TARGET RETURN APPROACH

Excite Ltd is a new Internet-based company that streams sports films to its customers. Excite has been in business for 20 months and already has to pay customers and revenue. Nigel Smith, the founder, has financed Excite so far by using his own financial resources and cash flow from company sales. However, he has run out of personal funds and realizes he needs substantial new funding in order to develop the business properly. Nigel has approached your venture capital fund for backing. 

Based on his new business plan, Nigel believes he needs £5 million, which he thinks will be enough funding to achieveNet Income (profit after taxes) of £5 million by the end of Year 5 in the business plan. He believes comparable companies would be valued at20x Net Income at that time. Given the investment risk, you perceive, you believe your fund must require an internal rate-of-return (IRR) of 50% in order to justify the investment. Excite already has 1,000,000 shares outstanding (all owned by Nigel).

Question 1:

What share of the company must your fund own in order to achieve a 50% IRR at the end of Year 5? 

Question 2:

How many shares will your fund need to purchase?

Question 3:

What price per share will your fund have to pay?

Question 4:

 What would be the post-money valuation of Excite for this financing?

Question 5:

What would be the pre-money valuation of Excite? Nigel confides that he could use as much as £12 million to get Excite to the stage when it could achieve a significant IPO or be sold to a company like Amazon. Based on this investment, Nigel believes he could produce a Net Income of £8 million by the end of Year 7

Question 6:

How much of Excite must your fund own if you were to fund the entire £12 million up-front, assuming you want to achieve a 50% IRR by the end of Year 7?

Question 7:

Which of the above investment strategies (investing £5m or £12m)would you choose and why?