Question
John Thompson, CEO of WVU, Inc., wants to raise $5 million in a private equity in his early stage venture. Thompson conservatively projects net income
John Thompson, CEO of WVU, Inc., wants to raise $5 million in a private equity in his early
stage venture. Thompson conservatively projects net income of $16 million in year five (five
years from now) and knows that comparable companies trade at a price to earnings ratio of 20.
a. If the Price to Earnings ratio for a company like John's is 20X, how much does he expect
his company to be worth at the end of year 5.
b. Sitting at his desk at the end of year 02, John wants to raise $5 million. If a Venture Capitalist wants a rate of return of 50% per year, what percent of the company should the venture capitalist ask for to earn her return in 5 years?
c. If the company has 1,000,000 shares outstanding before the private placement, how many
shares should the venture capitalist purchase?
d. What percent of the company should she buy if her required rate of return is only 30%?
e. John feels that he may need as much as $12 million in total outside financing to launch
his new product. If he seeks to raise the full amount in this round, how much of his
company will he have to give up (assume VC wants the standard 50%)?
Assume now that the company is worth $115 million, and that John needs to raise $5 million in a
private equity. Samantha, the venture capitalist, is still making her $5 million investment. There
are 1,000,000 shares outstanding initially.
f. What price per share should she agree to pay if her required rate of return is 50%?
g. How many shares would the VC purchase if her required rate of return is 30%?
start of business for year 1. So, an investment 5 years from now would be at the end of year 5.
Question 2
John Thompson, CEO of WVU, Inc., wants to raise $5 million in a private equity in his early
stage venture. Thompson conservatively projects net income of $16 million in year five (five
years from now) and knows that comparable companies trade at a price to earnings ratio of 20.
Samantha Jones of Gorsuch Capital likes Thompson's plan, but thinks it nave in one respect: to
recruit a senior management team, she believes Thompson will have to grant generous stock
options in addition to the salaries projected in his business plan. From past experience, she thinks
management should have the ability to own at least an 9% share of the company at the end of
year 5.
a. If Ms. Jones now insists that professional managers own 9% of the company at the end
of year 5, how much of the company is left for investors to own (as a dollar value)?
b. If Ms. Jones wants her investment in the company to be worth $30 million, what
percent of the company's equity should she insist on owning?
Question 3
John Thompson, CEO of WVU, Inc., wants to raise $5 million in a private equity in his early
stage venture. Thompson conservatively projects net income of $16 million in year five (five
years from now) and knows that comparable companies trade at a price to earnings ratio of 20.
On further analysis and discussion, Samantha and John agree that the company will probably
need another round of financing in addition to the current $5 million. Samantha believes that
NewVenture will need an additional $3 million in equity at the beginning of year 3. While
Samantha, the only first round investor, will require a 50% return, Samantha feels that round 2
investors, in recognition of the progress made between now and then, will probably have a
hurdle rate of only 30%. As before, a professional management team should have the ability to
own a 9% share of the company by the end of year 5.
a. Based on this new information, what percent of the company should Samantha seek
today (as percent with two decimal places (EX:12.34%))?
b. What price per share should she be willing to pay?
c. What percent of the company will the Round 2 investors seek?
d. What price per share will they be willing to pay?
How would the price per share change if you assume that the 9 for the professional management
is allocated at the beginning of the first period (before anyone invests) and the management
group gets diluted as new shares are issued in the second period rather than being protected from
dilution. Assume there are 1,000,000 shares outstanding at the end of Year 0 are already divided
between John and the firm's management when the firm is negotiating with Samantha for this
Series A funding. In other words, you would treat the professional managers' equity just like the founding entrepreneur's equity.
e. Based on this new information, what percent of the company should Samantha seek
today (as percent with two decimal places (EX:12.34%))
Question 4
John and Samantha continue to converse, and Samantha proposes a term sheet. Samantha still
wants to have a 50% rate of return on her $5 million investment and is offering to buy standard
preferred shares4. Thompson conservatively projects net income of $16 million in year five
(five years from now) and knows that comparable companies trade at a price to earnings ratio of
20. There is only one round of investment. There are 1,000,000 shares outstanding initially.
a. How much of the company would Samantha need to own in Year 05?
b. How many shares should she purchase?
c. At what price?
In a later counter-offer, Samantha proposes that instead of a standard preferred she be allowed to
use standard preferred and that her shares be augmented with a pay-in-kind dividend (a stock
dividend) equal to 10% of her investment every year. In addition to cash, Samantha will receive
shares. So, she would get the same number of shares initially, but they would behave differently
than the PP shares.
d. What is Samantha's internal rate of return on this transaction if she takes the same
number of shares as part A, just now with the in-kind dividend rather than preferred
shares.
e. If Samantha purchases the same number of shares for this deal as the deal with the
preferred cash dividend (Question 1a), what price per share does she pay?
*Check back to the lecture. For standard preferred, the investor gets a cash dividend (equal to the initial
investment in this case) and the remainder of the return in common stock. So, subtract the dividend off the top
from the value available to distribute between the investors and calculate her ownership % based on the new
value available to investors.
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