Chapter 12
PROFESSIONAL VENTURE CAPITAL
FOCUS
In this chapter, we consider the highest profile segment of the venture investing markets:
professional venture capital. We discuss the origins of venture capital and the periodic
fluctuations accompanying major new technologies. We give special attention to the
professional venture capital screening and investment processes.
LEARNING OBJECTIVES
LO 12.1: Discuss the history and current status of venture investing in the United States.
LO 12.2: Identify the seven stages of a typical professional venture investing cycle.
LO 12.3: Describe some of the specializations of venture capital firms.
CHAPTER OUTLINE
12.1 HISTORICAL CHARACTERIZATION OF PROFESSIONAL VENTURE
12.3 DETERMINING (NEXT) FUND OBJECTIVES AND POLICIES
12.4 ORGANIZING THE NEW FUND
12.5 SOLICITING INVESTMENTS IN THE NEW FUND
DISCUSSION QUESTIONS AND ANSWERS
1. What is a professional venture capitalist? How does this occupation differ from that
of an angel investor?
A professional venture capitalist is one who invests not only his own money but also
2. Briefly describe how professional venture capital got started after World War II.
See section 12.1 for details. Professional venture capital, as we know it today did not
3. What was the early role of the Small Business Administration (SBA) in fostering
venture investing?
The SBA initially helped small businesses get government contracts and then moved
4. Describe the development of professional venture investing in the 1960s, 1970s, and
early 1980s.
After the overheated SBIC market, private venture capital partnerships became the
5. What has happened to professional venture investing since the mid-1990s?
Much of the growth in VC investing during the second-half of the 1990s was
6. What are the components or stages in the professional venture investing cycle from
inception to funding?
(1) Determine (Next) Fund Objectives and Policies; (2) Organize New Fund (usually
7. What are the components or stages in the professional venture investing cycle after
funds have been raised until closure?
(5) Conduct Due Diligence and Actively Invest; (6) Arrange Harvest or Liquidation;
(7) Distribute Cash and Securities Proceeds (as available).
8. Who are the major suppliers of venture capital by type and size of commitment?
Refer to Figure 12.4 which shows Suppliers of Venture Capital as determined by
9. What is meant by the terms (a) capital call, (b) deal flow, and (c) venture investing
due diligence?
(a) capital call: when the venture fund calls upon the investors to deliver their
10. What is meant by the terms (a) lead investor, (b) SLOR, and (c) term sheet?
(a) lead investor: venture investors taking the lead for a group (syndicate) of other
11. Why should entrepreneurs care what pressures venture capitalists face in carrying
out their professional money management (intermediation) function?
Entrepreneurs should care about the outside pressures because venture capitalists
12. Why do venture capitalists make quick decisions on the infeasibility of some business
plans? When a business plan is not quickly determined to be infeasible, what
happens next and why?
Venture capitalists screen a large number of business plans in any given year. Due to
limited staffing and their receiving many plans that fall outside of their field for
13. What should be the goal of the financial projections in a business plan submitted to a
venture capitalist?
The goal of financial plans submitted to a VC is to provide evidence that the business
14. Is the compensation paid to venture capitalists (e.g. 2% management fee and 20%
carried interest) reasonable? What are a fund’s investors buying with this
compensation?
While the determination of reasonableness of VC compensation is somewhat
15. Why are venture capital funds typically organized as limited partnerships? In
particular, why are they private firms instead of public firms?
VC funds are typically private in part due to their ability to avoid registration with the
16. What can be learned from the SBA’s creation and the Internal Revenue Service’s
subsidy of venture investing through SBICs?
Typically tax subsidies attract investors. The SBIC structure subsidizes capital costs
17. Discuss why it is important to have an exit event for each investment held by a
venture investment fund.
An exit event for each investment is necessary to bring a venture capital fund to
closure. The VCs must arrange for the liquidation or harvest of each investment and
18. From the Headlines – Tabula: Describe the role venture capitalists played in the
founding and expansion of Tabula. Comment on possible reasons for the involvement
of multiple VC firms.
Answers will vary: Tabula was founded with venture capital and has completed
INTERNET ACTIVITIES
Web-researched results will vary due to constant updating of the related web sites.
2. Visit a venture capital fund’s web site and summarize the fund’s history and current
activities.
Web-researched results will vary due to constant updating of the related web sites.
EXERCISE/PROBLEMS AND ANSWERS
1. [Venture Capital Firms] List three venture capital firms active in your region and
describe their investing style and restrictions.
2. [Venture Capital Fund Raising] Locate a recent study covering venture capital
fundraising (not investing) for the previous year. Determine what the current sources
of funds tend to be.
3. [Venture Funding Attributes] Interview a local venture capitalist regarding what s/he
looks for in a promising venture seeking funding. Summarize your discussion.
Answers will vary.
4. [Venture Capital Firms] Determine the three largest venture capital firms in the U.S.
How much money do they have under management? In what areas, if any, do they
specialize? Where are they located? Where are their branch offices?
The venture capital sites (on the WWW) and annual reports (in libraries) typically
5. [Conducting Due Diligence] Suppose you become an intern at a local VC firm and
are asked to assist in due diligence on a proposed investment in a telecommunication
company. Explain how you would approach such a task and where and how you
would structure your investigation. What data sources would you use?
First, one typically would read the business plan/pitch submitted for consideration.
6. [Term Sheet Terms] List ten terms you might find in a venture capital fund’s terms
(see Figure 12.6). Explain what they are and why it might make sense to structure
them the way they are.
7. [Venture Investing Example] Find a recent Wall Street Journal article on venture
investing and summarize it.
Answers will vary.
8. [Recent VC Investment Levels] Update Figure 12.1 in terms of recent levels of VC
investments
Answers will vary.
9. [Venture Capital Investing Information] List ten web sites or hardcopy magazines
that contain venture capital investing information that might be of use to
entrepreneur’s seeking venture capital.
For example:
10. [Recent IPO Example] Locate a venture-capital-backed firm that recently completed
an initial public offering (IPO). Provide a summary of the venture’s history and
success through the IPO and to date.
Answers will vary. The Spatial Technology, Inc. Capstone Case at the end of the text
provides an in-depth case of the IPO of a venture-backed company.
MINI CASE: INTERACT SYSTEMS, INC.
Interact Systems, Inc. has developed software tools that help hotel chains solve
application integration problems. Interact’s Application Integration Server (AIS)
provides a two-way interface between central reservations systems (CRS) and property
All reservation traffic is routed from the CRS to individual hotel properties. This
allows Interact Systems to create a database that can be used to track customers and to
facilitate marketing programs, such as frequent stay or VIP programs, as a way of
increasing customer satisfaction. Interact forecasts application integration expenditures
in the hospitality industry to exceed $1 billion by 2021.
Westskow joined Interact in early 2018 as President and CEO. Prior to that time, he
worked in sales and marketing in the software industry for over 20 years.
A. A VC is considering providing the additional $5 million. What type of fund (stage
specialization, industry focus, etc.) would you approach? In what part of their
investing cycle would you hope to approach them?
B. Discuss how Interact Systems would be expected to fare in the VC screening
process involving each element of Figure 12.5.
Venture capital firm requirements: giving up equity position anyway; previous
VC investment; size is not unreasonable for this stage with sales in place
C. Discuss typical issues that might be addressed in a term sheet using Figure 12.6
as a reference.
Answers will vary depending on students’ perceptions from the description and how they