Angel Investors, VCs, Hedge Funds and Private Equity Investors: Angel Investors, VCs, Hedge Funds and Private Equity Investors Professor Rajendra K. Lagu Department of Electrical Engineering e-mail: rklagu@ee.iitb.ac.in Webpage: http://www.ee.iitb.ac.in/~rklagu


Economics of Investment: Economics of Investment Certain economic agents (individuals, households and corporations) have excess of income over their consumption (because of their plan to defer consumption). Certain other agents need more money than they have (temporarily). Intermediaries exist who bring together the above two types for economic gains (commissions, brokerage).


Slide3: HNWI Households Corporates Angels Banks Mutual Funds Pension Funds Insurance Cos Hedge Funds Venture Capital Funds


Slide4: Angels Hedge Funds Banks Mutual Funds Pension Funds Insurance Cos VC Funds Fixed Income Securities Forex Commodities Startups & Private Equity


Nature of these investors: Nature of these investors Unconventional Make highly risky investments Deal with difficult Asset Pricing and Valuation Are free of regulatory issues


Target Companies: Target Companies Startups Early stage companies Private companies in the scale-up phase Pre IPO financing rounds


Sources of Finance: Sources of Finance Equity (common stock, preferred stock) Loans: long term, short term Lease finance Inter corporate deposits Bank cash credit and overdraft limits Debentures Fixed deposits Grants from government agencies Supplier credit and deferred payments Credit cards


Modes of Acquisition: Modes of Acquisition Primary market:public issue, rights issue (flotation costs) Secondary market (listing costs) Private placement (individual or institution) Banks and mutual funds Pension funds, insurance companies Debenture issue Fixed deposits


How to compare various sources ?: How to compare various sources ? Holding period (Duration) Repayment terms Interest rate Other strings attached Pledges and collaterals Finance marketing costs and lead time


Net Present Value (NPV) of an Investment: Net Present Value (NPV) of an Investment Horizon of interest: Typically 4 –5 years Expected future cash flows: Dividends, interests Residual value at the end of horizon: Market price Risk-free rate of return: Government bonds Risk premium: Investor dependent


Example: Angel Investment: Example: Angel Investment Three to five year horizon No dividend / interest IPO Price is the residual value Risk-free rate of return: 5 % (Bonds, Treasury bills) Risk premium: 20-40% (Early stage investment)


NPV of an Asset (Stock, Bond)Discounted Cash Flow Analysis: NPV of an Asset (Stock, Bond) Discounted Cash Flow Analysis NPV = CF1 / (1.0 + r) + CF2 / (1.0 + r) 2 + CF3 / (1.0+r) 3 + RV / (1.0 + r) 3 r = Expected rate of return CF i = Cash flow at the end of i th year RV = Residual value of the asset Discounting is the reverse of compounding Where


Funds Requirements: Funds Requirements Idea / Concept: USD 10K Prototype: USD 50K Product development: USD 0.5M – 2M Organization building: USD 8M-10M Scale up: USD 50M IPO: Initial Public Offer


Sources of Funds: Sources of Funds Idea / Concept: Personal savings Prototype: Loan from friends and relatives Incubation: Angel / Early stage fund Organization building: VC, first round Scale up: Second round / growth/ scale up funds IPO: Investment bankers, underwriters


Cost of Equity: Cost of Equity Angels would expect higher rate of returns than VCs Typical VC expectations is 40-50% compounded annual return Risk-return curve: New venture increasingly reduces its risk as it goes through stages


Angel Investors: Angel Investors High Net Worth Individuals Successful serial entrepreneurs (also parallel entrepreneurs) Good knowledge of technology and business acumen Have country-specific preferences (NRI, NRC) Hunt in packs


Examples…: Examples… James Clark (SGI to Netscape) Prakash Bhalerao (Alopa Networks) Kanwal Rekhi (Exodus Communications) K.Chandrasekhar, B.V. Jagdeesh Sabeer Bhatia (Hotmail Arzoo Navinmail) Rakesh Mathur (Junglee to Purple Yogi) Suhas Patil (Cirrus Logic)


Made In India and Served from India: Made In India and Served from India N.S. Raghavan Infosys IIM Bangalore Strand Genomics


Made in USA and Served from India: Made in USA and Served from India Mahesh Murthy Passionfund TiE Angel Forum Romesh Wadhwani Indian School of Business (ISB) Wadhwani Foundation


Peculiarities of Angel Investment: Peculiarities of Angel Investment Quick decision-making Low level of funds One-two days a week of commitment – after all they are putting their own money on the table!! Uncle-nephew relationship


Venture Capital Firms: Venture Capital Firms VCs look for private equity for young companies Mezzanine VC firms Scale-up VC firms Technology / “Space” specific Biotechnology Networking Chips and hardware E Commerce


Structure of a VC Firm: Structure of a VC Firm General partners 3-5 (themselves successful entrepreneurs): put about 2-3% of the corpus Limited partners (Pension funds, Retirement plans): Put 97% corpus Corpus = Fund, typically ranges between USD 50M to 2B Management fee is about 2-3 % per year Funds about 5-30 new companies per year Employs junior managers for due diligence(associates) After IPO/Acquisition, general partners keep 20% of gains, limited partners get Principal+80%


VC Firm’s Annual Throughput: VC Firm’s Annual Throughput 10,000 qualified business plans 1000 meetings 400 company visits 25 new investments


Role of the VC in the Portfolio Company: Role of the VC in the Portfolio Company Negotiate aggressive terms Select strong co-investor Help in constituting the Board of Directors Assist in Recruitment Market validation Strategic relationships Pursue liquidity aggressively


Valuation: Bargaining Point: Valuation: Bargaining Point Causes of mismatch Asymmetry of information Ego Greed Factors that drive the valuation Technology, ESOP rates, management Orders in hand, scalability, brand strength Patents and copyrights


Difficulties in Valuing Start-up Companies: Difficulties in Valuing Start-up Companies Immediate earnings are negative No past history No comparable companies No market prices


VC Fund Raising Process: VC Fund Raising Process Introduction (phone call, e-mail, referral) Submit business plan / executive summary Presentation Company visit Due diligence (management reference checks, customer calls, market analysis) More meeting(s) Term sheet Legal / Closing


Innovations in Financing Terms: Innovations in Financing Terms Third party collaterals SIDBI USA Small Business Administration Flexible, milestone-based equity conversion options and release of funds in tranches


Some big names in India and USA: Some big names in India and USA Silicon Valley --Sand Hill Road Addresses Kleiner Perkins Sequoia Capital Battery Ventures India Chrysalis Capital Acer Technology Ventures Westbridge Capital Jump Startups


Hedge Funds: Hedge Funds Hottest and most talked about in the business press Started by ex-Wall Streeters Quantum Fund : George Soros LTCM: Long Term Capital Management (Myron Scholes and Robert Merton, 1997 Economics Nobel)


Hedge Funds: Privileges and Promises: Hedge Funds: Privileges and Promises Not scrutinized by SEC Ask for long term commitment from investors : 6 months to 2 years Take simultaneous positions in securities, commodities, Forex and Bond markets Global (Transnational operations) Promise absolute return irrespective of market trends and movements


Hedge Fund Strategies: Hedge Fund Strategies Fixed Income Arbitrage Equity market-neutral statistical arbitrage Convertible Arbitrage Merger Arbitrage Distressed securities Event-driven strategies Macro investors: EIC Analysis Sector-specific positioning


Who can invest?: Who can invest? Accredited investors Income of USD 200K/year Net worth of USD 1 Million exclusive of house, automobiles and other consumer durables Hedge fund typically limits to 99 investors and has minimum investment of USD 100K – 500K Fund of Funds


Private Equity Investment: Private Equity Investment Large, profitable private limited or deemed public companies who need finance but don’t want to do an IPO Examples: Patni Computers, Persistent Systems Limited Deal is usually in tens of crores


Some deals in the last 6 months: Some deals in the last 6 months


References: References Google!! Indian Venture Capitalist Association http://www.indiavca.org/ Joseph G. Nicholas, “ Investing in Hedge Funds”, Bloomberg Press, 2000 http://www.hedgefund.net http://www.hedgefundmarketing.org/Cheat_Sheet.htm