Please, summarize the article in to 1 page 

Venture Capital and Private Equity: A Course Overview

Josh Lerner*

November 199

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*Harvard Business School and National Bureau of Economic Research. Helpful
comments were provided by Paul Gompers, Steve Kaplan, Jay Light, Scott Mason, Bob
Merton, Andre Perold, Bill Sahlman, and seminar participants at Harvard Business
School. The development of this course was funded by Harvard Business School’s
Division of Research.

1. The Backdrop

Over the past fifteen years, there has been a tremendous boom in the private

equity industry. The pool of U.S. private equity funds—partnerships specializing in

venture capital, leveraged buyouts, mezzanine investments, build-ups, and distressed

debt—has grown from $5 billion in 1980 to about $150 billion in 1996. Private equity’s

recent growth has outstripped that of almost every class of financial product.

While the growth in private equity has been striking, the potential for future

development is even more impressive. Despite its growth, the private equity pool today

remains relatively small. For every one dollar of professionally managed private equity in

the portfolio of U.S. institutional investors, there are about $40 of publicly traded

equities. The ratios are even more uneven for overseas institutions.
1

Both the demand for and supply of such capital are likely to expand. First

consider the demand for private equity. A number of studies suggest that privately held

firms continue to face substantial problems in accessing the financing necessary to

undertake profitable projects.2 Meanwhile, corporations are increasingly willing to sell

off divisions to private equity investors as part of corporate “refocusings.” The supply

1
These statistics (as well as those below) are taken from the European Venture Capital

Association, 1997 EVCA Yearbook, Zaventum, Belgium, European Venture Capital
Association, 1997; Asian Venture Capital Journal, Venture Capital in Asia: 1996/97
Edition, Hong Kong, Asian Venture Capital Journal, 1996; and various issues of the
Private Equity Analyst.

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of private equity is also likely to continue growing. Within the past two years, numerous

pension funds have invested in private equity for the first time. Many experienced

investors have also decided to increase their allocations to venture capital and buyout

funds. These increased allocations will take a number of years to implement.

These patterns are even more dramatic overseas. Recent rates of growth in foreign

private equity markets have outstripped the United States by a wide margin. In Great

Britain, for instance, the size of the private equity pool increased by 37% in 1994 alone.

At the same time, the size of foreign private equity pool remains far below the United

States. This suggests considerable possibilities for future growth. The disparity can be

illustrated by comparing the ratio of the private equity pool to the size of the economy.

In 1995, this ratio was 8.7 times higher in the United States than in Asia, and 8.0 times

higher in the United States than in continental Europe.

At the same time, the private equity industry—both in the United States and

internationally—has been quite turbulent. A strategy of investing in the average venture

and buyout fund at a pace that tracked the U.S. market between 1980 and 1995 would

have yielded returns below those from investments in most public equity markets.
3 Due

to the illiquidity and risk of private equity, we would expect instead a higher return.

These poor returns largely stemmed from funds begun in the 1980s, when a large number

2Many of these studies are summarized in R. Glenn Hubbard, “Capital-Market
Imperfections and Investment,” Journal of Economic Literature, forthcoming.

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of private equity investors raised first funds, and established organizations aggressively

expanded. Many of the new funds could not find satisfactory investments, while rapid

growth created turmoil at some established organizations. The early 1990s saw far fewer

funds raised and rising returns. With the recent growth in private equity fundraising, it is

unclear whether the high returns seen in the recent years can be sustained.

This cycle of growth and disillusionment has created much instability in the

industry. Understanding these patterns—and their impact on investor behavior—is

critical whether one intends to work for, receive money from, underwrite the offerings of,

or invest in or alongside private equity funds.

2. Course Objectives

This document describes a course on the private equity industry at Harvard

Business School. This course was developed by the author of this working paper, and

was first taught in the 1993-1994 academic year. In recent years, two full sections, each

of approximately 100 MBAs and others4 have signed up for the course, with a significant

waiting list. The cases in this course have also been used in a variety of other settings,

including an annual executive education course on private equity organized by Paul

Gompers and the author at Harvard Business School, and in entrepreneurship and private

equity courses at a variety of schools, including Dartmouth College, Northwestern

3
Venture Economics, Investment Benchmarks Report: Venture Capital, New York,

Venture Economics, 1996, page 281.

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University, the University of Chicago, and the University of California at Los Angeles.

Three primary pedagogical objectives motivate the design and structure of the

course. First, and most fundamentally, the course seeks to deepen students’

understanding of corporate finance. This course differs from some academic programs in

entrepreneurship, which emphasize the uniqueness of private equity finance and the

limited applicability of academic theory. For instance, one leading entrepreneurship text

states:

There are both stark and subtle differences, both in theory and practice,
between entrepreneurial finance as practiced in higher potential ventures
and corporate or administrative finance, which usually occurs in larger
publicly traded companies. Further, there are important limits to some
financial theories as applied to new ventures.

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By way of contrast, this course emphasizes the relevance of the intellectual frameworks

used to analyze corporate finance problems (incomplete contracting theory, agency

problems, etc.) for the private equity industry. Wherever possible, the links to both

First-Year Finance and many of the elective second-year finance courses at Harvard

Business School are emphasized. Thus, one goal is to review and apply the key concepts

and tools of corporate finance in an environment that the students perceive as very

interesting.

4Approximately 10% of the seats are reserved for cross-registrants from Harvard’s
medical, law and other graduate schools, as well as from other local schools.
5Jeffry Timmons, New Venture Creation: Entrepreneurship for the 21st Century, Boston,
Irwin, 1994, page 447.

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Second, the course seeks to build familiarity with the key institutional features of

the private equity industry. Whether discussing fund structures, potential investments,

or returns, participants in the private equity industry often describe phenomena in

language that is somewhat different from other financial investors. Understanding the key

frameworks employed by private equity investors, and relating them to traditional finance

practice, is thus an important goal. A related objective is building an appreciation for the

gradations inherent in the industry. Students often consider the private equity industry

as an undifferentiated whole, without appreciating the very significant differences in the

standards and practices that exist between these groups. An appreciation of the many

important differences between these groups is important lesson.

Much of the fulfillment of this second goal, it is important to note, takes place

outside of the classroom. An important component of the course is the final paper.

Whether students intend to work for a private equity organization or to accept money

from one, careful due diligence is essential. Private equity funds jealously guard their

privacy, and distinguishing between top-tier organizations and less reputable concerns is

not always easy. The final paper offers an opportunity to become better acquainted with

the resources available at Baker Library and elsewhere, including trade magazines, legal

handbooks, academic articles, and on-line databases. An important resource in completing

the project is the VentureOne database of private equity financings, which the firm has

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generously made available to the class.6

Finally, a crucial objective is to build an appreciation of the valuation process in

the private equity setting. Valuation issues are often the subject of contentious disputes,

whether the context is assessing the relative past returns of several private equity groups,

determining the impact of a shift in a buyout fund’s fee structure, allocating equity in a

start-up to management and one or more private equity groups, or assessing the impact of

a “sweetner” of warrants (a grant of warrants in addition to a block of equity) on the price

paid per share by private equity investors. Industry practice, reflecting private equity’s

early state of evolution relative to many other financial sectors, can often appear to the

outside observer as sloppy and not standardized. Skill in analyzing value is likely to be

an increasingly important competitive skill in the private equity industry.

This course consequently introduces a wide array of valuation methodologies.

These range from approaches commonly seen in practice (e.g., the use of comparables and

the “venture capital” method) to those less frequently employed but likely to be useful

nonetheless (the use of Monte Carlo simulations and option pricing techniques). The

course emphasizes not only the mechanisms employed, but also how to clearly

communicate the strengths and limitations of each approach. These discussions are

facilitated by the use of Harvard Business School’s electronic infrastructure. For a

6Within a few broad guidelines, a broad range of final projects are encouraged. In previous
years, final projects have ranged from traditional papers analyzing trends in private
equity markets to case studies of particular investments and funds to draft private
placement memorandums for new private equity funds.

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typical class, a spreadsheet containing the case problems is posted on the School’s

intranet prior to class, the class discussion includes an analysis of the spreadsheet (with

the spreadsheet simultaneously projected on the central screen), and the fully worked

analysis is posted on the intranet immediately after class.

The intellectual origins of this course are two-fold. First, there has been a growing

amount of both theoretical and empirical research into the private equity industry over

the past decade, which seeks to apply the more general frameworks of corporate finance

in these settings.7 The course seeks to build drawn upon and illustrate these frameworks

wherever possible.

Second, there has been a long tradition of entrepreneurship education at the

Harvard Business School, dating back to the introduction of “Management of New

Enterprises” by Myles Mace in 1947. “Venture Capital and Private Equity” particularly

complements “Entrepreneurial Finance,” a course developed by William Sahlman in the

1980s. While the focus here is on one class of financial institutions that finance firms,

rather than entrepreneurs’ search for capital, the course seek to present complementary

frameworks.

3. Course Organization

This section reviews the structure of the modules in considerable detail, as well as

7 Much of this research is reviewed in George Fenn, Nellie Liang, and Steven Prowse, The
Economics of the Private Equity Industry, Washington: Federal Reserve Board, 1995.

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the intellectual frameworks underlying them. For the reader who wishes to skip over

these detailed descriptions, we first briefly summarize the four parts of the course.

The first module of “Venture Capital and Private Equity” examines how private

equity funds are raised and structured. The structure of private equity funds have a

profound effect on the behavior of venture and buyout investors. The module seeks not

only to understand the features of private equity funds and the actors in the fundraising

process, but also to analyze which institutions serve to increase the profits from private

equity investments as a whole, and which seem designed mostly to shift profits between

the parties.

The second module of the course considers the interactions between private

equity investors and the entrepreneurs that they finance. The course approaches these

interactions through a two-part framework, first identifying the four critical factors that

make it difficult for the types of firms backed by private equity investors to meet their

financing needs through traditional mechanisms, and then considering six classes of

financial and organizational responses by private equity investors.

The third module of “Venture Capital and Private Equity” examines the process

through which private equity investors exit their investments. Successful exits are critical

to insuring attractive returns for investors, but private equity investors’ behavior around

the exiting process can sometimes lead to severe problems for entrepreneurs. We seek to

understand which institutional features associated with exiting private equity investments

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increase the overall amount of profits from private equity investments, and which actions

seem to be intended to shift more of the profits to particular parties.

The final module reviews many of the key ideas developed in the course. Rather

than considering traditional private equity organizations, however, the two cases examine

organizations with very different goals, examining funds established by a large corporation

and a non-profit organization. These cases allow us not only to understand these challenging

initiatives, but to review the elements that are crucial to the success of traditional private

equity organizations.

3.A.

Module 1: Private Equity Fundraising and Partnerships

The first module of “Venture Capital and Private Equity” examines how private

equity funds are raised and structured. These funds often have complex features, and the

legal issues involved are frequently arcane. But the structure of private equity funds has a

profound effect on the behavior of venture and buyout investors. Consequently, it is

important to understand these issues, whether the students intend to work for, receive

money from, or invest in or alongside private equity funds.

The module seeks not only to understand the features of private equity funds and

the actors in the fundraising process, but also to analyze them. We map out which

institutions serve primarily to increase the profits from private equity investments as a

whole, and which seem designed mostly to shift profits between the parties. We seek to

understand the functions of and reasons for each aspect of private equity fundraising. In

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this way, students develop their ability to analyze a wide variety of contractual

arrangements.

3.A.1. Why This Module?

The structuring of venture and buyout funds may initially appear to be a complex

and technical topic, one better left to legal specialists than general managers. Private

equity partnership agreements are complex documents, often extending for hundreds of

pages. Practitioner discussions of the structure of these firms are rife with obscure terms

such as “reverse claw-backs.”

But the subject is an important one. For the features of private equity funds—

whether management fees, profit sharing rules, or contractual terms—have a profound

effect on the behavior of these investors. It is clearly important to understand these

influences if one works for a private equity fund. But an understanding of these

dynamics is also valuable for the entrepreneur financing his company through these

investors, the investment banker underwriting a firm backed by private equity funds, the

corporate development officer investing alongside venture capitalists in a young

company, and the pension fund manager placing her institution’s capital into a fund.

An example may help to illustrate this point. Almost all venture and buyout

funds are designed to be “self-liquidating”: i.e., to dissolve after ten or twelve years. The

need to terminate each fund imposes a healthy discipline, forcing private equity investors

to take the necessary-but-painful step of terminating underperforming firms in their

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portfolios. (These firms are sometimes referred to as the “living dead” or “zombies.”)

But the pressure to raise an additional fund can sometimes have less pleasant

consequences. Young private equity organizations frequently rush young firms to the

public marketplace in order to demonstrate a successful track record, even if the

companies are not ready to go public. This behavior, sometimes known as

“grandstanding,” can have a harmful effect on the long-run prospects of the firms dragged

prematurely into the public markets.8

Second, the study of these arrangements can provide insights into a wide range of

contractual frameworks. An extensive literature, spurred by the formalization of

“incomplete contracting” theory by Sanford Grossman, Oliver Hart, John Moore, and

others, has in recent years examined the contractual relationships between principals and

agents in a wide variety of settings.9 The negotiations of private equity partnership

agreements is a particular stark setting, which makes it suitable for examining many of

these issues. In particular, the structuring of private equity partnerships and their

investments into portfolio firms provide insights into the parallels to and limitations of

the approaches to corporate governance taken by investors in publicly traded firms.10

8Paul A. Gompers, “Grandstanding in the Venture Capital Industry,” Journal of
Financial Economics, 43 (September 1996) pages 133-156.
9These are reviewed, for instance, in Jean Tirole, The Theory of Industrial Organization,
Cambridge, MIT Press, 1990.
10This point is emphasized, for instance, in Michael C. Jensen, “Presidential Address:
The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems,”
Journal of Finance, 48 (July 1993), pages 831-880, and Andrei Shleifer and Robert

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A final rationale for an examination of the concerns and perspectives of

institutional investors and intermediaries is that they provide an often-neglected avenue

into the private equity industry. Many students diligently pursue positions at the

traditional private equity organizations, but neglect other routes to careers as private

equity investors. A position evaluating private equity funds and putting capital to work

in these organizations is likely to lead to a network of relationships with private equity

investors that may eventually pay handsome dividends.

3.A.2. The Framework

There are a wide array of actors in the private equity fundraising drama.

Investors—whether pension funds, individuals, or endowments—each have their own

motivations and concerns. These investors frequently hire intermediaries. Sometimes

these “gatekeepers” play a consultative role, recommending attractive funds to their

clients. In other cases, they organize “funds-of-funds” of their own. Specialized

intermediaries concentrate on particular niches of the private equity industry, such as

buying and selling interests in limited partnerships from institutional investors. In

addition, venture and buyout organizations are increasingly hiring placement agents who

facilitate the fundraising process.

This module examines each of these players. Rather than just describing their

roles, however, we highlight the rationales for and impacts of their behavior. Some

Vishny, “A Survey of Corporate Governance,” Journal of Finance, 52 (June 1997), pages
737-783.

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institutions and features have evolved to improve the efficiency of the private equity

investment process, while others appear to be designed primarily to shift more of the

economic benefits to particular parties.

Investing in a private equity fund is in some respects a “leap of faith” for

institutional investors. Most pension funds and endowments typically have very small

staffs. At the largest organizations, a dozen professionals may be responsible for

investing several billion dollars each year. Meanwhile, private equity funds undertake

investments that are either in risky new firms pursuing complex new technologies or in

troubled mature companies with numerous organizational pathologies and potential legal

liabilities.

Many of the features of private equity funds can be understood as responses to

this uncertain environment, rife with many information gaps. For instance, the “carried

interest”—the substantial share of profits that are allocated to the private equity

investors—helps address these information asymmetries by insuring that all parties gain

if the investment does well. Similarly, pension funds hire “gatekeepers” to ensure that

only sophisticated private equity funds with well-defined objectives get funded with their

capital.

At the same time, other features of private equity funds can be seen as attempts

to transfer wealth between parties, rather than efforts to increase the size of the overall

amount of profits generated by private equity investments. An example was the drive by

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many venture capital funds in the mid-1980s—a period when the demand for their

services was very strong—to change the timing of their compensation. Prior to this

point, venture capital funds had typically disbursed all the proceeds from their first few

successful investments to their investors, until the investors had received their original

invested capital back. The venture capitalists would then begin receiving a share of the

subsequent investments that they exited. Consider a fund that had raised capital of $50

million, whose first three successful investments yielded $25 million each. Under the

traditional arrangement, the proceeds from the first two offerings would have gone

entirely to the institutional investors in their fund. The venture capitalists would have

only begun receiving a share of the proceeds at the time that they exited the third

investment.

In the mid-1980s, venture capitalists began demanding—and receiving—the right

to start sharing in even the first successfully exited investments. The primary effect of

this change was that the venture capitalists began receiving more compensation early in

their funds’ lives. Put another way, the net present value of their compensation package

increased considerably. It is not surprising, then, that as the inflow into venture capital

weakened in the late 1980s, institutional investors began demanding that venture

capitalists return to the previous approach of deferring compensation.

This twin tension—between behavior that increases the size of the “pie” and

actions that simply change the relative sizes of the slices—runs through this module. We

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attempt to both understand the workings of and the reasons for the key features of these

funds using this framework.

3.A.3. The Structure of the Module

The first half of the module introduces the key elements of the private equity

fundraising process. Among the actors whose structure and concerns we examine are

institutions, private equity investors, “funds-of-funds,” and “gatekeepers.” We put

particular emphasis on the agreements that bring these parties together into limited

partnerships. Because they play such an important role in shaping behavior,

compensation terms is an especial focus.

The second half of the module looks at the raising of three funds by private equity

organizations. We look at private equity organizations of very different maturities and

with varied investment targets: two men seeking to raise a first fund to pursue

opportunistic late-stage investments, a venture organization trying to raise its second seed

capital fund, and a established British private equity organization considering a new

template for a fund to undertake buyouts across Europe. The funds that emerged from

these circumstances reflected not only the differences between the investments that each

fund promised to make, but also each group’s ability to persuade—or demand—a better

deal from its investors.

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3.B. Module 2: Private Equity Investing11

The second module of the course considers the interactions between private

equity investors and the entrepreneurs that they finance. These interactions are at the

core of what private equity investors do. We approach these interactions through a

framework that highlights the particular challenges that portfolio firms pose to private

equity investors, as well as the mechanisms that these investors have developed to

address these challenges.

3.B.1. Why This Module?

It is easy to build a case that the financing and guidance of dynamic private

businesses lie at the heart of the private equity process. Nonetheless, addressing the

frequently complex interactions between investors and the firms in their portfolios in

eight class sessions is a somewhat daunting challenge. To thoroughly examine how

venture and buyout investors assess, fund, control, and shape the strategy of firms would

certainly be enough to fill several courses! Fortunately, a number of courses at Harvard

Business School—including “Coordination, Control, and Management of Organizations,”

“Entrepreneurial Finance,” “Entrepreneurial Management,” and “Entrepreneurial

11The frameworks in this module were developed jointly with Paul Gompers. They are
explicated in more detail in our essay, “Dynamic Capital,” Unpublished manuscript
(Harvard Business School). See this manuscript as well for a discussion of the many
strands in the corporate finance literature that we draw upon in developing these
frameworks.

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Marketing”—also explore aspects of the management of new ventures and buyouts. In

our discussions, we draw on insights from each of these classes when appropriate.

We approach the cases in this module through a framework which helps us

organize these complex interactions. First, we categorize the reasons why the types of

firms backed by private equity investors find it difficult to meet their financing needs

through traditional mechanisms, such as bank loans. These difficulties can be sorted into

four critical factors: uncertainty, asymmetric information, the nature of firm assets, and

the conditions in the relevant financial and product markets. At any one point in time,

these four factors determine the choices that a firm faces. As a firm evolves over time,

however, these factors can change in rapid and unanticipated ways.

We also consider six classes of responses by private equity investors to these

challenges. The first three relate to the investment process itself: the determination of the

sources from which the firm should raise capital, how the investment should be

structured, and how the profits should be divided. The second set involves the investors’

more general interactions with the firm: the monitoring of management performance, the

shaping of the firm’s assets, and the evaluation of whether to continue or terminate the

investment. Thinking about these four classes of problems and six sets of responses

helps organize the complex interactions between private equity investors and the firms in

their portfolios.

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3.B.2. The Framework (1): The Financing Challenge

Entrepreneurs rarely have the capital to see their ideas to fruition and must rely on

outside financiers. Meanwhile, those who control capital—for instance, pension fund

trustees and university overseers—are unlikely to have the time or expertise to invest

directly in young or restructuring firms. It might be thought that the entrepreneurs would

turn to traditional financing sources, such as bank loans and the issuance of public stock,

to meet their needs. But a variety of factors are likely to lead to some of the most

potentially profitable and exciting firms not being able to access these financing sources.

Private equity investors are almost invariably attracted to firms that find

traditional financing difficult to arrange. Why are these firms difficult to finance?

Whether managing a $10 million seed investment pool or a $1 billion leveraged buyout

fund, private equity investors are looking for companies that have the potential to evolve

in ways that create value. This evolution may take several forms. Early-stage

entrepreneurial ventures are likely to grow rapidly and respond swiftly to the changing

competitive environment. Alternatively, the managers of buyout and build-up firms may

create value by improving operations and acquiring other rivals. In each case, the firm’s

ability to change dynamically is a key source of competitive advantage, but also a major

problem to those who provide the financing.

As mentioned above, the characteristics of these dynamic firms are analyzed using

a four-factor framework. The first of these, uncertainty, is a measure of the array of

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potential outcomes for a company or project. The wider the dispersion of potential

outcomes, the greater the uncertainty. By their very nature, young and restructuring

companies are associated with significant levels of uncertainty. Uncertainty surrounds

whether the research program or new product will succeed. The response of firm’s rivals

may also be uncertain. High uncertainty means that investors and entrepreneurs cannot

confidently predict what the company will look like in the future.

Uncertainty affects the willingness of investors to contribute capital, the desire of

suppliers to extend credit, and the decisions of firms’ managers. If managers are adverse

to taking risks, it may be difficult to induce them to make the right decisions. Conversely,

if entrepreneurs are overoptimistic, then investors want to curtail various actions.

Uncertainty also affects the timing of investment. Should an investor contribute all the

capital at the beginning, or should he stage the investment through time? Investors need

to know how information-gathering activities can address these concerns and when they

should be undertaken.

The second factor, asymmetric information, is distinct from uncertainty. Because

of his day-to-day involvement with the firm, an entrepreneur knows more about his

company’s prospects than investors, suppliers, or strategic partners. Various problems

develop in settings where asymmetric information is prevalent. For instance, the

entrepreneur may take detrimental actions that investors cannot observe: perhaps

undertaking a riskier strategy than initially suggested or not working as hard as the

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investor expects. The entrepreneur might also invest in projects that build up his

reputation at the investors’ expense.

Asymmetric information can also lead to selection problems. The entrepreneur

may exploit the fact that he knows more about the project or his abilities than investors

do. Investors may find it difficult to distinguish between competent entrepreneurs and

incompetent ones. Without the ability to screen out unacceptable projects and

entrepreneurs, investors are unable to make efficient and appropriate decisions.

The third factor affecting a firm’s corporate and financial strategy is the nature of

its assets. Firms that have tangible assets—e.g., machines, buildings, land, or physical

inventory—may find financing easier to obtain or may be able to obtain more favorable

terms. The ability to abscond with the firm’s source of value is more difficult when it

relies on physical assets. When the most important assets are intangible, such as trade

secrets, raising outside financing from traditional sources may be more challenging.

Market conditions also play a key role in determining the difficulty of financing

firms. Both the capital and product markets may be subject to substantial variations.

The supply of capital from public investors and the price at which this capital is available

may vary dramatically. These changes may be a response to regulatory edicts or shifts in

investors’ perceptions of future profitability. Similarly, the nature of product markets

may vary dramatically, whether due to shifts in the intensity of competition with rivals

or in the nature of the customers. If there is exceedingly intense competition or a great

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deal of uncertainty about the size of the potential market, firms may find it very difficult

to raise capital from traditional sources.

3.B.3. The Framework (2): The Activities of Private Equity Investors

Private equity investors have a variety of mechanisms at their disposal to address

these changing factors. Careful crafting of financial contracts and firm strategies can

alleviate many potential roadblocks. We highlight six of these responses.

The first set relates to the financing of firms. First, from whom a firm acquires

capital is not always obvious. Each source—private equity investors, corporations, and

the public markets—may be appropriate for a firm at different points in its life.

Furthermore, as the firm changes over time, the appropriate source of financing may

change. Because the firm may be very different in the future, investors and entrepreneurs

need to be able to anticipate change.

Second, the form of financing plays a critical role in reducing potential conflicts.

Financing provided by private equity investors can be simple debt or equity, or involve

hybrid securities like convertible preferred equity or convertible debt. These financial

structures can potentially screen out overconfident or under-qualified entrepreneurs. The

structure and timing of financing can also reduce the impact of uncertainty on future

returns.

A third element is the division of the profits between the entrepreneurs and the

investors. The most obvious aspect is the pricing of the investment: for a given cash

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infusion, how much of the company does the private equity investor receive?

Compensation contracts can be written that align the incentives of managers and

investors. Incentive compensation can be in the form of cash, stock, or options.

Performance can be tied to several measures and compared to various benchmarks.

Carefully designed incentive schemes can avert destructive behavior.

The second set of activities of private equity investors relate to the strategic

control of the firm. Monitoring is a critical role. Both parties must ensure that proper

actions are taken and that appropriate progress is being made. Critical control

mechanisms—e.g., active and qualified boards of directors, the right to approve important

decisions, and the ability to fire and recruit key managers—need to be effectively

allocated in any relationship between an entrepreneur and investors.

Private equity investors can also encourage firms to alter the nature of their assets

and thus obtain greater financial flexibility. Patents, trademarks, and copyrights are all

mechanisms to protect firm assets. Understanding the advantages and limitations of

various forms of intellectual property protection, and coordinating financial and

intellectual property strategies are essential to ensuring a young firm’s growth. Investors

can also shape firms’ assets by encouraging certain strategic decisions, such as the

creation of a set of “locked-in” users who rely on the firm’s products.

Evaluation is the final, and perhaps most critical, element of the relationship

between entrepreneurs and private equity investors. The ultimate control mechanism

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exercised by the private equity investors is to refuse to provide more financing to a firm.

In many cases, the investor can—through direct or indirect actions—even block the firm’s

ability to raise capital from other sources.

3.B.4. The Structure of the Module

This module illustrates these frameworks with examples from a wide variety of

private equity funds and industries. We carefully identify the types of problems that

emerge in different types of private equity transactions. Another important aspect of

this module is to explore the institutional and legal aspects of each type of private equity

transaction: venture capital, buyouts, build-ups, and venture leasing. We highlight how

private equity organizations employ these mechanisms and react to these regulations to

promote success.

Among the specific issues raised in private equity transactions that we consider

are:

• the investment criteria and approaches of venture investors.

• the alternative criteria and approaches employed by later-stage
investors, as well as the associated providers of debt financing to these
firms.

• the nature of transactions that incorporate elements both of venture
capital and buyouts, such as venture leasing and leveraged build-ups.

• the extent to which deal structures can be translated into overseas
markets, such as developing nations.

• the various ways in which valuation issues are addressed, including
many of the methodologies specific to the private equity industry and

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the opportunities for the application of new valuation techniques
(including Monte Carlo simulations and option pricing analyses).

• the relationship between financing choices and firm strategy.

• the structure and implementation of relationships with strategic co-
investors.

• the restructuring of entrepreneurial ventures in distress.

3.C. Exiting Private Equity Investments

The third module of “Venture Capital and Private Equity” examines the process
through which private equity investors exit their investments. Successful exits are critical

to insuring attractive returns for investors and, in turn, to raising additional capital. But

private equity investors’ concerns about exiting investments—and their behavior during

the exiting process itself—can sometimes lead to severe problems for entrepreneurs.

We employ an analytic framework very similar to that used in the first module of

the course. We not only seek to understand the institutional features associated with

exiting private equity investments in the United States and overseas, but also to analyze

them. We map out which features are designed primarily to increase the overall amount

of profits from private equity investments, and which actions seem to be intended to shift

more of the profits to particular parties. In the process, we draw on the extensive

insights into and studies of the going-public process by financial economists.12

12Much of this literature is summarized in Jay R. Ritter, “Initial Public Offerings,”
Unpublished working paper (University of Florida).

25

3.C.1. Why This Module?

At first glance, the exiting of private equity investments may appear outside the

scope of “Venture Capital and Private Equity.” It might seem that such issues are more

appropriate for courses such as “Capital Markets” or “Investment Management,” which

focus on public markets. But since the need to ultimately exit investments shapes every

aspect of the private equity cycle, this is a very important issue for both private equity

investors and entrepreneurs.

Perhaps the clearest illustration of the relationship between the private and public

markets was seen during the 1980s and early 1990s. In the early 1980s, many European

nations developed secondary markets. These sought to combine a hospitable

environment for small firms (e.g., they allowed firms to be listed even if they did not have

an extended record of profitability) with tight regulatory safeguards. These enabled the

pioneering European private equity funds to exit their investments. A wave of

fundraising by these and other private equity organizations followed in the mid-1980s.

After the 1987 market crash, initial public offering activity in Europe and the United

States dried up. But while the U.S. market recovered in the early 1990s, the European

market remained depressed. Consequently, European private equity investors were

unable to exit investments by going public. They were required either to continue to hold

the firms or to sell them to larger corporations at often-unattractive valuations. While

U.S. private equity investors—pointing to their successful exits—were able to raise

substantial amounts of new capital, European private equity fundraising during this

26

period remained depressed. The influence of exits on the rest of the private equity cycle

suggests that this is a critical issue for funds and their investors.

The exiting of private equity investments also has important implications for

entrepreneurs. As discussed in the first module, the typical private equity fund is

liquidated after one decade (though extensions of a few years may be possible). Thus, if a

private equity investor cannot foresee how a company will be mature enough to take

public or to sell at the end of a decade, he is unlikely to invest in the firm. If it was

equally easy to exit investments of all types at all times, this might not be a problem. But

interest in certain technologies by public investors seems to be subject to wide swings.

For instance, in recent years “hot issue markets” have appeared and disappeared for

computer hardware, biotechnology, multimedia, and Internet companies. Concerns about

the ability to exit investments may have led to too many private equity transactions being

undertaken in these “hot” industries. At the same time, insufficient capital may have

been devoted to industries not in the public limelight.

Concerns about exiting may also adversely affect firms once they are financed by

private equity investors. Less scrupulous investors may occasionally encourage

companies in their portfolio to undertake actions that boost the probability of a

successful initial public offering, even if they jeopardize the firm’s long-run health: e.g.,

increasing earnings by cutting back on vital research spending. In addition, many private

equity investors appear to exploit their inside knowledge when dissolving their stakes in

investments. While this may be in the best interests of the limited and general partners of

27

the fund, it may have harmful effects on the firm and the other shareholders.

3.C.2. The Framework of the Analysis

The exiting of private equity investments involves a diverse range of actors.

Private equity investors exit most successful investments through taking them public.13

A wide variety of actors are involved in the initial public offering. In addition to the

private equity investors, these include the investment bank that underwrites the offering,

the institutional and individual investors who are allotted the shares (and frequently sell

them immediately after the offering), and the parties who end up holding the shares.

Few private equity investments are liquidated at the time of the initial public

offering. Instead, private equity investors typically dissolve their positions by

distributing the shares to the investors in their funds. These distributions usually take

place one to two years after the offering. A variety of other intermediaries are involved in

these transactions, such as distribution managers who evaluate and liquidate distributed

securities for institutional investors.

This module examines each of these players. Rather than just describing their

roles, however, we highlight the rationales for and impacts of their behavior. We again

employ the framework of the first module. We assess which institutions and features

13A Venture Economics study finds that a $1 investment in a firm that goes public provides
an average cash return of $1.95 in excess of the initial investment, with an average holding
period of 4.2 years. The next best alternative, an investment in an acquired firm, yields a

28

have evolved to improve the efficiency of the private equity investment process, while

which have sprung up primarily to shift more of the economic benefits to particular

parties.

Many of the features of the exiting of private equity investments can be

understood as responses to many uncertainties in this environment. An example is the

“lock up” provisions that prohibit corporate insiders and private equity investors from

selling at the time of the offering. This helps avoid situations where the officers and

directors exploit their inside knowledge that a newly listed company is overvalued by

rapidly liquidating their positions.

At the same time, other features of the exiting process can be seen as attempts to

transfer wealth between parties. An example may be the instances where private equity

funds distribute shares to their investors that drop in price immediately after the

distribution. Even if the price at which the investors ultimately sell the shares is far less,

the private equity investors use the share price before the distribution to calculate their

fund’s rate of return and to determine when they can begin profit-sharing.

3.C.3. The Structure of the Module

This module examines this important topic over three class sessions. We begin by

exploring the need for avenues to exit private equity investments. To do this, we examine

cash return of only 40 cents over a 3.7 year mean holding period. See Venture Economics,
Exiting Venture Capital Investments, Wellesley, Venture Economics,

1988.

29

Europe’s private equity markets. As described above, the inability to exit investments

has been a major stumbling block to the development of its private equity industry.

We then examine the exiting of private equity investments in the United States. In

the second case of this module, we examine the differing incentives and actions of venture

capitalists, investment bankers, and public market investors during an initial public

offering. The final case examines the distribution process. We explore both the rationales

for stock distributions and the implications for private equity investors, entrepreneurs,

firms, limited partners, and the specialized distribution managers that they hire. Once

again, we seek to assess which behavior increases the size of the “pie” and which actions

simply change the relative sizes of the slices.

3.D. Module 4: Course Review

The final module reviews many of the key ideas developed in the course. Rather
than considering traditional private equity organizations, however, the two cases examine

organizations with very different goals from the ones we have considered previously. Large

corporations, government agencies, and non-profit organizations are increasingly emulating

private equity funds. Their goals, however, are quite different: e.g., to more effectively

commercialize internal research projects or to revitalize distressed areas. These cases allow

us not only to understand these exciting and challenging initiatives, but to review the

elements that are crucial to the success of traditional venture organizations.

3.D.1. Why This Module?

30

Since corporate and public venture capital initiatives are so different from traditional

private equity funds, one may wonder why these cases are included in the course. There are

three main reasons. First, this arena is the focus of intensive activity of late. These funds

today are important investors. Second, it is difficult to examine the issues faced in adapting

the private equity model without thinking about the rationales for the key features of

traditional private equity funds. Thus, this section of the course allows us to review and

revisit many of the issues we have considered in the previous three modules. Finally,

corporate venture capital programs, in particular, provide an interesting alternative way to

break into the private equity field that few students consider.

Interest in adopting the private equity model has exploded in recent years. In an

era when many large firms are questioning the productivity of their investments in

traditional R&D laboratories, venture organizations represent an intriguing alternative for

corporate America. Much of the interest has been stimulated by the recent success of the

independent venture sector. While total annual disbursements from the venture industry

over the past two decades have never exceeded the R&D spending of either IBM or

General Motors, the economic successes of venture-backed firms—such as Intel,

Microsoft, Genentech, Thermo Electron, and Cisco Systems—have been profound. The

Private Equity Analyst estimates that at least two dozen such programs were launched in

1996 alone.14 Meanwhile, several leading private equity organizations—including

14Asset Alternatives, “Corporate Venturing Bounces Back, With Internet Acting as
Springboard,” Private Equity Analyst, 6 (August 1996) pages 1 and 18-19.

31

Kleiner, Perkins, Caufield & Byers and Advent International—have begun or expanded

funds dedicated to making strategic investments alongside corporations.

The growth of venture funds organized by public and non-profit bodies has been

even more striking. Recent estimates suggest that close to 40% of venture or venture-like

disbursements in the United States—and more than half of early-stage investments—came in

1995 from “social” sources: those whose primary goal was not a high economic return. Nor

has this activity been confined to the United States. Governments in dozens of countries

have established significant public venture programs. In recent years, non-profit

organizations have also become increasingly active in encouraging and overseeing venture

funds. Some of America’s largest and most prestigious foundations, such as the Ford and

McArthur Foundations, have been particularly active backers of community development

venture funds. An interesting new trend has been the involvement of successful private

equity investors, most notably Henry Kravis, as investors in and advisors to community

development funds.

A second reason for the inclusion of this module is that it allows us to review and

think about the key features of independent private equity firms. In particular, in adopting

the private equity model, features of independent funds have been adjusted or altered. In

some cases, these changes have been benign; but in others, the consequences have been

disastrous. By reviewing successful and failed modifications of the private equity model to

serve the goals of corporate, public, and non-profit organizations, we gain a deeper

32

understanding of how traditional funds work. During discussions, we return repeatedly to

the frameworks developed in the earlier modules of the course.

Finally, corporate venture capital programs represent an interesting avenue for entry

into the private equity field that relatively few students consider. The intense competition

for jobs in traditional private equity organizations allows many funds to demand that new

hires already have a demonstrated investment track record. Yet it is difficult to develop such

a track record without a job in the industry. Corporations are often much more willing to

hire candidates directly out of school. If one can successfully make one’s way into a

corporate venture group, it can provide valuable experience and serve as a stepping-stone to

a position at an independent private equity firm.

3.D.2. Corporate Venture Capital

The first corporate venture funds were engendered by the successes of the early

venture capital funds, which backed such firms as Digital Equipment, Memorex, Raychem,

and Scientific Data Systems. Excited by this success, large companies began establishing

venture divisions. During the late 1960s and early 1970s, more than 25% of the Fortune 500

firms attempted corporate venture programs.

These generally took two forms, external and internal. At one end of the spectrum,

large corporations financed new firms alongside other venture capitalists. In many cases, the

corporations simply provided funds for a venture capitalist to invest. Other firms invested

directly in start-ups, which gave them a greater ability to tailor their portfolios to their

33

particular needs. At the other extreme, large corporations attempted to tap the

entrepreneurial spirit within their organizations. These programs sought to establish a

conducive environment for creativity and innovation within the corporate workplace. In an

ideal world, internal venture programs allowed entrepreneurs to focus their attention on

developing their innovations, while relying on the corporation for financial, legal, and

marketing support.

In 1973, the market for new public offerings—the primary avenue through which

venture capitalists exit successful investments—abruptly declined. Independent venture

partnerships began experiencing much less attractive returns and encountered severe

difficulties in raising new funds. At the same time, corporations began scaling back their

own initiatives. The typical corporate venture program begun in the late 1960s was

dissolved after only four years.

Fueled by eased restrictions on pension investing and a robust market for public

offerings, fundraising by independent venture partnerships recovered in the early 1980s.

Corporations were once again attracted to the promise of venture investing. These efforts

peaked in 1986, when corporate funds managed two billion dollars, or nearly 12% of the

total pool of venture capital. After the stock market crash of 1987, however, the market for

new public offerings again went into a prolonged decline. Returns of and fundraising by

independent partnerships declined sharply. Corporations scaled back their commitment to

venture investing even more dramatically. By 1992, the number of corporate venture

34

programs had fallen by one-third and their capital under management represented only 5% of

the venture pool.

As has been often pointed out in this course, the entire venture capital industry is

cyclical. So too has been corporate venturing. At the same time, it appears that the decline

of the earlier corporate venture programs was also due to three structural failings. First,

these programs suffered from a lack of well-defined missions. Typically, they sought to

accomplish a wide array of not necessarily compatible objectives: from providing a window

on emerging technologies to generating attractive financial returns. This confusion over

program objectives often led to dissatisfaction. For instance, when outside venture

capitalists were hired to run a corporate fund under a contract that linked compensation to

financial performance, management frequently became frustrated about their failure to invest

in the technologies that most interested the firm.

A second cause of failure was insufficient corporate commitment to the venturing

initiative. Even if top management embraced the concept, middle management often resisted.

R&D personnel preferred that the funds be devoted to internal programs; corporate lawyers

disliked the novelty and complexity of these hybrid organizations. New senior management

teams in many cases terminated programs, seeing them as expendable “pet projects” of their

predecessors. Even if they did not object to the idea of the program, managers often were

concerned about its impact on the firm’s accounting earnings. During periods of financial

pressure, money-losing subsidiaries were frequently terminated in an effort to increase

reported operating earnings.

35

A final cause of failure was inadequate compensation schemes. Corporations have

frequently been reluctant to compensate their venture managers through profit-sharing

(“carried interest”) provisions, fearing that they might need to make huge payments if their

investments were successful. Typically, successful risk-taking was inadequately rewarded

and failure excessively punished. As a result, corporations were frequently unable to attract

top people (i.e., those who combined industry experience with connections to other venture

capitalists) to run their venture funds. All too often, corporate venture managers adopted a

conservative approach to investing. Nowhere was this behavior more clearly manifested

than in the treatment of lagging ventures. Independent venture capitalists ruthlessly

terminate funding to failing firms because they want to devote their limited energy to firms

with the greatest promise. Corporate venture capitalists have frequently been unwilling to

write off unsuccessful ventures, lest they incur the reputational repercussions that a failure

would entail.

Consequently, concerns linger about attempts to replicate the success of venture

capital firms in the corporate setting. The previous two surges in corporate venture capital,

like today’s activity, were stimulated by well-publicized successes of independent venture

investors. When their initial venture investments faltered in the past, corporations rapidly

abandoned their programs. Avoiding the mistakes of the past is a major challenge for

corporate venture capital programs today. In this module, we explore how one corporate

venture fund is seeking to address these challenges.

36

3.D.3. Social Venture Capital

It is interesting to note that the primary motivation in 1946 for the founders of the

world’s first private equity fund, American Research and Development, was largely not the

creation of profits. Rather it was the encouragement of economic growth in the United

States and New England. As founder (and former Harvard Business School professor)

General Georges Doriot responded, when confronted by some investors who complained

about the slow progress of many of his investments:

You sophisticated stockholders make five points and sell out. But we have
our hearts in our companies: we are really doctors of childhood diseases here.
When bankers or brokers tell me I should sell an ailing company, I ask them,

“Would you sell a child running a temperature of 104?”15

While American Research and Development sought to combine social goals with

profits, the Small Business Investment Company (SBIC) program is generally regarded as

the first explicit “social venture capital” endeavor. This program was launched by the U.S.

government in 1958 in the aftermath of the Soviet Union’s launch of the world’s first

satellite, Sputnik. The level of social venture activity remained relatively modest until the

late 1970s. During the past fifteen years, over one hundred state and federal initiatives have

been launched. European and Asian nations have also undertaken many similar initiatives.

While these programs’ precise structures have differed, the efforts have been predicated

on two shared assumptions: (i) that the private sector provides insufficient capital to new

15Patrick Liles, Sustaining the Venture Capital Firm, Cambridge, Management Analysis
Center, 1977, page 70.

37

firms, at least in certain regions or industries, and (ii) that the government can identify

firms where investments will ultimately yield high social and/or private returns.

While the sums of money involved are modest relative to public expenditures on

defense procurement or retiree benefits, these programs are very substantial when

compared to contemporaneous private investments in new firms. For instance, the SBIC

program led to the provision of more than $3 billion to young firms between 1958 and

1969, more than three times the total private venture capital investment during these

years. In 1995, the sum of the financing provided through and guaranteed by social

venture capital programs in the United States was at least $2.4 billion. This sum was

substantial relative to the $3.9 billion disbursed by traditional venture funds in that year.

Perhaps more significantly, the bulk of the public funds were for early-stage firms, which

in the past decade have only accounted for about 30% of the disbursements by traditional

venture funds. Some of America’s most dynamic technology companies received support

through these programs while still private entities, including Apple Computer, Chiron,

Compaq, Federal Express, and Intel. Public venture capital programs have also had a

significant impact overseas. Germany, for instance, has created over the past two decades

about 800 federal and state government financing programs for new firms, which provide

the bulk of the external financing for technology-intensive start-ups.

Many of the same problems that haunt corporate venture programs, however, also

bedevil social venture initiatives. Among them are the difficulty of balancing multiple

objectives, the investors’ frequent failure to appreciate the long-run nature of these

38

investments, and the struggle to design appropriate compensation schemes. In this module,

we examine one community development venture fund’s efforts to overcome these barriers.

The course concludes with a final lecture. Prior to the lecture, we review the

decisions that the Yale endowment faced in deciding how much of the endowment to allocate

to private equity and how to structure its portfolio. The students reflect how the insights

gained to the course have led them to shift their recommendations regarding the allocation of

funds to private equity, or reinforced their existing convictions.

4. Future Directions

This course is very much still a work in progress. This final section describes the

directions in which the course will evolve in the short run, as well as possible long-run

directions.

The immediate goals for course development are three-fold: expanding the range of

private equity investments considered, deepening the treatment of legal issues, and building

stronger links with the frameworks used in courses on investments and capital markets.

During the 1997-1998 academic year, a new case study will examine a fund specializing in

mezzanine investments. Other possibilities in future years include cases about a private

equity investment into a strategic alliance (a form of financing increasingly seen in developing

nations) and about a fund specializing in oil-and-gas investments. A second change in this

academic year’s version of the course will be the addition of a half-day lecture that reviews

the legal constraints that limit venture and buyout investments, along with the provision of

39

supplemental readings on this subject. Finally, an expanded lecture will explore some of the

challenges associated with the valuation of private equity investments, the assessment of the

returns of private equity organizations, and the bench-marking and risk-adjustment of the

performance of these groups.

More generally, the future evolution of this course will reflect the changes in the

private equity industry itself. Some thoughtful observers believe that the industry will stay

narrowly focused on growth and restructuring opportunities in the United States. Others

believe that the recent wave of international expansion will continue unabated. Yet others

argue that similarly structured funds will increasingly spring up to invest a number of other

asset classes (such as the recent growth in timberland partnerships). Another open question

is whether the somewhat similar challenges that face hedge funds and private real estate

partnerships are appropriate subject matters for this course. In the short run, at least,

“Venture Capital and Private Equity” will retain its current focus.

40

Course Outline, 1996-1997 Academic Year16

INTRODUCTION

Yale University Investments Office (9-296-040) 1/22/97
The Economics of the Private Equity Industry, ch. 1
Venture Capital and Private Equity: Course Overview (9-297-045)

I. THE PRIVATE EQUITY CYCLE: FUNDRAISING

FOX Venture Partners (9-296-041) 1/24/97
The Economics of the Private Equity Industry, ch. 2 and 5
Venture Capital and Private Equity: Module I (9-297-040)

Acme Investment Trust (9-296-0

42

) 1/29/97
A Note on Private Equity Partnership Agreements (9-294-084)
The Economics of the Private Equity Industry, ch. 4

Weston Presidio Offshore Capital (9-296-055) 1/30/97

ARCH Venture Partners (9-295-105) 1/31/97

Schroder Ventures (9-297-026) 2/5/97
Note on European Buy-outs (9-296-051)

II. THE PRIVATE EQUITY CYCLE: INVESTING

A Note on Valuation in Private Equity Settings (9-297-050) 2/6/97
Information Sources about Private Equity (9-295-066)
VentureOne Annual Report
Venture Capital and Private Equity: Module II (9-297-041)

Apex Investment Partners (A) (9-296-028) 2/7/97
The Economics of the Private Equity Industry, ch. 3

16To order copies or request permission to reproduce materials, call 1-800-545-7685 or
write Harvard Business School Publishing, Boston, Massachusetts 02163. The web site
is http://www.hbsp.harvard.edu/.

41

GO Corporation (9-297-021) 2/12/97
High Technology’s Premiere Venture Capitalist

The Fojtasek Companies and Heritage Partners (9-297-046) 2/13/97
How to Value Recapitalizations and Leveraged Buyouts

Aberlyn Capital Management (9-294-083) 2/20/97
A Note on the Venture Leasing Industry (9-294-069)

Aberlyn Capital Management (continued) 2/21/97
Brealey and Myers, Principles of Corporate Finance, ch. 20

Apex Investment Partners (B) (9-296-029) 2/26/97

The Exxel Group (9-297-068) 2/27/97
A Note on Private Equity in Developing Countries (9-297-039)

III. THE PRIVATE EQUITY CYCLE: EXITING

The European Association of Security Dealers (9-295-116) 3/12/97
Venture Capital and Private Equity: Module III (9-297-042)

ImmuLogic Pharmaceutical Corp. (A) (9-293-066) 3/13/97
ImmuLogic Pharmaceutical Corp. (B-1) (9-293-067)
ImmuLogic Pharmaceutical Corp. (B-2) (9-293-068)
ImmuLogic Pharmaceutical Corp. (B-3) (9-293-069)
ImmuLogic Pharmaceutical Corp. (B-4) (9-293-070)
ImmuLogic Pharmaceutical Corp. (C) (distributed in class) (9-293-071)

RogersCasey Alternative Investments (9-296-024) 3/19/97
The Economics of the Private Equity Industry, ch. 6 and 7

IV. APPLYING THE PRIVATE EQUITY MODEL IN OTHER SETTINGS

Xerox Technology Ventures (9-295-127) 3/20/97
Venture Capital and Private Equity: Module IV (9-297-043)

Northeast Ventures (9-296-093) 3/26/97

FINAL LECTURE 3/27/97

42

43

Further Readings Not Included in Course Package

Module 1: Private Equity Fundraising and Partnerships

Legal and descriptive works:

Joseph W. Bartlett, Venture Capital: Law, Business Strategies, and Investment Planning,
New York, John Wiley,1988 and supplements, chapter 20.

Craig E. Dauchy and Mark T. Harmon, “Structuring Venture Capital Limited
Partnerships,” The Computer Lawyer, 3 (November 1986) pages 1-7.

Michael J. Halloran, Lee F. Benton, Robert V. Gunderson, Jr., Keith L. Kearney, Jorge
del Calvo, Venture Capital and Public Offering Negotiation, Englewood Cliffs, NJ,
Aspen Law and Business, 1995, volume 1, chapters 1 and 2.

Practitioner and journalistic accounts:

Asset Alternatives, “Venture Firms Seek Bigger Share of Fund Profits,” Private Equity
Analyst, 6 (March 1996) pages 1 and 14-16.

Renee Deger, “Barbarians Behind the Gate,” Venture Capital Journal, 35 (November
1995) pages 45-48.

E.S. Ely, “Dr. Silver’s Tarnished Prescription,” Venture, 9 (July 1987) pages 54-58.
Steven P. Galante, Directory of Alternative Investment Programs , Wellesley, Asset

Alternatives, 1995, section II.
Jason Huemer, “Brinson Partners on a Roll,” Venture Capital Journal, 32 (June 1992)

pages 32-36.
Robert Moreland and Jesse E. Reyes, “The Debate Over Performance,” Venture Capital

Journal, 32 (October 1992) pages 44-48.
Jesse E. Reyes, “Industry Struggling to Forge Tools to Measure Risk,” Venture Capital

Journal, 30, (September 1990) pages 23-27.
Venture Economics, 1992 Terms and Conditions of Venture Capital Partnerships, Boston,

Venture Economics, 1992.
Venture Economics, “A Perspective on Venture Capital Management Fees,” Venture

Capital Journal, 27 (December 1987) pages 10-14.
Lisa Vincenti, “Ship of Holes,” Venture Capital Journal, 35 (November 1995) pages 388-

341.

Academic studies:

Paul A. Gompers, “Grandstanding in the Venture Capital Industry,” Journal of Financial
Economics, 43 (September 1996) pages 133-156.

Paul A. Gompers and Josh Lerner, “The Use of Covenants: An Empirical Analysis of
Venture Partnership Agreements,” Journal of Law and Economics, 39 (October
1996) pages 566-599.

44

Paul A. Gompers and Josh Lerner, “An Analysis of Compensation in the U.S. Venture
Partnership,” Harvard Business School Working Paper #95-009, 1994.

Blaine Huntsman and James P. Hoban, Jr., “Investment in New Enterprise: Some
Empirical Observations on Risk, Return and Market Structure,” Financial
Management, 9 (Summer 1980) pages 44-51.

Module 2: Private Equity Investing

Legal works:

Joseph W. Bartlett, Venture Capital: Law, Business Strategies, and Investment Planning,
New York, John Wiley,1988 and supplements, chapters 6 through 13.

Michael J. Halloran, Lee F. Benton, Robert V. Gunderson, Jr., Keith L. Kearney, Jorge
del Calvo, Venture Capital and Public Offering Negotiation, Englewood Cliffs, NJ,
Aspen Law and Business, 1995, volume 1, chapters 5 through 9.

Jack S. Levin, Structuring Venture Capital, Private Equity, and Entrepreneurial
Transactions, Boston, Little, Brown, 1995, chapters 2 through 8.

Practicing Law Institute, Venture Capital (Commercial Law and Practice Course
Handbook Series), New York, Practicing Law Institute, various years, various
chapters.

Practitioner and journalistic accounts:

Asset Alternatives, “As Deal Valuations Soar, Managers Increasingly Resort to
‘Ratchets,’” Private Equity Analyst, 5 (December 1995) pages 1, 12-16.

Leonard A. Batterson, Raising Venture Capital and the Entrepreneur, Englewood Cliffs,
NJ, Prentice-Hall, 1986.

Coopers & Lybrand, Three Keys to Obtaining Venture Capital, New York, Coopers &
Lybrand, 1993.

Harold M. Hoffman and James Blakey, “You Can Negotiate with Venture Capitalists,
Harvard Business Review, 65 (March-April 1987) 16-24.

Robert J. Kunze, Nothing Ventured: The Perils and Payoffs of the Great American
Venture Capital Game, New York, HarperBusiness, 1990.

Robert C. Perez, Inside Venture Capital: Past, Present and Future, New York, Praeger,
1986.

James L. Plummer, QED Report on Venture Capital Financial Analysis, Palo Alto, QED
Research, 1987.

Academic studies:

George P. Baker and Karen H. Wruck, “Organizational Changes and Value Creation in
Leveraged Buyouts: The Case of O.M. Scott & Sons Company,” Journal of
Financial Economics, 25 (December 1989) pages 163-190.

45

Paul A. Gompers, “Optimal Investment, Monitoring, and the Staging of Venture Capital,”
Journal of Finance, 50 (December 1995) pages 1461-1489.

Steven N. Kaplan and Richard S. Ruback, “The Valuation of Cash Flow Forecasts: An
Empirical Analysis,” Journal of Finance, 50 (September 1995) pages 1059-1093.

Steven N. Kaplan and Jeremy Stein, “The Evolution of Buyout Pricing and Financial
Structure in the 1980s,” Quarterly Journal of Economics, 108 (May 1993) pages
313-358.

Josh Lerner, “The Syndication of Venture Capital Investments,” Financial Management,
23 (Autumn 1994) pages 16-27.

Josh Lerner, “Venture Capitalists and the Oversight of Private Firms,” Journal of
Finance, 50 (March 1995) pages 301-318.

Krishna G. Palepu, “Consequences of Leveraged Buyouts,” Journal of Financial
Economics, 27 (September 1990) pages 247-262.

William A. Sahlman, “The Structure and Governance of Venture Capital Organizations,”
Journal of Financial Economics, 27 (October 1990) pages 473-521.

Module 3: Exiting Private Equity Investments

Legal works:

Joseph W. Bartlett, Venture Capital: Law, Business Strategies, and Investment Planning,
New York, John Wiley,1988 and supplements, chapter 14.

Michael J. Halloran, Lee F. Benton, Robert V. Gunderson, Jr., Keith L. Kearney, Jorge
del Calvo, Venture Capital and Public Offering Negotiation, Englewood Cliffs, NJ,
Aspen Law and Business, 1995, volume 2.

Jack S. Levin, Structuring Venture Capital, Private Equity, and Entrepreneurial
Transactions, Boston, Little, Brown, 1995, chapter 9.

Practitioner and journalistic accounts:

James S. Altschul, “Staging the Small IPO,” CFO, 7 (November 1992) pages 70-74.
Paul F. Denning, and Robin A. Painter, Stock Distributions: A Guide for Venture

Capitalists, Boston, Robertson, Stephens & Co. and Testa, Hurwitz & Thibeault,
1994.

European Venture Capital Association, Venture Capital Special Paper: Capital Markets
for Entrepreneurial Companies, Zaventum, Belgium, European Venture Capital
Association, 1994.

Mark Mehler, “Mangy Mutts Go Public,” Upside, 4 (October 1992) pages 48-53 and 64.
Ann Monroe, “The High-Tech Crapshot,” Institutional Dealers’ Digest, 61 (March 13,

1995) pages 12-23.
Special Supplement on Initial Public Offerings, Upside, 3 (January 1991).
Venture Economics, Exiting Venture Capital Investments, Wellesley, Venture Economics,

1988.

46

Academic studies:

Alon Brav and Paul A. Gompers, “Myth or Reality?: Long-Run Underperformance of
Initial Public Offerings; Evidence from Venture Capital and Nonventure Capital-
backed IPOs,” unpublished working paper, Harvard University, 1996.

Christopher B. Barry, Chris J. Muscarella, John W. Peavy III, and Michael R.
Vetsuypens, “The Role of Venture Capital in the Creation of Public Companies:
Evidence from the Going Public Process,” Journal of Financial Economics, 27
(October 1990) pages 447-471.

Paul A. Gompers and Josh Lerner, “Venture Capital Distributions: Short-Run and Long-
Run Reactions,” unpublished working paper, Harvard University, 1996.

Steven N. Kaplan, “The Staying Power of Leveraged Buyouts,” Journal of Financial
Economics, 29 (October 1991) pages 287-313.

Josh Lerner, “Venture Capitalists and the Decision to Go Public,” Journal of Financial
Economics, 35 (June 1994) pages 293-316.

T.H. Lin and Richard L. Smith, “Insider Reputation and Selling Decisions: The
Unwinding of Venture Capital Investments During Equity IPOs,” unpublished
working paper, Arizona State University, 1995.

Tim Loughran and Jay R. Ritter, 1995, “The New Issues Puzzle,” Journal of Finance, 50
(March 1995) pages 23-51.

William C. Megginson and Kathleen A. Weiss, “Venture Capital Certification in Initial
Public Offerings,” Journal of Finance 46 (July 1991) pages 879-893.

Module 4: Module Review

Practitioner accounts and studies about corporate venture capital:

Asset Alternatives, “Corporate Venturing Bounces Back, With Internet Acting as
Springboard,” Private Equity Analyst, 6 (August 1996) pages 1 and 18-19.

Zenas Block and Oscar A. Ornati, “Compensating Corporate Venture Managers,” Journal
of Business Venturing, 2 (1987) pages 41-52.

Norman D. Fast, The Rise and Fall of Corporate New Venture Divisions, Ann Arbor,
UMI Research Press, 1978.

G. Felda Hardymon, Mark J. DeNino, and Malcolm S. Salter, “When Corporate Venture
Capital Doesn’t Work,” Harvard Business Review, 61 (May-June 1983) pages
114-120.

E. Lawler and J. Drexel, The Corporate Entrepreneur, Los Angeles, Center for Effective
Organizations, Graduate School of Business Administration, University of
Southern California, 1980.

Kenneth W. Rind, “The Role of Venture Capital in Corporate Development,” Strategic
Management Journal, 2 (April 1981) pages 169-180.

47

Robin Siegel, Eric Siegel, and Ian C. MacMillan, “Corporate Venture Capitalists:
Autonomy, Obstacles, and Performance,” Journal of Business Venturing, 3 (1988)
pages 233-247.

Practitioner accounts and studies about social venture capital:

Peter Eisenger, “The State of State Venture Capitalism,” Economic Development
Quarterly, 5 (February 1991) pages 64-76.

Peter Eisenger, “State Venture Capitalism, State Politics, and the World of High-Risk
Investment,” Economic Development Quarterly, 7 (May 1993) pages 131-139.

Josh Lerner, “The Government as Venture Capitalist: An Empirical Analysis of the SBIR
Program,” Harvard Business School Working Paper #96-038, 1996.

Charles M. Noone and Stanley M. Rubel, SBICs: Pioneers in Organized Venture Capital,
Chicago, Capital Publishing, 1970.

Steven J. Waddell, “Emerging Socio-Economic Institutions in the Venture Capital
Industry: An Appraisal,” American Journal of Economics and Sociology, 54 (July
1995) pages 323-338.