Case study: cryptographic

It was January 2017 and Paul, one of the partners of the venture capital fund Johnson & Smith (J&S) was assessing whether or not they should invest in the firm Cryptographic. The companys business was the development and commercialisation of cryptographic software. The cryptographic market was in a process of rapid expansion, given its many applications, and the fact that both entreprise and government departments were moving their operations from paper to online. The expected market growth was 55 percent annually over the next five years.

In the previous year, 2016, Cryptographics revenues were three million euros. The company had contacted J&S because they were looking to raise two million euros in financing in order to expand across Europe. For the year 2019, Cryptographics business plan forecasted an after-tax profit margin of approximately 30 percent of sales. Paul thought that if they were to invest, they would be able to sell their shares in the company in three years time. Similar companies stock was quoted at 15 times their earning after taxes (P/E ratio of 15x).

Cryptographic was founded at the beginning of 2015, issuing 1,000,000 shares at a price of 0.01 euro per share. In addition, the companys employee stock option plan implied that they would need an additional 100,000 shares to help recruit a management team to take charge of the European expansion.

Questions

Paul, the partner of J&S responsible for the analysis, was trying to prepare some numbers for a Monday call. What might the value of Cryptographic be at the time of J&S exit?

What percentage of Cryptographics capital should J&S request in exchange of their investment? J&S target internal rate of return (IRR) for a project with Cryptographics current risk profile was 40 percent annually.

How many shares would the venture capital fund be getting with their two million euros? How much would they pay per share?

Table: Cryptographic's financial table