Venture Capital and Private
Equity
Session 4
Professor Sandeep Dahiya
Georgetown University
Course Road Map
• What is Venture Capital - Introduction
• VC Cycle
– Fund raising
– Investing
• VC Valuation Methods
• Term Sheets
• Design of Private Equity securities
– Exiting
• Time permitting – Corporate Venture
Capital (CVC)
Quick Review of VC Valuation
Method
• Remember - In venture capital all valuation
is “implied valuation”. Simply put the value
arises because VC(s) is(are) willing to
finance the company!
• The terms (amount invested, fraction of
ownership received) fix the post-money and
pre-money value of the business
• This process is made transparent by
reporting of “Capitalization Table” or simply
“Cap Tables” – Let us see how these are
created…
Capitalization Tables
Page 10 (Bottom) of ONSET ventures case describes the financing
history of TallyUp. Onset offered to invest $750,000 at a price $1
per share in return for 31.6% of the company. Later, ONSET
invested another $250,000 at the same price ($ 1 per share) when
Reed Tausig as the CEO. Please draw up the capitalization tables,
pre-money and post money valuations for tally before and after
each round of financing.
Before Financing
Investor
Founders
ONSET Ventures
Option Pool
Total For Round
Cumulative Total
After Intial 750,000 investment
# of shares
1,625,000
$ per share
$0.000
$ total
$0
1,625,000
$0.000
$0
%
ownership # of shares
100%
1,625,000
750,000
100%
2,375,000
$ per
share
$1.00
$ total
$1,625,000
$750,000
%
ownership
68.42%
31.58%
$1.00
$2,375,000
100%
Price Per Share
Pre-Money Valuation
Cash Infusion
Post-money Valuation
$1
1,625,000
750,000
2,375,000
After Next Investment of
$250,000
After Intial 750,000 investment
Investor
Founders
ONSET Ventures
Option Pool
Total For Round
Cumulative Total
# of shares
1,625,000
750,000
2,375,000
$ per
share
$1.00
$1.00
After next 250,000 investment
$ total
$1,625,000
$750,000
%
ownership # of shares
68.42%
1,625,000
31.58%
1,000,000
$ per
share
$1.00
%
$ total
ownership
$1,625,000 61.90%
$1,000,000 38.10%
$2,375,000
250,000
2,625,000
$1.00
$1.00
$250,000
$2,625,000
100%
Price Per Share
Pre-Money Valuation
Cash Infusion
Post-money Valuation
$1
1,625,000
750,000
2,375,000
$1
$2,375,000
250000
$2,625,000
9.52%
100%
After Option Pool Creation of
750,000 Shares
After next 250,000 investment
Investor
Founders
ONSET Ventures
Option Pool
# of shares
1,625,000
1,000,000
$ per
share
$1.00
Total For Round
Cumulative Total
250,000
2,625,000
$1.00
$1.00
After Option Pool
%
$ total
ownership # of shares
$1,625,000 61.90%
1,625,000
$1,000,000 38.10%
1,000,000
750,000
$ per
share
$1.00
$1.00
%
ownershi
$ total
p
$1,625,000 48.15%
$1,000,000 29.63%
$750,000
22.22%
$250,000
$2,625,000
$0.00
$1.00
$0
$3,375,000
9.52%
100%
750,000
3,375,000
Price Per Share
Pre-Money Valuation
Cash Infusion
Post-money Valuation
$1
$2,375,000
250000
$2,625,000
$1
$2,625,000
0
$3,375,000
22.22%
100%
What if Mann is able to do a $3.5
million round at 2.5 times step up
(ONSET invests $1 million in this
round)
After Option Pool
Raise 3.5 Million Total at 2.5 Step Up
Investor
Founders
ONSET Ventures
Option Pool
New VC
# of shares
1,625,000
1,000,000
750,000
$ per
share
$1.00
$1.00
%
$ total
ownership
$1,625,000 48.15%
$1,000,000 29.63%
$750,000
22.22%
Total For Round
Cumulative Total
750,000
3,375,000
$0.00
$1.00
$0
$3,375,000
22.22%
100%
# of shares
1,625,000
1,400,000
750,000
1,000,000
$ per
share
$2.50
$2.50
$2.50
%
$ total
ownership
$4,062,500
34.03%
$3,500,000
29.32%
$1,875,000
15.71%
2500000 20.94%
1,400,000
4,775,000
$2.50
$2.50
$3,500,000
$11,937,500
Price Per Share
Pre-Money Valuation
Cash Infusion
Post-money Valuation
$1
$2,625,000
0
$3,375,000
$2.50
$3,375,000
3,500,000
$11,937,500
29.32%
100%
TallyUp – What Happened
• Was able to raise 4 million in the next
round at post-money value of $ 13
million (>2.5x step-up)
• Raised 4 more rounds – changed name
to Callidus Software
• Did IPO in 2003 at $13.5 share
• ONSET owned 17% of the company at
the time of IPO
Term Sheets…
Let us look at Trendsetter
Term Sheet
• Getting first Term Sheet is MAJOR
break through!
– Validates entrepreneur/idea
– Establishes a price
– Can be shopped around (especially in
later rounds)
Term Sheets in Venture
Financing
• Responses by investors
• Critical Issues
– Active Screening
– Uncertainty
– Stage financing
– Asymmetric
– Syndication
Information
– Use of Stock options/grants
– Nature of Firm’s assets
with strict vesting
– Conditions of relevant
requirements
financial and product
– Contingent control
markets
mechanisms – Covenants and
restrictions
– Strategic composition of
Board of Directors
Got a Term
Sheet
Multiple Rounds,
Multiple Tranches
Check the Term Sheet!
Trendsetter is Lucky!
• If you were advising Trendsetter which
offer would recommend?
– Valuation
– Liquidation Preference (and Antidilution)
– Vesting
– Corporate Governance
Valuation (Cap Tables)
Alpha
Investor
Founders
VC
Option Pool
Total For Round
Cumulative Total
# of shares
4,000,000
4,761,905
3,000,000
4,761,905
11,761,905
Mega
$ per
share
$1.05
$1.05
$1.05
$ total
$4,200,000
$5,000,000
$3,150,000
$1.05
5,000,000
$12,350,000
%
ownership
34.01%
40.49%
25.51%
# of shares
4,500,000
5,000,000
2,500,000
100%
5,000,000
12,000,000
$ per
share
$1.00
$1.00
$1.00
$ total
$4,500,000
$5,000,000
$2,500,000
$1.00
5,000,000
$12,000,000
Price Per Share
Pre-Money Valuation
Cash Infusion
Post-money Valuation
$1.05
7,350,000
5,000,000
12,350,000
$1.00
7,000,000
5,000,000
12,000,000
%
ownership
37.50%
41.67%
20.83%
100%
Liquidation
• Deemed liquidation event
• Liquidation preference (2X, 3X, etc.)
– Non Participating
– Fully Participating
Will See in
Details Later
• Qualified public offering (QPO)
What Type of Security?
• Alpha
– Convertible Preferred (CP) Stock
• Mega
– Participating Convertible Preferred (PCP)
Stock
TYPE OF LIQUIDATION EVENT IS
CRITICAL!
Exit Values
Term Sheet Alpha
Enterprise
Value ($
VC
Million)
5.00
7.50
10.00
15.00
20.00
25.00
29.69
30.00
35.00
37.04
40.00
45.00
50.00
55.00
60.00
100.00
200.00
240.00
500.00
Liquidation
5.00
6.01
7.02
9.05
11.07
13.10
15.00
15.00
15.00
15.00
16.20
18.22
20.25
22.27
24.29
40.49
80.98
97.18
202.45
Owner/Employees
VC
0.00
1.49
2.98
5.95
8.93
11.90
14.69
15.00
20.00
22.04
23.80
26.78
29.76
32.73
35.71
59.51
119.02
142.82
297.55
IPO
Owner/Employ
ees
VC
24.29
40.49
80.98
97.18
202.45
35.71
59.51
119.02
142.82
297.55
Term Sheet Mega
Liquidation
IPO
Owner/Employ
Owner/Employ
ees
VC
ees
5.00
0.00
7.50
0.00
8.54
1.46
10.63
4.37
12.71
7.29
14.79
10.21
16.75
12.94
16.88
13.12
18.96
16.04
19.81
17.23
21.04
18.96
23.13
21.87
25.21
24.79
27.29
27.71
29.38
30.62
46.04
53.96
87.71
112.29
104.38
135.62
100.01
139.99
212.72
287.28
208.35
291.65
Anti-Dilution Protections
• Down round
Read the Note on
Anti-dilution provisions: Typology
and Numerical Example
• Full-ratchet vs. weighted
average
• Adjusted conversion
price, adjusted
conversion rate
Broad-base weighted average
anti-dilution
NCP = OCP * (OB+NM/OCP) / (OB+SI)
NCP= New Conversion Price
OCP= Old Conversion Price in effect immediately prior
to new issue
OB = Number of shares of shares outstanding
immediately prior to this round
NM = New Money received by the Corporation
SI = Number of shares of stock issued in this round
Another way of writing it
(Pre-Money Value+Money in new round)
NCP 
(Total # of Shares after financing)
Why do we see these features?
• Convertible preferred
• Participating Convertible Preferred
• Full Ratchet/ Weighted Average
Ratchet
• Registration rights
Challenges for VCs
• Private Equity Partnerships (PEP) have
become the dominant organization
form as it addresses challenges faced
by LPs (Investors) and GPs(VC, Buyout
Firm).
• Are there issues between GPs and the
portfolio companies?
Challenges of Venture Financing
• Critical issues involved in • Responses by VCs
financing young firms
– Active Screening
– Stage financing
– Uncertainty
– Syndication
– Asymmetric
– Use of Stock options/grants
Information
with strict vesting
– Nature of Firm’s assets
requirements
– Conditions of relevant
– Contingent control
financial and product
mechanisms – Covenants and
markets
restrictions
– Strategic composition of
Board of Directors
Securities used by VCs
• Common Stock
• Debt
• Preferred Stock
• Never – why
not?
• Never – why
not?
• Interestingwhy?
VCs response #1– Security
Design
• Redeemable Preferred (RP)
• Convertible Preferred (CP) - Forced
Conversion Clause
• Participating Convertible Preferred
(PCP)
VCs response #2 Vesting
• Vesting – creates “Golden Handcuffs”
for key employees
• Idea being that you have to “Earn”
your share of the company!
• Also keeps the option pool from being
depleted if employees leave
VCs response #3 Covenants
• Covenants
– Positive Covenants
• Example Provide regular information
– Negative Covenants
• Example Sale of assets
– Others
• Mandatory redemption
• Board Seats