Where the 2/20% Venture Capital Structure Comes from

Again, I just want to get this out there. Venture capital, other private equity and alternative asset classes often get paid in the following way: x% of the total money they are investing plus Y% of the returns they generate above some hurdle. Classic case is 2/20. 

There are a many stories where this comes from: whale hunting, spice trading and other stuff. According to a fascinating book I want to recommend More money than God this is not actually true but what dreamed up by the first Hedge Fund guy. This is fascinating to me because the whaling and other stories are told soo often and apparently it is bullshit.

Venture Capital Compensation

German Software Stocks - Financial Analysis Intro

As stated previously I will analyse German Software companies. Most financial information is meaningless to me for the purpose of arriving at an attractive price. I can of course compile benchmarks and understand why current coverage, cash cycle theoretically matter but I don’t feel comfortable with it.

What I will do instead is put a value on the whole business then divide that by the number of shares. That will give me the price that I’d be willing to pay for more shares.

But, before I do this I want to share my approach so that I do the same thing for all companies and can improve. This is also written fast and based on common sense. I write we because I own a share of each company.

I will keep this part purely financial, some of the questions serve as preparation for qualitative research or asking the management.

Questions I want answers to:

  1. Does selling the current products make more cash than it costs to make them?
  2. Are there more customers for the products with similar acquisition costs in the future?
  3. Have less people bought our products in the lastly?
  4. Are we making a lot of investments?
  5. Have we made a lot of investments in the past?
  6. How good have the past investments been?

Definition of “Investment” and “Investment” in the context of Software businesses

An “investment” is something that you do today to generate cash in the future. If it does not generate cash it was a bad investment. But, if it does generate cash it is not automatically a good investment. Because it could also not be an investment at all.

Example: If I am in the business of selling balloons on the Oktoberfest, than the thing to put gas into the balloon is not an investment. Yes, it generates cash. Yes, it is re-used when there is gas filled it. But if I buy a new one, I cannot tell my investors that I have “invested” in something. The new gas thing will not generate more revenue at the next Octoberfest, it will just allow me to do any revenue.

Normally, I would expect to find the “investments” in the assets on the balance sheet. Now, in case of software, most likely there will not be an asset on the balance sheet but I expect it to be somewhere on the incoming statement - hidden as labour costs.

Enough theory, let’s start

I feel there has been too much theory from me. I will start and later come back to this article. The questions above still stand.

Share price experiment

Share price experiment

Having spend a lot of time on thinking what makes a product profitable, I am not spending more time thinking about what business do. Less on the venture capital side, more on the value investment side. In this article I set the context for a number of analysis that I want to do.

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Is Michael Porter wrong?

Is Michael Porter wrong?

I am trying a new way of writing. Live commenting on the me reading a piece about Michael Porter, the author of competitive advantage and general strategy genius. The foundation for this is the piece "The Gospel According to Michael Porter" from the magazine Institutional Investor.

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