The Effects of Diversification on Venture Capitalist

You are comparing the required returns of two venture capitalists who are interested in investing in the same software firm. One venture capitalist has all of his capital invested in only software firms, whereas the other venture capitalist has invested her capital in small companies in a variety of businesses. Which of these two will have the higher required rate of return?

□ The venture capitalist who is invested only in software companies

□ The venture capitalist who is invested in a variety of businesses

□ Cannot answer without more information

This question is designed to check on a concept introduced in an earlier chapter on risk and return on the difference between risk that can be eliminated by holding a diversified portfolio and risk that cannot, and then connecting it to the question of how a business seeking funds from a venture capitalist might be affected by this perception of risk. The answer to this question, in turn, will expose the reader to more questions about whether venture capital in the future will be provided by diversified funds, and what a specialized venture capitalist (who invests in one sector alone) might need to do in order to survive in such an environment. I hope that this will allow readers to see what, for me at least, is one of the most exciting aspects of corporate finance, which is its capacity to provide a framework which can be used to make sense of the events that occur around us every day and make reasonable forecasts about future directions. The second way in which I have tried to make this an active experience is by introducing what I call live

Concept Questions

Active learning

Live Case Studies case studies at the end of each chapter. These case studies essentially take the concepts introduced in the chapter and provide a framework for applying these concepts to any company that the reader chooses. Guidelines on where to get the information to answer the questions is also provided.

While corporate finance provides us with an internally consistent and straight forward template for the analysis of any firm, information is clearly the lubricant that allows us to do the analysis. There are three steps in the information process - acquiring the information, filtering that which is useful from that which is not and keeping the information updated. Accepting the limitations of the printed page on all of these aspects, I have tried to put the power of online information and the internet to use in several ways.

1. The case studies that require the information are accompanied by links to web sites that carry this information.

2. The data sets that are difficult to get from the internet or are specific to this book, such as the updated versions of the tables, are available on my web site and intergrated into the book. As an example, the table that contains the dividend yields and payout ratios by industry sectors for the most recent quarter is referenced in chapter 9 as follows:

http: ~adamodar/datasets/dividends.html

There is a dataset on the web that summarizes dividend yields and payout ratios for U.S. companies, categorized by sector.

3. The spreadsheets that are used to analyze the firms in the book are also available on my web site, and referenced in the book. For instance, the spreadsheet used to estimate the optimal debt ratio for Disney in chapter 8 is referenced as follows:

http: / /

This spreadsheet allows you to compute the optimal debt ratio firm value for any firm, using the same information used for Disney. It has updated interest coverage ratios and spreads built in.

As I set out to write this book, I had two objectives in mind. One was to write a book that not only reflects the way I teach corporate finance in a classroom, but more importantly, conveys the fascination and enjoyment I get out of the subject matter. The second was to write a book for practitioners that students would find useful, rather than the other way around. I do not know whether I have fully accomplished either objective, but I do know I had an immense amount of fun trying. I hope you do too!

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  • patricia
    Do a “venture capitalist” analysis?
    8 years ago

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