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The Business of Venture Capital: Insights from Leading Practitioners on the Art of Raising a Fund, Deal Structuring, Value Creation, and Exit Strategies, 2nd Edition


Praise for The Business of Venture Capital

The Business of Venture Capital is a comprehensive book with data, industry trends, and insights from leading VCs and LPs—a must have for practitioners.”
—David York, Managing Director, Top Tier Capital Partners,
a Fund-of-Funds with over $2 billion under management

“Whether you are a practitioner or a student of the venture capital industry, this book offers innumerable insights into the art of the deal.”
—Scott Kupor, Managing Partner, Andreessen Horowitz

“A valuable resource for beginners and experts alike, The Business of Venture Capital addresses the complexities and challenges of being a successful venture capitalist.”
—Michael Kim, Managing Partner, Cendana Capital, a next generation Fund-of-Funds

“Mahendra’s research into today’s most active investors reveals how the Venture Capital model is evolving. It’s the closest book I’ve found to a User’s Manual for VC.”
—David Cowan, Bessemer Venture Partners

“Combines concrete examples and deep insights of industry leaders–a must-have for any venture investor or practitioner.”
—Karim Faris, General Partner, Google Ventures

“Mahendra demonstrates how skill, discipline, and often luck and intuition can help to create successful venture capitalists. This is engaging and enjoyable.”
—Jon Callaghan, True Ventures

“Detailed yet accessible description of the many facets of venture capital–from the nuanced considerations of an LP to the intricate mechanics of the entrepreneurial companies they bet on.”
—Amish Jani, Founder and Managing Director, FirstMark Capital


“If you read only one guide to becoming a successful VC, this is the one to read.”
—Paul Maeder, Chairman, National Venture Capital Association (NVCA)

“Captures the LP mindset succinctly—any GP or aspiring VCs can benefit from this book.”
—Timothy Recker, Chairman, Institutional Limited Partners Association (ILPA)

“… packs the insights and wisdom of those who have done it, not once but multiple times.”
—Frank Caufield, cofounder, Kleiner Perkins Caufield and Byers,
one of the world’s leading venture firms

“An immensely useful and comprehensive guide.”
—Mark Florman, CEO, British Venture Capital Association (BVCA)

MAHENDRA RAMSINGHANI has over a decade of experience in fostering the growth of early-stage technology businesses. As Director-Venture Capital Initiatives for Michigan Economic Development Corporation (MEDC), Mahendra led the legislation for two Fund-of-Fund programs that deploy $200+ million in VC funds in Michigan. For his economic contributions, his US Citizenship was approved under “National Interest,” a category reserved for less than 1% of the applicants.

He is also the co-author of Startup Boards (Wiley, 2014) with VC and author Brad Feld. His articles have appeared in Forbes and MIT Technology Review.

Mahendra’s background includes a Bachelor’s in Electronics Engineering and MBA with a major in Marketing & Finance. He lives in San Francisco, CA.

Foreword xv

Preface xix

Acknowledgments xxiii

PART ONE Raising the Venture Fund 1

CHAPTER 1 The Basics 3

Raise the Venture Fund 3

Find the Right Investment Opportunities 4

Generate Financial Returns 6

Roles and Responsibilities 8

Compensation 9

Notes 12

CHAPTER 2 Getting In 13

Entry-Level Positions: Analysts and Associates 14

Internships and Campus Recruitment 18

Midlevel Positions: Principals and MDs 19

Honing Investment Expertise within Allied Fields 22

Senior Partner versus Junior Associate 24

What about Luck? 25

Notes 26

CHAPTER 3 Building Your Career as a Venture Capitalist 29

Intellectual Stimulation and Financial Returns 30

Aptitudes and Attitudes of Successful Practitioners 31

The Challenges of a VC Career 40

Notes 43

CHAPTER 4 The Universe of Limited Partners 45

An Overview of Alternative Assets 47

Sources of Capital: Limited Partners 51

Fund of Funds 59

FoF Models: Variation of a Theme 61

Comparison of Limited Partnerships 65

Notes 67

CHAPTER 5 How Limited Partners Conduct Fund Due Diligence 69

Sourcing and First Screens 70

Evaluating the Venture Firms 71

Notes 74

CHAPTER 6 Defining Your Fund’s Investment Strategy 77

Sector-Based Strategy 79

Stage and Geography 81

Notes 86

CHAPTER 7  How Institutional Investors Evaluate Fund Managers 89

The Fund Management Team Dynamics: Stability, Skill Set, and Alignment 91

Notes 99

CHAPTER 8 Fund Size and Portfolio Construction 101

Fit within the LP’s Current Portfolio 105

Market Timing 106

Why LPs Terminate Existing Relationships 108

Notes 109

CHAPTER 9 Performance Analysis 111

Individual Performance and Attribution 111

Fund-Level Performance 113

Comparison Benchmarks 117

Public Market Equivalents 119

The Quest for the Elusive Top Quartile Managers 119

All the Managers Are Above Average 122

Notes 124

CHAPTER 10 Emerging Managers: A Promise of the Future 125

Why LPs Seek Emerging Managers 127

How Investors Rank Emerging Managers 130

Institutional Allocations for Emerging Managers 131

A Tale of Two Emerging Managers 132

The Global Emerging Manager: 500 Startups 133

Notes 134

CHAPTER 11 The Venture Capital Firm, Operations, and Culture 137

The DNA of a Firm 137

Governance of the Firm 142

Notes 147

CHAPTER 12 The Fund-Raising Process 149

Build Your Target List of Investors 151

Fund Marketing Materials 152

Presentation Slides 154

Making the Presentation Pitch: Drink Your

Own Kool-Aid® 154

Attracting the Lead Investor: Your “Nut” 156

Communicate, Create, and Maintain Momentum 158

Announcing the Close 159

Notes 160

CHAPTER 13 Terms of Investment: The Limited Partnership Agreement 161

Key Terms 161

Fund Financial Terms 164

Fund Governance Terms 168

What Institutional LPs Seek 171

Offering Sweeteners to Attract LPs: A Double-Edged Sword 173

What Matters Most 173

Notes 175

CHAPTER 14 The Role of Placement Agents in Fund-Raising 177

Agents Bring Market Intelligence and Relationships 179

Ethical Challenges 182

Notes 183

PART TWO Making Investments 185

CHAPTER 15 Sourcing Investment Opportunities 189

The Best Source: The Network 194

Accelerators and Demo-Days 196

The VC e-Marketplace: AngelList, Kickstarter and FundersClub 197

Angels 197

The Fountainheads of Academia and Research 199

Corporate Research 200

Trade Conferences 201

Pitch Me, Bro 203

Competitions: From $40 Million Moonshot to $10K 204

Cold Calling 205

You Win Some, You Miss Some 206

Notes 209

CHAPTER 16 The Art of Conducting Due Diligence 213

The Due Diligence Checklist 214

What Is Important: Jockey, Horse, or Markets? 217

Who Invests in Rap Music and Shaving Blades? 220

Notes 223

CHAPTER 17 Management Team Diligence 225

Assessing Intangibles 225

How to Assess the Jockey 229

Serial Entrepreneurs versus First-Time Entrepreneurs 237

What about Charisma? 238

The Importance of Conducting Background Investigations 239

Notes 241

CHAPTER 18 Diligence beyond Management 245

Assessing the Market 245

Evaluating the Idea or Product 247

The Business Model 249

Financial Projections 251

Do Business Plans Matter? 252

Notes 253

CHAPTER 19 Structuring Investment Transactions 255

The Spirit of the Term Sheet 255

Negotiation Stress Points 256

Structuring Terms to Generate Target Returns 258

Valuation Methods and Other Voodoo Arts 260

The Drivers of Valuation 261

The Simplified Form of the Venture Capital Method of Valuation 262

Comparable Valuations of Similar Investments (Comps) 264

Discounted Cash Flow Method 266

Convertible Loan 268

Equity: Preferred Stock 270

Liquidation Preference 273

Antidilution Protections 277

Milestone-Based Financing: Risk Mitigation or Distraction 279

Governance and Control: Protecting Your Securities 280

Exit-Related Provisions 281

Other Terms 284

Syndicating Investments 285

Keeping Term Sheets Simple 286

The Closing Process: After the Term Sheet 289

Notes 291

CHAPTER 20 Serving on the Board 295

Self-Education: Preparing for Your Board Role 296

Roles and Responsibilities of a Board Member 297

Legal Requirements of Board Service 298

Notes 302

CHAPTER 21 Board Culture, Composition, and Orientation 303

Toward a Better Board Culture 305

A VC Reports to Limited

Partners and the Venture Capital Firm 309

Importance of Independent Directors 309

Notes 310

CHAPTER 22 Board Value Creation and Evaluation 311

Good Governance as the First Step toward Value Creation 313

The CEO’s Perspective on VC Value Add 314

Board Self-Evaluation 317

Notes 318

CHAPTER 23 Challenges in the Boardroom 321

Challenges among Shareholders 322

Managing CEO Transition 326

Best Practices in Managing Transitions 328

Alignment of Exit Method, Timing, and Exit Value 329

Notes 330

CHAPTER 24 Exit Strategies 333

Preconditions for an Exit 334

Secondary Markets 339

Notes 342

CHAPTER 25 Acquisitions: The Primary Path to an Exit 343

The Sell Process 349

When an Acquirer Comes Knocking 353

The Buy-Side Acquisition Process 354

Deal Killers 358

Notes 359

CHAPTER 26 Initial Public Offering 361

The IPO Process: The Long and Winding Road 362

Steps to an IPO 363

Not an Endgame, but a Financing Event 366

Timing the Market 367

IPO Underpricing and Dutch Auctions 367

Information Asymmetry: The Bigger Fool Theory of IPO Underpricing 369

The Dutch Auction: Eliminate the Pop and Those Middlemen 370

Post IPO: Should VCs Stay Engaged? 371

Notes 373

CHAPTER 27 Human Psychology 375

Emotions versus Logic 375

Reciprocation, Obligations, and Indebtedness 376

A VC with Ego: Why Should I Eat Your Leftovers? 376

Conformity (or Groupthink) 377

Rock Stars in the Business 378

That Overhyped Rolodex is Not as Useful as You Think 378

Notes 379

Afterword 381

About the Author 385

About the Companion Web Site 387

Index 389