Generally vcs look for compound rates of return

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Unformatted text preview: ublic offering); the remaining 5 to 10 percent are devoted to the buyout or acquisition of other companies. Generally, VCs look for compound rates of return ranging from 20 to 50 percent or more, depending on both the development stage and the attributes of each company. Earlier-stage investments tend to demand higher returns than later-stage financing because of the higher risk associated with the earlier stages of a firm’s growth. Deal Structure and Pricing Regardless of the development stage, venture capital investments are made under a legal contract that clearly allocates responsibilities and ownership interests between existing owners (founders) and the VC fund or limited partnership. The terms of the agreement will depend on numerous TABLE 7.2 Organization of Institutional Venture Capital Investors Organization Description Small business investment companies (SBICs) Corporations chartered by the federal government that can borrow at attractive rates from the U.S. Treasury and use the funds to make venture capital investments in private companies. Financial VC funds Subsidiaries of financial institutions, particularly banks, set up to help young firms grow and, it is hoped, become major customers of the institution. Corporate VC funds Firms, sometimes subsidiaries, established by nonfinancial firms, typically to gain access to new technologies that the corporation can access to further its own growth. VC limited partnerships Limited partnerships organized by professional VC firms, who serve as the general partner and organize, invest, and manage the partnership using the limited partners’ funds; the professional VCs ultimately liquidate the partnership and distribute the proceeds to all partners. 316 PART 2 Important Financial Concepts factors related to the founders; the business structure, stage of development, and outlook; and other market and timing issues. The specific financial terms will, of course, depend on the value of the enterprise, the amount of funding, and the perceived risk. To control the VC’s risk, various covenants are included in the agreement, and the actual funding may be pegged to the achievement of measurable milestones. The VC will negotiate numerous other provisions into the contract, both to ensure the firm’s success and to control its risk exposure. The contract will have an explicit exit strategy for the VC that may be tied both to measurable milestones and to time. The amount of equity to which the VC is entitled will, of course, depend on the value of the firm, the terms of the contract, the exit terms, and the minimum compound rate of return required by the VC on its investment. Although each VC investment is unique and no standard contract exists, the transaction will be structured to provide the VC with a high rate of return that is consistent with the typically high risk of such transactions. The exit strategy of most VC investments is to take the firm public through an initial public offering. Going Public initial public offering (IPO) The first public sale of a firm’s stock. prospectus A portion of a security registration statem...
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