venture capital exam pt 2

What is the purpose of the management fee in a VC firm?

To cover operating expenses such as salaries, office costs, and travel.

How is the management fee typically calculated?

As an annual fee, typically 2%, based on committed capital.

What is 'carried interest' in a VC fund?

The VC firm's share of profits, typically 20%, representing their primary upside.

What is the function of a hurdle rate?

It is the minimum return (often 8%) LPs must receive before the VC firm is entitled to carried interest.

Why is a hurdle rate used in VC agreements?

To protect investors from paying carried interest on poor fund performance.

Who are the Limited Partners (LPs) in a VC fund?

The investors, such as pension funds, endowments, and family offices, who provide capital without managing the fund.

What is the role of General Partners (GPs) in a VC firm?

They manage the fund, make investment decisions, and receive compensation through management fees and carry.

What is a capitalization table (cap table)?

A spreadsheet tracking all equity ownership in a company, including share types, owners, and ownership percentages.

What is an option pool?

A reserve of shares set aside for future employee equity, typically created before a funding round.

How does the creation of an option pool affect founders versus new investors?

It dilutes the founders' ownership but does not dilute the new investors.

What is dilution in the context of equity?

The reduction in the ownership percentage of existing shareholders when new shares are issued.

When does dilution typically occur in a startup's lifecycle?

It happens every time new investors join during a funding round.

What is pre-money valuation?

The company's value before new investment is added.

How is post-money valuation calculated?

Pre-money valuation plus the new investment amount.

What is the formula for calculating an investor's ownership percentage?

Investment divided by post-money valuation.

What is a liquidation preference?

A VC's right to be paid out before other shareholders during a liquidation event like an acquisition or IPO.

What distinguishes preferred stock from common stock in a VC deal?

Preferred stock includes special rights such as liquidation preferences and anti-dilution protections.

What are the primary methods VCs use for sourcing deals?

Network, brand, referrals, and proprietary access.

What factors drive the 'picking' phase of the VC investment process?

Market size, team quality, power-law thinking, stage focus, and industry expertise.

What are the two common structures for liquidation preferences?

1x non-participating preferred and participating preferred.

Who typically holds common stock in a startup?

Founders and employees.

What are the four key factors for winning the best founders to a fund?

Speed, trust, value-add services, and reputation.

What is the core principle of Power-Law Thinking in venture capital?

The belief that VC returns are dominated by a few outlier investments.

What is a 'fund-returning deal'?

An investment that returns the entire value of the fund on its own.

How is Terminal Value defined in the context of a VC investment?

The company's value at the time of exit, such as an IPO or acquisition.

What is the purpose of Terminal Value in VC calculations?

To calculate the total returns for Limited Partners (LPs) and the VC firm.

What is Anti-Dilution Protection?

An investor right that adjusts share price downward if a company raises money at a lower valuation in a future round.