The 2018 version of our annual "Intro to VC" lecture we give at USC

1. Venture Capital 101
Brent Granado
General Partner, Sway Ventures
Brett Munster
Principal, Sway Ventures

2. Quick Background On Us
Brent Granado
General Partner
MBA Class of 2011
Brett Munster
Principal
MBA Class of 2015

3. Enough about us, lets talk
Venture Capital

4. Where VC fits into the alternative asset landscape
by risk
RISK
EXPECTED+RETURN
Fixed+Income+Yield
Shorter+Duration
Higher+Cash+Pay+Component
Lower+Risk
Longer+Duration
Higher+Multiples
Low+Cash+Yield
Higher+Risk
Venture'Capital
Growth
Buyout
Secondaries
Mezzanine
Private+Debt
Infrastructure
Real+Estate

5. Where VC fits into the alternative
asset landscape by capital
Commodities
Liquid
Alternatives
Institutional
Loans
Real Estate
Hedge Funds
Private Equity
Total Money Invested
($Trillions)
Venture Capital
0.028
Of#the#nearly#
$11#trillion
invested#into#alternative#
assets#in#2015,#
VC#accounted#for#about#
0.26%##
Source: http://www.strategyand.pwc.com/media/file/Alternative-investments.pdf

6. Source: http://a16z.com/2016/09/11/vc-economics/
Google and Apple combined spent about $20 billion in R&D alone.
Private equity buyout funds raised about 10x that VC raised.
The 500 largest U.S. public companies distributed more than $1 trillion in cash back to their
shareholders.
Hedge fund assets under management were about $3 trillion.
U.S. GDP was about $17 trillion. VC dollars are a fraction of a fraction of a percent of this.
The U.S. VC industry raised about $28 billion in new capital.
While VC dollars are a significant source of capital for facilitating new business creation, the
total capital deployed is remarkably small. Here are some 2015 numbers to illustrate:
VC is very much a niche industry

7. However, VC does have a disproportionate
impact on the economy
Venture Capital investment as
percentage of US GDP in 2015
0.16%
Percent of total market cap attributable to
VC backed companies in 2015
57%
Percent of public companies
were funded by VC in 2015
43%
Percent of jobs as a result of VC
backed companies 2015
38%
Source: Stanford GSB, How Much Does Venture Capital Drive the US Economy, 2015

8. The top 5 companies by market cap were all VC
backed
Sequoia, Arthur Rock, Matrix
Sequoia, KPCB
KPCB
Accel, Greylock, Peter Thiel
Technology Venture'Investors (TVI)

9. Source: http://www.citylab.com/work/2013/06/americas-top-metros-venture-capital/3284/
VC capital tends to concentrate around
entrepreneurial ecosystems

10. Management Co, LLC
2% Annual Management Fee
Venture Fund, LP
LPs invests in
the fund
Initial Investment +
80% of returns
20% Carry
GPs invest 1-10%
of fund
Company 1 Company 2 Company 3 Company N
General Partners
Venture Capitalists who
run the fund
Limited Partners
Endowments
Pension Funds
Family Offices
UHNW
VC Fund Structure – “2 and 20”

11. For Limited Partners
• Long term investment (10+ yrs)
• Not Liquid
• High Fees compared to wealth
management
• Many funds don’t yield desired returns
For Companies
The day you take outside money is the
first day towards the end of it remaining
your company – investors need liquidity
at some point.
Potential Downside of Venture Capital

12. Big Upside Potential
A small allocation has the potential to juice overall
returns. Even if the venture fund isn’t successful, the
impact on the overall portfolio performance is only
minor because of the small allocation.
So why do LP’s invest in such a risky, illiquid
asset class?
14.75% 4.75%5.00%Return

13. U.S. Venture Capital IRR by Fund Vintage Year Net to Limited Partners
Source: Cambridge Associates “US Venture Capital Index and Selected Benchmark Statistics”, 2017
Venture Capital industry returns over the years

14. Source: Cambridge Associates “US Venture Capital Index and Selected Benchmark Statistics”, 2014
Top Quartile vs Bottom Quartile U.S. Venture Capital IRR by Fund Vintage Year
Net to Limited Partners
Large variance in performance between top tier
and bottom tier funds

15. The Power Law
A very small number of companies drive an overwhelming
majority of the returns in venture. In a typical fund of 25 -
30 companies, only 1-3 companies will account for ~95%
of the economic return. Because of this dynamic, VCs need
large exits to cover the rest of the portfolio’s losses. This is
critical to understanding why VC’s behave the way the do.
Source: CB Insights
VC returns are driven by the “Power Law”

16. Magnitude of “Homeruns”
The “Babe Ruth Effect”
What is interesting and perhaps counter-intuitive is that the very best performing funds actually
lose money more often than good performing funds do. However, great funds not only have more
home runs in their portfolio, they have home runs of greater magnitude.
Magnitude of “Homeruns” Percent of portfolio that loses money
Source: Chris Dixon, A16Z http://cdixon.org/2015/06/07/the-babe-ruth-effect-in-venture-capital/
VC’s need to swing for the fences to be successful

17. Venture is all about
Magnitude, not Frequency

18. $100M Fund LPs expect at
least 20% IRR
$300M
Return
Assuming it takes 6-7 years on average for companies to exit, that means a fund needs
to return roughly 3x the size of the fund to achieve desired returns.
Lets do some simple VC math

19. “Power Law” in effect
Return
Profile
# of
Companies
Investment
($M)
Return
($M)
Total Exit
Amount ($M)
% of
Return
Fail 60% 15 $48 $0 $0 0%
1x Return 30% 7.5 $24 $24 $120 8%
Homerun 10% 2.5 $8 $276 $1,380 92%
Total 25 $80* $300
Assuming the venture fund owns 20% of their portfolio companies, a $100 million
venture fund needs to be part of at least $1.5 Billion worth of exits in order to
generate the desired returns.
*Assumes 2% management fee for the life of the fund (10 years).
$1,500
More VC math – achieving a 3x return

20. “Power Law” in effect
Return
Profile
# of
Companies
Investment
($M)
Return
($M)
Total Exit
Amount ($M)
% of
Return
Fail 60% 15 $240 $0 $0 0%
1x Return 30% 7.5 $120 $120 $600 8%
Homerun 10% 2.5 $40 $1,380 $6,900 92%
Total 25 $400* $1,500
The bigger the fund, the larger the exits have to be. Again, assuming 20% ownership, a
$500 million venture fund needs to be part of at least $7.5 Billion worth of
exits in order to generate the desired returns.
*Assumes 2% management fee for the life of the fund (10 years).
$7,500
Same exercise, but with a larger fund

21. In 2010, Andreessen Horowitz (one of the top Silicon Valley VC firms) invested $250K
into Instagram via its seed round. Two years later, Facebook acquired the company for
$1 billion, netting the VC firm $78 million (312x return).
However, at the time, Andreessen Horowitz had $2.7B under management, meaning
they needed to return $8.1B to their investors. This means the firm would have
required 103 more Instagrams across their funds to make the model work!
This is why bigger firms have to write bigger checks.
The Instagram mistake?

22. The Three Ass Rule
Big Ass Market Kick Ass ProductSmart Ass Team
So what do VC’s look for in start-ups?

23. But Its Not Always Easy To See The Future…
?
A VC’s job is to evaluate what a company can
become, not what it is today

24. Lets take a look at two
Case Studies

25. Uber started its platform with high end, on-demand black car services. Because not
very many people use private car services, many thought it was “too niche” (VC code
for too small) of a market. As a result, many early investors passed because their
market analysis was wrong.
Uber’s true market size isn’t even the Taxi
market, its much bigger. For example, in San
Francisco, Uber generates 3x the revenue as
the entire SF taxi market at its peak and is still
growing.
Source: http://www.businessinsider.com/uber-revenue-san-francisco-2015-1
Revenue($m)
2015 San Francisco Market
Uber vs Taxi
Case Study #1: Uber and its small market size

26. In 2008, AirBnB was a marketplace for air mattresses on the floors of people's
apartments. Most investors could not imagine most people using this product, let alone
completely disrupting the lodging industry.
At the time, the company was seeking to raise a $150,000 seed round at a $1.5 million
valuation. In other words: That $150,000 would’ve meant a 10% stake of AirBnB, an
investment that would now be worth $310 million. All but one investor passed.
Case Study #2: AirBnB and its product evolution
500,000 stays per night
65,000 cities
2.3m listings

27. Brent Granado
General Partner, Sway Ventures
brent@swayvc.com
@BrentGranado
Brett Munster
Principal, Sway Ventures
brett@swayvc.com
@bmunst
Now that everyone is an expert VC, any questions?