A venture capitalist (VC) is considering providing financing of $10 million to a startup firm in return for common stock in the firm. The VC plans to invest in the firm for 5 years after which the VC expects the firm will sell at an Enterprise Value-to-EBITDA multiple of 4. After 5 years, the firm is expected to have EBITDA of 100 million, debt outstanding of $250 mln and cash balance of $50 mln.

1. Assume that the VC will be granted common stock. If the VCs required rate of return is 45%, how much equity ownership must be given to the VC?

2. Instead of common stock, the VC is offered convertible debt that pays a 10% annual interest. In Year 5 (i.e., at exit) the debt can be converted into equity. Assuming that the VC wants a 38% IRR, what fraction of the firm’s equity must be given up to the VC at conversion in five years?