Fund.us and the Valuation Formula

Your friend Marissa recently sold her company, now qualifies as an accredited investor, and would like to make some angel investments. She has been introduced to Grant and Shelley, who are co-founders of a startup, Fund.us that makes wearable devices for expectant mothers. These wristbands measure biometric data with a particular focus on pregnancy and prompt the user about nutrition, exercise, and fetal development including signs of fetal distress.

They believe that by giving immediate feedback to expectant mothers, prompting them to seek medical attention at the first indication of risk, that they can improve early treatment of many conditions that threaten the health of mother and baby.

The industry has been growing at over 20% per year for each of the past five years, and is anticipated to continue doing so for the foreseeable future. Grant and Shelley had the idea to start the company three years ago. To start the company, they each contributed $20,000, for a total of $40,000. They decided to issue themselves 2,000,000 shares each, for a total number of shares issued and outstanding of 4,000,000.

The company showed a small loss the first year, but broke even the following year and even showed a small profit. Last year, the company made $100,000 in profit on $1 million in sales.

Both Grant and Shelley are very optimistic about the growth of their company. However, the equipment they purchased to make sensors for their wristbands when they started the company was second-hand and they have reached the full capacity of the equipment. They have researched the purchase of new equipment and have found that for a total investment of $500,000 in new equipment and computers they would have the ability to manufacture over 1,000 times their annual production of wristbands currently. Capacity to meet demand would not be an issue for the foreseeable future. They believe they could secure contracts to double their revenues for the coming year if they could buy the equipment and thereby make $200,000 in profit. The second year after raising capital, they feel revenues should be $3 million, with profits rising to $300,000. Projections for the end of the third year show a profit of $400,000 on $4 million in sales.

Grant and Shelley are not sure what the exact exit or harvest strategy is at this time, but they have researched their industry and know that the average public company in their industry group is trading for 30 times trailing earnings and private companies sell for 7 times trailing earnings. Also private companies in their industry can be valued for up to 1 times revenue and public companies for up to 2.5 times revenue.

They are looking to sell 15% of the company to raise the needed investment of $500,000.

Marissa is considering making an investment into Fund.us and has asked your opinion about whether this would be a good investment. She has told you she really needs to make a minimum of 100% rate of return. She thinks the market is there for Grant and Shelley to hit their projections and doesnt doubt that the product is sound.

QUESTIONS

Using the Valuation Formula, explain whether Marissa should invest in the company if her exit strategy is a private valuation in three years.

Using the Valuation Formula, explain whether your friend should invest in the company if her exit strategy is in a public valuation at the end of the third year for the company's projections:

Marissa has now decided she doesn't need 100% compounded rate of return to make this investment and she will be satisfied if she can make a 20% compounded rate of return on her money (at the end of the third year). Grant and Shelley have decided to sell her one third of the company for the investment of $500,000 on a post-money valuation. The exit strategy will be in a private company valuation. Should you recommend to Marissa that she make the investment into Fund.us?

Note: in Excel, the Valuation Formula is expressed as ((1+IRR)^years*(investment))/(multiple)(exit value)