FINS5523 Alternative Asset Classes Week 4 – Venture Capital Investing: Instruments 1
2 Review What are the main advantages of the VCLP structure over other structures? Why can’t LPs fill the partnership agreement with as many covenants as possible? What are the main advantages of corporate venture funds (CVCs)?
3 Areas of concerns in private firm investments Risk Adverse selection Moral hazard VC investment toolkits covered today: Diversification Conservative valuation Financing instrument Screening and due diligence Staging and Syndication Lecture Outline
4 Focus of next 3 lectures Lecture Outline
5 Lecture Outline Risk Market (systematic) Firm (idiosyncratic) Moral Hazard Information Adverse Selection
6 Risks in Private Equity Investments
7 1. Market Conditions (Systematic Risk) Areas of systematic risk Uncertainty on the size of a potential market Uncertainty on the direction of the economy Uncertainty of future competition within a market Uncertainty with respect to future replacement technologies Uncertainty with respect to enforceability of contracts and protection of copyrights Do VCs have to be concerned about systematic risks?
8 2. Firm Specific Risk This refers to the array of potential outcomes for a company or project. The wider the dispersion of these possible outcomes the greater the risk. Should VCs be concerned about firm-specific risk? What factors make the possible outcomes of a young entrepreneurial firms widely dispersed?
9 2. Firm Specific Risk Entrepreneurial firm success is low probability event 9
10 2. Firm Specific Risk 'Not a surprise': Investors lose millions in Shoes of Prey collapse – SMH 13/3/2019 - Shoes of Prey was one of Australia's most high-profile startups , launched in 2009 by former husband and wife Michael and Jodie Fox, and Mike Knapp. - raised $US29.5 million in total from top investors , including Blue Sky Alternative Investments, US fund Greycroft Partners, Atlassian co-founder Mike Cannon-Brookes, Blackbird Ventures, Khosla Ventures as well as high-end American retailer Nordstrom , which opened Shoes of Prey design centres in some of its stores. - “Over the last 2 years we've made very good progress with our manufacturing capability however we've struggled to grow at the rates we'd forecast,” - "Despite all the right trends towards personalisation and our success within the customisation niche, contrary to our market research , the mass-market fashion customer just didn't respond as we expected,“ - "We weren't able to clearly prove that these customers were willing to pay us enough at a large enough scale to cover our fixed costs ," Mr Fox said.
11 Adjustments for RISK Survey results from Gompers, Gornall, Kaplan and Strebulaev (2019, Journal of Financial Economics ) “How Do Venture Capitalists Make Decisions?”
12 Adjustments for RISK
13 2. Risk vs. Information In a perfect market, risk considerations are irrelevant to the VC if they are sufficiently compensated by high returns
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