Textbook
Venture Capital and the Finance of Innovation, 2nd EditionSeptember 2010, ©2011

In Venture Capital and the Finance of Innovation, future and current venture capitalists will find a useful guide to the principles of finance and the financial models that underlie venture capital decisions. Assuming no knowledge beyond concepts covered in firstyear MBA course, the text serves as an innovative model for the valuation of start ups, and will familiarise you with the relationship between risk and return in venture capital, historical statistics on the performance of venture capital investments, total and partial valuation—and more.
Part I VC Basics
Chapter 1 The VC Industry 3
1.1 What Is Venture Capital? 3
1.2 What Do Venture Capitalists Do? 9
1.3 The History of Venture Capital 10
1.4 Patterns of VC Investments in the United States 14
Summary 19
Key Terns 20
References 20
Chapter 2 VC Players 21
2.1 Firms and Funds 21
2.2 The Limited Partners 27
2.3 VC Partnership Agreements 30
Summary 41
Key Terms 42
References 42
Exercises 42
Appendices: Key Terms and Conditions for Three VC Funds 43
Chapter 3 VC Returns 46
3.1 Industry Returns 46
3.2 Fund Returns 53
Summary 62
Key Terms 63
References 63
Exercises 63
Chapter 4 The Cost of Capital for VC 65
4.1 The Capital Asset Pricing Model 65
4.2 Beta and the Banana Birds 69
4.3 Estimating the Cost of Capital for VC 74
Summary 79
Key Terms 80
References 80
Exercises 80
Chapter 5 The Best VCs 83
5.1 The Economics of VC 83
5.2 The Best VCs: A Subjective List 86
5.3 VC Value Added and the Monitoring of Portfolio Firms 95
Summary 98
Key Terms 98
References 98
Chapter 6 VC Around the World 99
6.1 The Global Distribution of VC Investing 99
6.2 The Cost of Capital for International VC 111
Summary 119
Key Terms 199
References 119
Exercises 120
Chapter 7 The Analysis of VC Investments 123
7.1 VC Investments: The Historical Evidence 123
7.2 The Investment Process 135
Summary 144
Key Terms 145
References 145
Chapter 8 Term Sheets 146
8.1 The Basics 147
8.2 The Charter 151
8.3 Investor Rights Agreement 155
8.4 Other Items 159
Summary 161
Key Terms 161
References 162
Exercises 162
Chapter 9 Preferred Stock 163
9.1 Types of Preferred Stock 163
9.2 Antidilution Provision 173
Summary 176
Key Terms 177
References 177
Exercises 177
Chapter 10 The VC Method 178
10.1 The VC Method: Introduction 178
10.2 The Standard VC Method 184
10.3 The Modified VC Method 185
Summary 192
Key Terms 192
References 192
Exercises 192
Chapter 11 DCF Analysis of Growth Companies 195
11.1 DCF Analysis: Concepts 196
11.2 DCF Analysis: Mechanics 198
11.3 Graduation Value 204
11.4 DCF Analysis: The RealityCheck Model 207
Summary 212
Key Terms 212
References 213
Exercises 213
Chapter 12 Comparables Analysis 214
12.1 Introduction to Comparables Analysis 215
12.2 Choosing Comparable Companies 219
12.3 Using Comparable Companies to Estimate the Cost of Capital 224
Summary 226
Key Terms 227
References 227
Exercises 227
Appendix 12.A: Potential Comparables for Semico 228
Part III Partial Valuation
Chapter 13 Option Pricing 231
13.1 European Options 232
13.2 Pricing Options Using a Replicating Portfolio 234
13.3 The BlackScholes Solution 238
13.4 American Options 242
13.5 RandomExpiration Options 243
13.6 Reading Exit Diagrams 245
13.7 Carried Interest as an Option 247
Summary 248
Key Terms 249
References 249
Exercises 249
Appendix 13.A RE Options: Technical Details 250
Chapter 14 The Valuation of Preferred Stock 252
14.1 BaseCase OptionPricing Assumptions 253
14.2 RP Valuation 254
14.3 Excess Liquidation Preferences 257
14.4 Dividends 259
14.5 CP Valuation 261
14.6 CP with Excess Liquidation Preferences or Dividends 263
14.7 Combining RP and CP 266
14.8 Comparing RP and CP 268
Summary 269
Key Terms 270
References 270
Exercises 270
Chapter 15 LaterRounds Investments 272
15.1 Series B 272
15.2 A Conversion Shortcut 277
15.3 Series C 278
15.4 Dividends in Later Rounds 282
15.5 Beyond Series C 285
Summary 288
Key Terms 288
Exercises 288
Chapter 16 Participating Convertible Preferred Stock 290
16.1 Binary Options 291
16.2 The Valuation of PCP 292
16.3 The Valuation of PCPC 294
16.4 Series B and Beyond 296
Summary 303
Key Terms 303
References 303
Exercises 303
Chapter 17 Implied Valuation 305
17.1 PostMoney Valuation Revisited 306
17.2 Measurements of Portfolio Value 310
17.3 Down Rounds? 314
17.4 How to Avoid Valuation Confusion 317
Summary 318
Key Terms 318
Exercises 319
Chapter 18 Complex Structures 320
18.1 Management Carveouts 320
18.2 Dealing with Partners 327
18.3 A Complex Example 329
Summary 334
Key Term 334
Exercises 34
Part IV The Finance of Innovation
Chapter 19 R&D Finance 339
19.1 R&D Around the World 339
19.2 Two Touchstones 345
19.3 How is R&D Financed? 349
19.4 Where Do We Go From Here? 354
Summary 355
Key Terms 356
References 356
Chapter 20 Monte Carlo Simulation 357
21.1 Decision Trees 379
21.2 Real Options in R&D 381
21.3 The Valuation of Real Options 382
21.4 RiskNeutral Probabilities 388
21.5 Drugco, Revisited 395
Summary 398
Key Terms 398
Exercises 398
Chapter 22 Binomial Trees 400
22.1 The BlackScholes Equation, Revisited 400
22.2 Multiple Strike Prices and Early Exercise 409
22.3 Dividends 411
Summary 417
Key Terms 418
References 418
Exercises 418
Chapter 23 Game Theory 419
23.1 What Is Game Theory 419
23.2 Simultaneous Games 423
23.3 Sequential Games 433
23.4 Game Theory and Real Options 438
Summary 443
Key Terms 443
Exercises 444
Chapter 24 R&D Valuation 445
24.1 Drug Development 445
24.2 Energy 455
24.3 The Forest and the Trees 464
Summary 464
References 465
Exercises 465
Appendix A Sample Term Sheet 466
Appendix B The VCFI Spreadsheets 484
Appendix C Guide to Crystal Ball 487
Glossary 512
Index 535
Ayako Yasuda is an Assistant Professor of Management at the Graduate School of Management, University of California, Davis. She was previously a faculty member in the finance department at the Wharton School of the University of Pennsylvania; prior to her Ph.D. she worked at the Investment Banking Division of Goldman, Sachs & Co. Dr. Yasuda received a BA and Ph.D. in Economics from Stanford University. She has won numerous research grants and has been published in the Journal of Finance, Journal of Financial Economics, and the Review of Financial Studies.
 New coauthor: Ayako Yasuda is Assistant Professor of Management at the Graduate School of Management, University of California, Davis and former faculty member in the finance department at the Wharton School of the University of Pennsylvania; prior to her Ph.D. she worked at the Investment Banking Division of Goldman, Sachs & Co.
 New unified treatment of investment decision making combining total valuation and partial valuation analysis.
 New rankings of the “best venture capitalists.”
 New webbased model (VCVtools.com) allowing easy visualisation and valuations of multiple term sheets in a startup.
 Refined version of “realitycheck” valuation model to allow for greater flexibility in growth assumptions.
 Updated riskreturn and costofcapital calculations.
 Updated industry data showing large changes in venture capital investments since 1999.
 Streamlined exposition of realoptions methodology, with new connections to venture capital valuation.
 Discussion of challenges facing venture capital in the second decade of the 21st century.
 Innovative model for the valuation of startups.
 The relationships between risk and return and strategy and finance in venture capital.
 Historical statistics on the performance of venture capital investments.
 Total Valuation: the data and methods used to value a highgrowth company.
 Partial Valuation: how to visualise and evaluate the special features of VC transactions such as convertible preferred stock, participating preferred stock, paymentinkind dividends, and liquidation preferences.
 Framework for modeling investment in "research and development."
 Cutting edge techniques such as MonteCarlo analysis, real options, binomial trees, and game theory.
—Paul A. Gompers, Eugene Holman Professor of Business Administration & Director of Research, Harvard Business School
"Despite the increasing importance of the venture capital
industry, until now there was no reference that could provide
practitioners with a specialized grounding in finance. With clear
explanations and practical models, Metrick’s book can fill
this gap. I enthusiastically recommend this book to all venture
capitalists."
—Ted Schlein, Partner, Kleiner Perkins Caufield &
Byers
"Investors in young, fastgrowing companies have a new way to
calculate their value without regard to the prices of other
companies’ stocks. This is an important advance, because most
other appraisal methods for startups are based on relative
valuation, which – as we saw at the top of the Internet
bubble – grossly overvalues a new company when comparable
companies in the same industry are also overvalued."
—Mark Hulbert, The New York Times, Dec. 31, 2006
This text refers to an alternate Hardcover
edition.
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