Origin of Venture Capital - 1
It did not exist as a profession before WWII
American Research & Development, the first VC firm, 1946, General George Doroit of HBS.
1953, SBA, 1958, SBIC
originally, SBIC could get up to $300,000 government money for each $150,000 PE. Half of the money in subordinated debentures, half in reduced int. loans.
Other benefits… taxes, losses...
History of Venture Capital-2
Successful story: SBIC invested in CEIR $900,000, 9months later, became 7 million
by 1961, 250 SBIC gone public
1964, pick of 722 SBIC, 1967 only 250 left.
1968, first time private VC > SIBC
ARD invested in DEC, $70,000 in 1957, got million in 1967.
1974, DOW fell to 600, NASDAQ to
1969, capital gain tax up. VC down.
1965-1980, avg vc return 25%
History of Venture Capital - 3
Sources: 1981, 23% pension, 23% families
1977, 105 private VC, 66 Corp vc, 66 SBIC
typically, expected return 50% for startups, 30-40% for second stage, 25-30% for expansion stage
IPO 1981, 448 co. billion, 1983, 884 co. billion
the supply and demand of VC: the delta factor
seed, early stage, later stage, conventional…
1980s, small firms 322 innovations per million employees, big firms only 225.
Sources of Funds
Angels: 250,000 individuals investing $20-30 billion, > $100,000 each investment
pension funds and ERISA ‘prudent man’
Taxes: 1969, %, 1978, 28%, 1981, 20%
1980, 25% of VC in seed and early stage projects, 1988, reduced to %
Elements of VC investment
Amount and timing of the investment
forms of investment (convertible, preferred…)
terms of investment (conversion price, liquidation preference, dividend rate, etc.)
put and call rights
registration rights
options pools
vesting schedule, employment contracts
board director representation
FVP: background
The existence of intermediaries b/w GP,LP
Angels investing $2-30 billion
Venture Capital Partnerships
why families would like this idea:
tax benefits: 39% income tax, but 28% capital gain tax, 14% if invested into small business and long term
federal inheritance taxes, 50% on individuals > $18 million assets. Gifts to children < $ 10,000/year, generation-skipping tax to grandchildren > $1 million
1992, 3% of the families with > $1million net assets control 44% of US household financial assets
Fox venture Partners
A $100 million fund: fund of fund concept
sources of fund: wealthy families
have to commit at least $2 million
why vc like this idea:
1. The LPs may be valuable information source
2. Avoiding vc dependent too heavily on institutional investors
3. Less restrictive terms from families
4. Want to involve in subsequent round of investments
Fox Venture Partners
FVP intended to invest $5 MM each in 20 funds
35% well known funds
40% specified by region or industry
20% new funds
5% international funds
this is different from buyout funds ($20 MM in minimum)
1994, billion in PE, $32 billion in VC, the rest: 5% mezzanine, 2% distressed debt purchase
362 fund in PE, among them, 194 VC
FVP: history of fund of fund
Gatekeepers managed $18 billion of PE funds, about 18% of the total
they provide advisory services to some clients
they serve as linkage between the VCs and the startups
providing the first screening for the venture capital firms, charge a service fees
Fox Venture Partners
The resistance from the wealthy families:
1. Information asymmetries, the one who need the service may not appreciate it.
2. Agency problems, family financial managers…
3. Lack of resources, not using a lead investor, limited resource to market the idea.
4. Ineffective marketing. Not show their track records
5. The structure of the proposed incentive scheme.
The size of the proposed compensation.
Fox Venture Partners
The challenges that FVP faces:
the educational role: the FVP will teach the families about the funds
potential competitors are lots: on the concept of funds of funds
since families now hired their financial managers, the similar agency problems in the institutional investors appeared as well
Yale University endowment origin
Yale was established in 1701 by 10 Connecticut clergymen.
The endowment started 1818, divinity school to offer theological instruction, several alumni made large gifts.
Yale use the money on land and building, and to invest in corp, railroad bond, equities
by 1899, the endowment reached $5million
Yale U. endowment history
1930, yale endow held 42% in equity, other U had only 11%
later 1930,then treasurer, Tighe decided to reduce equity %
but stock market booming in 1950-60, end of 1960, the trustee wanted to increase the equity portion and to contract out the portfolio management to an outside advisor
by bear market: 1969-1979, yale’s endowment declined by 46%
Yale investments office -1997
David swensen: 15 employee office
investment philosophy: different from other U.
David likes Keynes maxim: worldly wisdom teaches us that it is better for reputation to fail conventionally then to succeed unconentionally. But he is willing to take the risk of being different. Not following the crowd.
David Swensen’ s philosophy-1
Strongly believed in equity: whether public or private
equities are real stream of income , bands are a contractual sequence of nominal cash flow
$1 invested in end of 1925 in corp stocks worth $1371 by end of 1996, but only $34 in T bonds , $14 in T bills
hold a diversified portfolio, risk can be reduced by diversification rather than time the market
David Swensen’ s philosophy-2
Increasingly seek opportunities in less efficient markets: why?
The difference b/w 25 and 75th percentiles:
fixed income fund mg: minimal
common stock mg: 3% per annum
private equity mg: 15% per annum
to utilize outside managers for all but most routine or indexed investment
the managers have the max autonomy
but the selection process is long and careful
incentives: not by the size of the management but by the performance
Four Characteristics of new firms
that affect their financing strategies
Uncertainty - measure of the array of potential outcomes for a company or project. The wider the dispersion of the potential outcomes, the greater the uncertainty.
Asymmetric information, the entrepreneur knows more about his company’s prospects than investors, suppliers or strategic partners.
If more important assets are intangible
substantial variations in market conditions.
Six activities of PE firms
The firm’s financing:
sources of financing: PE. Or public market.
Forms of financing: equity or debt.
Division of profits between the entrepreneurs and investors
strategic control of the firm:
monitoring , a critical role
ability to alter the nature of the assets and obtain greater financial flexibility
evaluation is the final and the most critical points for the entrepreneur and the investor.
Xerox Technology Ventures
1946, Haloid company, a photography paper company. 1949, the first copy machine.
1960s, Xerox forms xerox computer services, scientific data systems, palo alto research center,,, to enter into computer industry.
‘mouse’ and laser printer were designed by Parc.
Xerox Technology Ventures
The establishment of XTV was driven by two events in 1988:
the difficulty to spinoff the Parcplace
publication of the book “ fumbling the future
‘we need a system to prevent technology from leaking out of the company
two strategies:
to litigate those to leave with new technology
$300,000 law suit against IBM, a woman dating people from competing firm
to invest those leave
develop venture funds internally
Corporate Ventures
2 extremes of corporate venture subsidiaries
Internal ventures:
only looking at internal technologies
insufficient compensations: Block and Omati research on 207 ventures in 42 fortune 1000 companies
high turnover rates
difficult to terminate
External ventures:
all the innovation activities
ex. 3M. Designates at least 25% of its business come from products not in existence 5 years earlier.
XTV: startup and implementation
$30million fund to promote tech developed in Xerox
“XTV is a hedge against repeating missteps of the past.” by Xerox chairman Kearns
XTV is a corporate division, but Adams crafted an agreement with Xerox resembled the typical agreement between LP and GP.
The preparation of the term sheet.
XTV: the implementation 1
Similar to PIPs: the goal of XTV is to max returns.
Usual conflicts of goals between corp and internal VC
structure: 20% of ‘carried interests’
the degree of autonomy
the same time frame: 10 years
give up controls of the companies they invested
after several rounds, Xerox holds 20-50% of equity.
XTV: the implementation 2
XTV principals:
1. Relationship with the corp, just like LP and GP
2. leverage the assets of Xerox whenever possible.
Do the traditional VC job
also help the ventures whenever they can :
1. Supplier chennels
2,firms can use Xerox offices and facilities
certificates as ‘a xerox company’ or ‘ a xerox alliance company’
