Class 1 - Valuation

Question 1

What is a venture capital fund

Answer 1

A private investment fund that is specialized in investing in innovative enterprises. it looks for high returns

For institutional investors;
retail investors are not solicited

Question 2

Which type of investors does a venture capital fund typically target?

Answer 2

For institutional investors;
retail investors are not solicited 
… but can include High Net worth Individuals…
	Family « office »
	Angels  

Institutional investors are…
 Endowment funds
 Pension funds
 In the past, VC funds solicited commercial banks or investment banks but they no longer do so because it is too risky for commercial banks

Question 3

Why do VC funds exclude retail investors?

Answer 3

Because they solicite investors directly on a one on one basis. VC investments do not have a risk profile that is appropriate for retail investos

Question 4

What type of investment is VC?

Answer 4

VC funds are
« alternative investments »

And sometimes regrouped with private equity, real estate, hedge funds, real assets…

VC typically targets start ups and tech companies
PE targets more well established companies that already have cash flows but need more financing

Question 5

In what type of companies do VC funds invest?

Answer 5

VC Funds invest in private companies with high growth potential. They look for innovative companies. They have a high growth potential because they are based on a new technology of some sort

Question 6

What management style do venture capitalist have?

Answer 6

They are active investors.
They manage companies as much as they manage investments.

They are invovled in the company because their investment is parked for many years. It is not a liquid investment and thus, they are active towards it and involved.

En comparable, traditionnal investments are very liquid so you dont need to be active since you can leave the investment when you want.

Question 7

Why do they demand high returns?

Answer 7

VC funds are expecting (demanding) high returns…

For high-risk investments  

Question 8

How are the returns realized?

Answer 8

The return on VC funds investments is realized by
 Bringing companies they invest in on the market with an IPO (Initial Public Offering)
 Selling companies they invest in, sometimes as part of a consolidation play 

Simple scheme :
Invest - Monitor - Exit

Question 9

What role do VC funds play in the finance industry?

Answer 9

VC funds fill a void in the finance of new high growth innovative companies

Commercial banks do not lend money to these companies. They lend to companies that have assets to put in collateral and somewhat stable cash flows.

Question 10

Define those expressions : 
“VC Firms”
“Limited Partnership (LP)”
“LP (Limited Partners)”
“GP (General Partners)”
“Early-Stage Fund”
“Late-Stage Fund”
“Management Fee”
“Carried Interest”

Answer 10

“VC Firms” : funds themselves
“Limited Partnership (LP)” : contract between the LPs and the fund
“LP (Limited Partners)” : investors
“GP (General Partners)” : fund managers
“Early-Stage Fund” : start ups
“Late-Stage Fund” : more stable companies that are still a bit young
“Management Fee” : fees payed for the GP’s job (typically 2%)
“Carried Interest” : GP catches 20% of all upside of the fund

Question 11

How is value « created »?

Answer 11

two factors :
Company with high growth potential
Return on invested capital (ROIC) which “greatly exceeds” the cost of capital…
TO FINANCE GROWTH WITH INTERNAL CASH FLOWS

By investing in a company that will grow in value because of its cash flows.
Value is created when a company has a competitive edge over other companies, which will generate more cash flows. those companies created a new technology and have good margins.

Question 12

How do we recognize value creation in investments in general?

Answer 12

with a model based on forecasts : DCF

Question 13

How are investment projects evaluated?

What is the best method to establish that an investment is creating value?

Answer 13

based on free cash flows
the best method to establish if hte investment creates value is by calculating its NAV or the PV of CF

we can also look at the value creation vs cost of capital

Question 14

How is risk accounted for in the valuation of investments?

Answer 14

in the discount rate. we chose the discount rate based on the risk of the investments

Question 15

What are « Value Drivers » according to KOLLER et. al.?

IMPORTANT***

Answer 15

• Growth potential for a long period of time
• potential to realize high net margin based on their competitive edge, which gives it a capacity to finance its growth internally.

Question 16

name some Basic notions of performance analysis

According to Koller et. al.

Answer 16

Return On Invested Capital (ROIC)
Net Operating Profit Less Adjusted Taxes
(NOPLAT)
ROE

Question 17

Define the important ratios :
Return On Invested Capital (ROIC)
Net Operating Profit Less Adjusted Taxes
(NOPLAT)
ROE

Answer 17

ROIC= ,Net Operating Profit Less Adjusted Taxes/ Invested Capital (IC)

ROIC = (1-t) × (EBITA/Revenues) × (Revenues/Invested capital)

ROE = ROIC + ([ROIC- (1-T) kd ] x D/E)

Question 18

Why are Interest payments are not accounted for in NOPLAT

Answer 18

because we want to isolate the company from its capital structure. you want to see what comes from its core business. adjusted tax means that we normalize the taxes. you set a normal basis of taxes because we want to represent the company on a perpetual basis so it needs to be representative.

Question 19

What are the basics of the DCF model?

Answer 19

Free Cash Flow (FCF)
FCF = NOPLAT + Noncash Operating Expenses - Investments in Invested Capital

FCF= NOPLAT - Net Increase in Invested Capital

Question 20

Why are free cash flows the basic tenet of business valuation? REVOIR ENREGISTREMENT AUDIO

Answer 20

because value is created based on the cash flows created. thus, assessing what will be the created cash flows is important to value a company

Question 21

What is generally the period over which financials are forecasted?
What is the basic principle underlining the length of the forecast period?

Answer 21

5 years because we want to be able to make adjustments. the, we assume the growth will be the same for a perpetual basis.

Question 22

What the easiest assumption to set the perpetual growth?

Answer 22

growth of the economy (2%) based on the fact that the company will defend its place in the market and the economy (it will not lose market share)

Question 23

How do KOLLER et. al. suggest resolving the difficulty of forecasting financial results over a long period?

Answer 23

forecast 5 years and then assume stable margins. you have to attain the representative year with the projected cash flows to then calculate the terminal value

Question 24

How is value creation usually represented in financial forecasts?
IMPORTANT***

Answer 24

growth and margins

Question 25

Why base forecasts on revenue?

Answer 25

Because the revenue is easier to forecast and then you assess the margins

Question 26

Which are the most important factors in value creation?

Answer 26

growth and margins

Question 27

what is the value creation at its best

Answer 27

A business …
 Which has a better return on its investment than its cost of capital (ROIC  WACC ) (thus, growth)
 Which realized sustained growth over a long period of time (done with good margins)

Question 28

why is microsoft and interesting case?

Answer 28

because they have been able to grow the company at a 25% rate over 34 years. they were able to do so because they were able to finance their growth internally with its good margins.

Question 29

what is Corporate finance at its best

Answer 29

Financing growth with internal cash flows