Class 11 - Financial distress Flashcards
Why care about financial distress …
in a course on VC financing?
way to foresee the possibility and takeinto account this posibility to value the company correcly and to invovle vc fund managers to avoid financial distress
most companies are in technical bankruptcy until they ahve the financing they need!
explain the 10 reasons to care
- One in ten companies is very successful … A company has approximate success
… Eight are left behind !?
1 in ten is very successful in general
left behind : not necessaryly bankrupt but sold or they dont do nothing
if theres a 10% of sucess, 90% of financial distress!
probability approach is more accurate then having a high discount rate
- Companies rely on their VC as the ONLY source of funding
… which is not always available!
when a vc fund invest, it becomes a partner and the only source of fuding
so if the vc fund decides to stop investing on a follow up basis, puts companies in danger !
they invest in stages so theres always the possibility of not getting the follow up financing - The creation of value is based on innovation
theres a technological risk/business risk as to the value of the tech! you dont know if its gonna sell or not, often youre creating a new market
explains why vc are able to get a ghigh return, because the companies are very risky!
8 companies going bankrupt is notbecause they were ismanaged, but rather because the drug is not working!
- Historical data shows a failure rate of 49.1% of the first rounds of financing after 10 years
failure rate is not always recognized, you can have living dead companies, they are still 9in the ptf but just because the vc dont want to write off the company - Some VCs tend to be late-stage investors
… To the detriment of the “early-stage” companies which suffer as a result!
at the time, vc was seen as investing only in start up
apres, some funds decided to invest in late stage companies, time to market is sooner donc avantageux, moins de risque - VC investments can be considered as “Calls” …
… more valuable the higher the volatility
vc investment are considered as call options because the real value is zero until you reach a certain point. all of nothing aspect
soit tu fais 10000% ou 0%
managers are paied out of options! ils sont payer sur le upside, donc le carry cest ocmme un call opion! tu as juste le upside. you want to be compensated with the successes
they prefer owing a call on the fund rather than a part of the fund
Investments in successive stages take the place of control measures in case of failure!
stages means you know theres a lot of failure probability!
you want to reassesyour decisions
- VCs protect their downside
they buy preferred shares convertible into common shares when they go public
bargaining power of leaders : liquidation preferece (put on the treasury of the company) protect the investment from some of the downside and recuperating a part of the investment
Preferential redemption right for VCs (liquidation preference)
if theres a sale of the company and the liquididation prefrence quicks in, does it happen
in some circumpstention, the vc fund share the preference with the mangement of the firm
they do this to keep a certain reach in the firm
vc vendent lentreprise avec comme condition que le mangement reste alors pour que le mangement reste, les vc leur disent quils vont leur donner une partie du liquidation preference pour les garder
- VCs want to control the firms in which they invest
because of financial distress! it has to do with mangement risk. they know they dont bring something to the table with the innovatin, but rather with the management discision
cest pour diminuer leur risque de défauT1
involvement of vc : Presence on the board of directors Access to information about the company Veto right they want to reduce the agency risk and cost !
- VC fund managers are ready to change the direction of the firms …
vc funds are ready to change the management rather than the business plan.
its easier to change the management than the business plan
even though they say they invest in people, but if the tech is not good, they wont invest just because the person is good.
- Success: Entrepreneur’s Perspective
Three out of four entrepreneurs have zero returns; those with positive returns only get an average of $
5.8 million on exit.
founders have 0 return!
the founders are there to take on a lot of risk because its their only investment.
vc fund want them toonly focus on that project becuase if they fail, they have nothing
success vc perspective :Firms funded by VCs are more likely to make an IPO, and be acquired, and less likely to fail
ipo, or acquired
acquisition are not always done at a high price. on average, its not a very high retunr
caveats to distress analysis
Empirical analysis of distress
Difficult to analyse
Data availability
daa source :
VC fund, on a voluntary basis
Investors (LPs), on a voluntary basis
Both can be secretive!
unavailability of data.
the vc fund will not give them all their data, and relunctant to report bad investments. they dont want to report their data
your also not super precise on what they report
Selective survival bias
if you dont report your failure, you show better! but eventually your performance will be bad so its reported implicitly
Dispersion of returns ;The dispersion of returns is substantial, the gap is large between the worst and the best
Confusion : data base is not always clear with what is what
some are living dead, others are bankrupt, et tu pas pas savoir qui est quoi
restructuring of liquidation?
Nature of the assets involved : It would depend on the type of assets the firm owns…
what do you do when youre in distress
innovative company theres not a lot of assets so you dont have anything to liquidate. so if you go bankrupt, theres nothing left
Business turnaround and VCs
but the managers have little power, vc has a lot of rights.
si la firme est un failure, le mngt est encore moins important alrostu transferes la tech a une autre entreprise
characteristic of vc investment w/ financial distress
Characteristics of companies of interest for VCs
The value of tangible assets is often minimal
The value of intangible assets may be significant
Realization of asset value is often closely linked to the personnel of the firm
when a comapny is restructured, the management is not automatically fired, somethings they are of value because they know the tech
Long-term lenders are generally absent
Cash flow is not sufficient to determine the value of assets
The survival of the company depends mainly on the willingness of its partners to finance negative cash flows
Constant bankruptcy state
theres no debt!
they are in constant state of eminant bankrupcty pcq dependent des cashflows des investisseurs
stakes and basic principles
How to keep the future value of the company in the hands of its partners?
reorganization is almot always profitable
cest pk tu preferses avoir des living dead
Recovery is based on the realization of the risk
The rules on distribution amongst creditors aim to take into account the differences in the assumption of risk on the part of different types of creditors
going bankrupt is a realization of the risk
Managers can themselves coordinate the turnaround of their business
given the first right to restructure the company. they are the ones better positionned to bring success meme si ca va pas bien
ils ont pris du risque, avaient tord, they learned a few things alros tu laisses une chance!
le risque cest juste matérialisé, cest normal
youre not delinquant when you go bankrupt
you took a risk, we wanted you to take a risk, we cannot blame it on the managers becasue they were encouraged to take risks
The case of innovative firms :
Entrepreneurs must have the right to make mistakes …
… to get them to take risks
VC investors expect a high failure rate
they need to be able to make mistakes and take risks!
you want people to want to leave their day job and thake a risk without being punished
