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Fund Economics

Session 3: In this session, Samik Rakshit explains the economic model of venture funds

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Fund Economics

  1. 1. Fund Economics May 2020 Samik Rakshit Head Fund Operations, pi Ventures @samik_rakshit
  2. 2. Fees & Expenses Distribution Waterfall Fund Nuances Agenda
  3. 3. Management fee - Amount charged by the General Partner towards managing the fund on behalf of the Limited Partners. Usually it is 2% p.a. of the Commitment during the Commitment Period. Post that it will be 2% p.a. of Contribution less any Disposal/ Write-Offs etc. For more established VCs the management fee can be higher and be in the range of 3% Operating expense - Amount charged to operate the Fund viz. audit, valuation, fund administration etc. Usually it ranges between 0.25-0.5% p.a. of commitment. Set-up fee - Amount charged to Fund as an initial charge to set it up. It is a one time fee and in the range of 0.5-1% of the Commitment of the Fund. Investible corpus - The amount of Commitment which is meant for Portfolio Investment i.e. Commitment - (Management fee + Operating expense + Set-up fee). It usually ranges between 75-85% of the Total Fund Commitment. Fee & Expenses
  4. 4. Management Fee Curve Commitment period First close Final close (INR in crs) Year Mngt fee (%) Mngt fee (INR) Commitment (INR) Contribution % (cumulative) Disposal % (cumulative) Y1 2% 0.8 40 30% 0% Y2 2% 1.4 70 30% 0% Y3 2% 3.8 100 50% 0% Y4 2% 2 100 50% 2% Y5 2% 1.3 100 70% 5% Y6 2% 1.2 100 70% 10% Y7 2% 1.6 100 90% 10% Y8 2% 1 100 90% 40% Y9 2% 0.8 100 100% 60% Y10 2% 0.2 100 100% 90%
  5. 5. Fund 1 Fund Structure & Fund Flow Basic Concept
  6. 6. Investors (LP) (HNIs, Corporate, Banks, Others (Domestic & Foreign)) Commitment 2 Fund 1 Fund Structure & Fund Flow Basic Concept
  7. 7. Investors (LP) (HNIs, Corporate, Banks, Others (Domestic & Foreign)) Commitment 2 Fund 1 Manages the fund for LPs by making Investment decisions 3 General Partner Investment Committee & Advisory Board Investment team Investment Manager (IM) Fund Structure & Fund Flow Basic Concept
  8. 8. Investors (LP) (HNIs, Corporate, Banks, Others (Domestic & Foreign)) Commitment 2 Fund 1 Manages the fund for LPs by making Investment decisions 3 Portfolio 1 Portfolio 2 Portfolio 3 Portfolio 4 Portfolio 5 4 General Partner Investment Committee & Advisory Board Investment team Investment Manager (IM) Fund Structure & Fund Flow Basic Concept
  9. 9. Investors (LP) (HNIs, Corporate, Banks, Others (Domestic & Foreign)) Commitment 2 Fund 1 Manages the fund for LPs by making Investment decisions 3 Portfolio 1 Portfolio 2 Portfolio 3 Portfolio 4 Portfolio 5 4 - Pays Management fee. 5 General Partner Investment Committee & Advisory Board Investment team Investment Manager (IM) Fund Structure & Fund Flow Basic Concept
  10. 10. Investors (LP) (HNIs, Corporate, Banks, Others (Domestic & Foreign)) Commitment 2 Fund 1 Manages the fund for LPs by making Investment decisions 3 Portfolio 1 Portfolio 2 Portfolio 3 Portfolio 4 Portfolio 5 4 - Pays Management fee 5 EXIT 6 General Partner Investment Committee & Advisory Board Investment team Investment Manager (IM) Fund Structure & Fund Flow Basic Concept
  11. 11. Investors (LP) (HNIs, Corporate, Banks, Others (Domestic & Foreign)) Commitment 2 Fund 1 Manages the fund for LPs by making Investment decisions 3 Portfolio 1 Portfolio 2 Portfolio 3 Portfolio 4 Portfolio 5 4 - Pays Management fee. - Distribution on exit 5 Distribution on exit 7 EXIT 6 General Partner Investment Committee & Advisory Board Investment team Investment Manager (IM) Fund Structure & Fund Flow Basic Concept
  12. 12. Fund Manages the fund for LPs by making Investment decisions - Pays Management fee. (2% of INR 100cr = INR 2cr) - Distribution on exit (20% of INR 300cr = INR60cr) Distribution on exit - Return of Commitment (INR 100cr) - Distribution of profit (80% of INR300cr = INR240cr) Commitment INR 100 Portfolio 1 Portfolio 2 Portfolio 3 Portfolio 4 Portfolio 5 EXIT Exit @ 4x Total proceeds received (A) = INR 400cr (INR 100 cr X 4) Commitment (B) = INR 100cr Profit (A - B) = INR 300cr 21 3 4 5 6 7 Investors (LP) (HNIs, Corporate, Banks, Others (Domestic & Foreign)) General Partner Investment Committee & Advisory Board Investment team Investment Manager (IM) Fund Structure & Fund Flow Basic Concept Example
  13. 13. Fund Life Cycle Commitment Fund Investment Management fee Operating expense Set-up fee Return of Capital to all Investors Hurdle to Limited partner Catch-up to Investment Manager Profit share Investment Manager(20%) Limited partner (80%) Distribution Drawdown Hurdle Exits Distribution Waterfall Utilisation Temporary Investments Income from Temporary Investments
  14. 14. Distribution Waterfall Hurdle (LP) Catch-up (IM) LP IM IRR<12% Return of Capital In the ratio of their capital commitments IRR>12% LP Share (80%) IM (20%) Profit Zone Catch-up Calculation Hurdle computed @12% for LPs 80% return is 12% of profit 20% return should get 3% (12%*20% / 80%) Catch-up = 25% (3% / 12%)
  15. 15. Fund Manages the fund for LPs by making Investment decisions Commitment Portfolio 1 Portfolio 2 Portfolio 3 Portfolio 4 Portfolio 5 21 3 4 5 EXIT 7 6 - Pays Management fee. (1.5-2% of the fund) - Distribution on exit - Catchup - Carry (20%) - Distribution on exit - Hurdle (10-12%) - Profit share (80%) Investors (LP) (HNIs, Corporate, Banks, Others (Domestic & Foreign)) General Partner Investment Committee & Advisory Board Investment team Investment Manager (IM) Fund Structure & Fund Flow Hurdle, Catchup and Profit Share (Carry)
  16. 16. 0.00x 0.20x 0.40x 0.60x 0.80x 1.00x 1.20x 1.40x 1.60x 1.80x 2.00x Y1 Y2 Y3 Y4 Y5 Performance measure DPI RVPI TVPI Return(x)Return(x) Performance Measure Curve Performance ratios TVPI - Total Value (Distributions + Net Asset Value) divided by Paid-In capital DPI - Distributions divided by Paid-In capital RVPI - Residual Value (aka NAV) divided by Paid-In capital Year DPI RVPI TVPI Y1 0.00x 1.00x 1.00x Y2 0.40x 1.20x 1.60x Y3 0.50x 1.30x 1.80x Y4 0.60x 1.20x 1.80x Y5 1.90x 0.00x 1.90x
  17. 17. Drawdown - Drawdown from Investors are either made on a deal by deal basis or as per a fixed schedule. Management fee catch-up - At the Final closing the Management fee is calculated since the inception of the Fund as if the Commitment at Final closing was in existence since the beginning of the Fund life cycle. Temporary Investment - When Drawdown is as per fixed schedule there is a lead time between the time the Commitment is drawn and utilised. During the lead time, the money is parked in Liquid funds. Liquid funds ensures both returns and liquidity on the parked money. The return earned is distributed to the LPs. This can be adjusted with the Hurdle calculation. Commitment period - This is the period during which the fund can make new investments. Post the commitment period the fund can only make follow-ons. Further the Management fee also is calculated on commitment during the commitment period. Post the commitment period, the Management fee gets computed on the contribution less disposals/ write offs. Fund Nuances
  18. 18. Commitment - Amount promised by the Investors Drawdown/ Contribution - Amount paid by Investor. Drawdown to the fund is usually made either on a deal by deal basis or on a fixed drawdown schedule. Utilisation - Part of the Drawdown used for Fund Investment and expenses Temporary Investment - Part of the drawdown not utilised and parked in Money Market Instruments Return of Capital - Amount returned towards Drawdown Hurdle - Minimum Return assured to Investor. The amount the Fund has to pay to the LPs first before they can take the money. It usually ranges between 8-12%. Hurdle is not accrued in the books. Catch-up - Part of profit paid to Investment Manager to make good the payment made towards Hurdle to honour Profit Share Profit Share - amount of profit distributed to Limited Partner and General Partner. Usually the ratio is 20% IM (aka Carry) and 80% Limited Partner. Fund starts accruing Carry once the Fund IRR is more than Hurdle rate. Few Market Standards
  19. 19. For more information, write to samik@piventures.in *Thanks to Prof Shivaram from IIT Mumbai for the phrase J AI HIND*
  20. 20. Example 1 Proceeds 120 RoC 100 Amount after RoC 20 Profit share 80:20 LP 80% (80% x 20) 16 IM 20% (20% x 20) 4 Example 2 Proceeds 120 RoC 100 Amount after RoC 20 Hurdle @12% after Y1 (LP) 12 Amount after Hurdle 8 Catch-up (25% of Hurdle) (25% x 12) (IM) 3 Amount after catch-up 5 Profit share 80:20 LP 80% (80% x 5) 4 IM 20% (20% x 5) 1Example 3 Proceeds 115 RoC 100 Amount after RoC 15 Hurdle @12% after Y1 (LP) 12 Amount after Hurdle 3 Catch-up (25% of Hurdle) (25% x 12) (IM) 3 Amount after catch-up NIL Example 4 Proceeds 112 RoC 100 Amount after RoC 12 Hurdle @12% after Y1 (LP) 12 Amount after Hurdle NIL Hurdle, Catchup and Profit Share (Carry) Basic Example

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Session 3: In this session, Samik Rakshit explains the economic model of venture funds

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