Venture Capital and the Finance of Innovation

Cover......Page 1
Title Page......Page 5
Copyright......Page 6
PREFACE TO 2ND EDITION—A READER’S GUIDE......Page 9
ACKNOWLEDGMENTS......Page 15
CONTENTS......Page 19
PART I: VC BASICS......Page 27
1.1 What Is Venture Capital?......Page 29
1.2 What Do Venture Capitalists Do?......Page 35
1.3 The History of Venture Capital......Page 36
1.4 Patterns of VC Investment in the United States......Page 40
Summary......Page 45
References......Page 46
2.1 Firms and Funds......Page 47
2.2 The Limited Partners......Page 53
2.3 VC Partnership Agreements......Page 56
Summary......Page 67
Exercises......Page 68
Appendices: Key Terms and Conditions for Three VC Funds......Page 69
3.1 Industry Returns......Page 72
3.2 Fund Returns......Page 79
Summary......Page 88
Exercises......Page 89
4.1 The Capital Asset Pricing Model......Page 91
4.2 Beta and the Banana Birds......Page 95
4.3 Estimating the Cost of Capital for VC......Page 100
Summary......Page 105
Exercises......Page 106
5.1 The Economics of VC......Page 109
5.2 The Best VCs: A Subjective List......Page 112
5.3 VC Value Added and the Monitoring of Portfolio Firms......Page 121
References......Page 124
6.1 The Global Distribution of VC Investing......Page 125
6.2 The Cost of Capital for International VC......Page 137
References......Page 145
Exercises......Page 146
PART II: TOTAL VALUATION......Page 147
7.1 VC Investments: The Historical Evidence......Page 149
7.2 The Investment Process......Page 161
Summary......Page 170
References......Page 171
CHAPTER 8 TERM SHEETS......Page 172
8.1 The Basics......Page 173
8.2 The Charter......Page 177
8.3 Investor Rights Agreement......Page 181
8.4 Other Items......Page 185
Key Terms......Page 187
Exercises......Page 188
9.1 Types of Preferred Stock......Page 189
9.2 Antidilution Provisions......Page 199
Summary......Page 202
Exercises......Page 203
10.1 The VC Method: Introduction......Page 204
10.2 The Standard VC Method......Page 210
10.3 The Modified VC Method......Page 211
Exercises......Page 218
CHAPTER 11 DCF ANALYSIS OF GROWTH COMPANIES......Page 221
11.1 DCF Analysis: Concepts......Page 222
11.2 DCF Analysis: Mechanics......Page 224
11.3 Graduation Value......Page 230
11.4 DCF Analysis: The Reality-Check Model......Page 233
Key Terms......Page 238
Exercises......Page 239
CHAPTER 12 COMPARABLES ANALYSIS......Page 240
12.1 Introduction to Comparables Analysis......Page 241
12.2 Choosing Comparable Companies......Page 245
12.3 Using Comparable Companies to Estimate the Cost of Capital......Page 250
Summary......Page 252
Exercises......Page 253
Appendix 12.A: Potential Comparables for Semico......Page 254
PART III: PARTIAL VALUATION......Page 255
CHAPTER 13 OPTION PRICING......Page 257
13.1 European Options......Page 258
13.2 Pricing Options Using a Replicating Portfolio......Page 260
13.3 The Black-Scholes Solution......Page 264
13.4 American Options......Page 268
13.5 Random-Expiration Options......Page 269
13.6 Reading Exit Diagrams......Page 271
13.7 Carried Interest as an Option......Page 273
Summary......Page 274
Exercises......Page 275
Appendix 13.A RE Options: Technical Details......Page 276
CHAPTER 14 THE VALUATION OF PREFERRED STOCK......Page 278
14.1 Base-Case Option-Pricing Assumptions......Page 279
14.2 RP Valuation......Page 280
14.3 Excess Liquidation Preferences......Page 283
14.4 Dividends......Page 285
14.5 CP Valuation......Page 287
14.6 CP with Excess Liquidation Preferences or Dividends......Page 289
14.7 Combining RP and CP......Page 292
14.8 Comparing RP and CP......Page 294
Summary......Page 295
Exercises......Page 296
15.1 Series B......Page 298
15.2 A Conversion Shortcut......Page 303
15.3 Series C......Page 304
15.4 Dividends in Later Rounds......Page 308
15.5 Beyond Series C......Page 311
Exercises......Page 314
CHAPTER 16 PARTICIPATING CONVERTIBLE PREFERRED STOCK......Page 316
16.1 Binary Options......Page 317
16.2 The Valuation of PCP......Page 318
16.3 The Valuation of PCPC......Page 320
16.4 Series B and Beyond......Page 322
Exercises......Page 329
CHAPTER 17 IMPLIED VALUATION......Page 331
17.1 Post-Money Valuation Revisited......Page 332
17.2 Measurement of Portfolio Value......Page 336
17.3 Down Rounds?......Page 340
17.4 How to Avoid Valuation Confusion......Page 343
Key Terms......Page 344
Exercises......Page 345
18.1 Management Carve-outs......Page 346
18.2 Dealing with Partners......Page 353
18.3 A Complex Example......Page 355
Exercises......Page 360
PART IV: THE FINANCE OF INNOVATION......Page 363
19.1 R&D Around the World......Page 365
19.2 Two Touchstones......Page 371
19.3 How Is R&D Financed?......Page 375
19.4 Where Do We Go from Here?......Page 380
Summary......Page 381
References......Page 382
20.1 Event Trees......Page 383
20.2 Simulation with Continuous Probability Distributions......Page 388
20.3 Simulation with Multiple Sources of Uncertainty......Page 399
Exercises......Page 402
CHAPTER 21 REAL OPTIONS......Page 404
21.1 Decision Trees......Page 405
21.2 Real Options in R&D......Page 407
21.3 The Valuation of Real Options......Page 408
21.4 Risk-Neutral Probabilities......Page 414
21.5 Drugco, Revisited......Page 421
Exercises......Page 424
22.1 The Black-Scholes Equation, Revisited......Page 426
22.2 Multiple Strike Prices and Early Exercise......Page 435
22.3 Dividends......Page 437
Summary......Page 443
Exercises......Page 444
23.1 What Is Game Theory?......Page 445
23.2 Simultaneous Games......Page 449
23.3 Sequential Games......Page 459
23.4 Game Theory and Real Options......Page 464
Key Terms......Page 469
Exercises......Page 470
24.1 Drug Development......Page 471
24.2 Energy......Page 481
Summary......Page 490
Exercises......Page 491
APPENDIX A: SAMPLE TERM SHEET......Page 492
APPENDIX B: THE VCFI SPREADSHEETS......Page 510
APPENDIX C: GUIDE TO CRYSTAL BALL®......Page 513
GLOSSARY......Page 538
INDEX......Page 561