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Executive Summary

Investment banks invest directly into companies through venture capital and private equity investments

Private companies are valuated using multiple methods: Comparables, Discounted Cash Flow, Option Valuation and Venture Capital Method

1. Venture Capital
- Make equity investment and recoup investment through the company going public or merger & acquisition
- Venture capitalist expects high return and takes an active advisory role
- Target companies are privately owned, high growth potential and have a strong management team
- s
2. Leverage Buyouts
- Uses debt to finance the majority of the purchase price
- High leverage enhances investment returns
- Target companies have low leverage, lots of tangible asset and in financial distress
Venture Capital and Leveraged Buyout enable investors to directly invest
into private companies

Venture Capital Leveraged Buyout (LBO) Fund of Funds

Target Company - High growth potential - Low leverage Primary Aim: Diversified
- Strong management team - Lots of tangible asset Portfolio
- In financial distress

1. Initial Public Offering (IPO) 1. Initial Public Offering (IPO) Fund managers construct
Exit Strategy 2. Merger & Acquisition (M&A) 2. Merger & Acquisition (M&A) diversified portfolio with limited
3. Bankruptcy 3. Bankruptcy partnerships with venture
capital funds and leveraged
buyout firms
- Sophisticated investors - Senior & Subordinated Debt
Form of Financing
- Equity - Equity

- Significant influence - 100% ownership


Level of Ownership
- Take active management role - Total control of the company
There are four main approaches to private company valuation

Information on private companies are limited, early stage companies may experience negative cash flow and earnings

Comparables Discounted Cash Flow Option Valuation Venture Capital

Transaction Company Present Value Follow-on investment Uncertain cash flow & profit

- Acquisition Multiple - Projection of sales and - Black-Scholes Model - Discount terminal value at
- Market Price Multiple operating profits - Incorporates flexibility to wait, target rate of return (TRR)
- Scenario analysis is learn and make decision - Terminal value determined
recommended using price-earning ratio
- More calculations for required
ownership percentage

- Need comparable companies - Highly dependant on - Real-world situation may be - cash flows are uncertain and
- Difference between assumptions too complicated to be fully may be negative
accounting policies captured

Generic, used for many investment decisions More relevant for private equity investment
Venture Capital funds has a life cycle of 10-12 years, investors exit through complete
liquidation of the portfolio

Profit Allocation: Pre-Negotiated


rest of the period 10-12 yr

20% of net profit


to general partner

Based on capital
contribution
3 - 7 yr
Loss Allocation

Loss allocated same way as profit until loss


4 mo. to 1 yr offset prior profits and capital contribution

Excess loss are 100% allocated to limit partners,


Fundraising Investment Grow Company Cash Out total subsequent profits are allocated until loss
is offset
Venture capital covers a wide range of the investment spectrum with different
expectations & requirements from investors

Seed Capital Start-Up Financing 1st Financing 2nd Stage Financing 3rd Stage Financing

Innovative Concept Product Development Marketable Prototype Finance Working Capital Major Expansion

- Establish feasibility of - Product development - Start operations - Growth stage - Increase in sales
concept - Initial phrase of marketing - Development of product - Finance goods in - Company becomes
and infrastructure process, inventories etc profitable

VC contribute large amount of money Diligent research and agreement is required


Share corporate ownership VC firm would want fixed securities and
Invest in the form of convertible debt or preferred stock management to have a larger share for
- (highest recovery of residual value) performance incentive
- Funding is based on specified goals
Leverage Buyout uses debt financing to acquire distressed companies and increase
leverage to enhance returns
10% - 20%

Senior Debt: 5 - 8 years


15% - 30%
- Collateralized with tangible asset of the company
- Loan from bank or issued financial notes
- Incorporate revolving line of credit based on liquidation
50% - 70% value of receivables and inventory

Subordinate Debt: 6 - 10 years

- Financed by insurance companies or funds


- High yield non-investment grade bonds are an
alternative

Senior Subordinate Equity Financial Equity: 10% - 20%


Debt Debt Structure
- Makes up the difference between the price that is not
covered by the debt financing

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