49

3.2 Fund Returns 52

3.2.2 Evidence 58

Chapter 4 The Cost of Venture Capital 65

4.1 The Capital-Asset-Pricing Model 65

4.2 Beta and the Banana Birds 69

4.3 Estimating the Cost of VC 74

Chapter 5 The Best VCs 83

5.1 The Economics of VC 83

5.2 The Best VCs: A Subjective List 86

5.3 VC Value Added and the Monitoring of Portfolio Firms 94

Chapter 6 VC Around the World 98

6.1 The Global Distribution of VC Investing 98

6.2 The Cost of International Venture Capital 110

6.2.1 Baseline Model: The Global CAPM 110

6.2.2 Objections and Extensions to the Global CAPM 112

6.2.3 A Global Multifactor Model for Venture Capital 116

Part II Total Valuation

Chapter 7 The Analysis of VC Investments 123

7.1 VC investments: The Historical Evidence 123

7.2 The Investment Process 134

Chapter 8 Term Sheets 145

8.1.1 Investors 147

8.1.2 Price Per Share 148

8.1.3 Pre-money and Post-money Valuation 148

8.1.4 Capitalization 149

8.2 The Charter 150

8.2.1 Dividends 152

8.2.2 Liquidation Preference 152

8.2.3 Voting Rights and Other Protective Provisions 153

8.2.4 Mandatory Conversion 153

8.2.5 Redemption Rights 153

8.3 Investor Rights Agreement 154

8.3.1 Registration Rights 157

8.3.2 Matters Requiring Investor-Director Approval 157

8.3.3 Employee Stock Options 158

8.4 Other Items 158

8.4.1 Rights and Restrictions 159

8.4.2 Founders' Stock 160

Chapter 9 Preferred Stock 163

9.1 Types of Preferred Stock 163

9.2 Antidilution Provisions 173

Chapter 10 The VC Method 179

10.1 The VC Method: Introduction 179

10.1.1 Exit Valuation 180

10.1.2 Target Returns 181

10.1.3 Expected Retention 183

10.1.4 The Investment Recommendation 184

10.2 The Standard VC Method 185

10.3 The Modified VC Method 186

Chapter 11 Discounted-Cash-Flow Analysis of Growth Companies 195

11.1 DCF Analysis: Concepts 196

11.2 DCF Analysis: Mechanics 198

11.3 Graduation Value 203

11.4 DCF Analysis: The Reality-Check Model 207

11.4.1 Baseline Assumptions for the Reality-Check DCF 207

Chapter 12 Comparables Analysis 213

12.1 Introduction to Comparables Analysis 214

12.2 Choosing Comparable Companies 219

12.3 Using Comparable Companies to Estimate the Cost of Capital 223

Appendix 12.A Potential Comparables for Semico 227

Part III Partial Valuation

Chapter 13 Option Pricing 231

13.1 European Options 232

13.2 Pricing Options using a Replicating Portfolio 234

13.3 The Black-Scholes Solution 238

13.4 American Options 242

13.5 Random-Expiration Options 243

13.6 Reading Exit Diagrams 245

13.7 Carried Interest as an Option 247

Appendix 13.A RE Options: Technical Details 251

Chapter 14 The Valuation of Preferred Stock 252

14.1 Base-Case Option-Pricing Assumptions 253

14.2 RP Valuation 254

14.3 Excess Liquidation Preferences 257

14.4 Dividends 259

14.5 CP Valuation 261

14.6 CP with Excess Liquidation Preferences or Dividends 263

14.7 Combining RP and CP 265

14.8 Comparing RP and CP 267

Chapter 15 Later-Round Investments 271

15.1 Series B 271

15.2 A Conversion Shortcut 276

15.3 Series C 277

15.4 Dividends in Later Rounds 281

15.4.1 Accrued Cash Dividends 281

15.4.2 PIK Dividends 283

15.5 Beyond Series C 284

Chapter 16 Participating Convertible Preferred Stock 289

16.1 Binary Options 290

16.2 The Valuation of PCP 291

16.3 The Valuation of PCPC 293

16.4 Series B and Beyond 295

Chapter 17 Implied Valuation 304

17.1 Post-Money Valuation Revisited 305

17.2 Measurement of Portfolio Value 309

17.3 Down Rounds? 313

17.4 How to Avoid Valuation Confusion 316

Chapter 18 Complex Structures 319

18.1 Management Carve-outs 319

18.2 Dealing with Partners 326

18.3 A Complex Example 329

Part IV The Finance of Innovation

Chapter 19 R&D Finance 339

19.1 R&D Around the World 339

19.2 Two Touchstones 345

19.2.1 Drug Development 345

19.2.2 Energy Innovation 348

19.3 How Is R&D Financed? 350

Chapter 20 Monte Carlo Simulation 357

20.1 Event Trees 357

20.2 Simulation with Continuous Probability Distributions 362

20.3 Simulation with Multiple Sources of Uncertainty 373

Chapter 21 Real Options 379

21.1 Decision Trees 380

21.2 Real Options in R&D 382

21.3 The Valuation of Real Options 383

21.4 Risk-Neutral Probabilities 388

21.5 Drugco, revisited 395

Chapter 22 Binomial Trees 401

22.1 The Black-Scholes Equation, Revisited 401

22.2 Multiple Strike Prices and Early Exercise 410

22.3 Dividends 413

Chapter 23 Game Theory 421

23.1 What Is Game Theory? 421

23.2 Simultaneous Games 425

23.3 Sequential Games 435

23.4 Game Theory and Real Options 440

Chapter 24 R&D Valuation 447

24.1 Drug Development 447

24.2 Energy 458

24.3 The Forest and the Trees 466

Appendix A Information Sources for Venture Capital 468

Appendix B Sample Term Sheet 485

Appendix C The VCFI Spreadsheets 501

Appendix D Guide to Crystal Ball 507.

Notes:

Includes bibliographical references and index.

Local Notes:

Acquired for the Penn Libraries with assistance from the Charles R. Anderson Endowment Fund.

ISBN:

0470074280

OCLC:

70060933

Publisher Number:

9780470074282