In Class Review
Question 1: Valuation
John Thompson, CEO of NewVenture, Inc., seeks to raise $5 million in equity for his
early stage venture in January 2016. NewVenture is a subscription-based software company
that has experienced 75% revenue growth over the last year. The company generated $2.5
million of revenue in 2015, with an operating loss of ($450,000). Thompson projects that
NewVenture will achieve $30 million in revenue by 2020, followed by 5 years of 35%
revenue growth and 3% growth thereafter. He also estimates that the company will remain
unprofitable until 2020, with EBIAT margins of about -10% on average over the next 5 years,
growing over time to an average of 5% in years 6-10 and 10% thereafter. Asset intensity is
projected to remain at its current -10%.
a. Samantha Jones of Gorsuch Capital is considering an investment in January 2016.
Her experience with comparable ‘Software as a Service’ (SaaS) startups suggests that
NewVenture could exit in December 2020 with a 4X to 6X Price-to-Sales multiple.
Given this, what is her projected exit value for NewVenture in 2020?
b. Use the 3 stage model to estimate the value of NewVenture in 2020, assuming a
discount rate of 10% and that the startup meets the projections made by Thompson.
Does the multiple range assumed by Samantha Jones make sense given the projected
cash flows from NewVenture?
c. How should a forecast of lower growth or higher asset intensity relative to other firms
in the same industry impact her projected multiple?
d. What share of the company will she require in January 2016 if her annual required
rate of return is 50% and she anticipates an exit in December 2020 of $150 million?
e. What is the implied pre- and post-money valuation if she invests on those terms?
f. The company has 10,000,000 shares outstanding before the investment. How many
new shares should she purchase, and at what share price? Assume the investment is in
standard convertible preferred stock 1 with no dividends and a conversion rate to
common of 1:1.
We covered this in class, but just as a reminder, Preferred stock refers to a type of equity that has rights not
available to holders of common stock. There are two main types of preferred stock: Standard, or non-participating
Convertible Preferred Stock and Participating Preferred Stock. In the Standard convertible preferred stock, the
investor has the choice to either redeem their investment or convert into common at an agreed upon conversion
rate, based on which option gives them a higher payoff. With “Participating,” preferred stock, investors do not
have to choose. They first take their liquidation preference and then also participate in the remaining proceeds on
an “as-converted basis”.
1
Question 2: Comparing Securities
Jones proposes taking participating preferred stock with 1X liquidation preference 2 in return
for her $5 million investment.
a. Assuming she invests $5 million at the valuation calculated in Question 1(d), how much
money will she get with this security if NewVenture exits in December 2020 at a $150
million valuation?
b. Why might Thompson feel this is unfair?
c. What is a reasonable counter-proposal for Thompson to offer Jones? Hint: What share
of the company does Samantha Jones actually require if she is given participating
preferred stock and her required rate of return is still 50% per annum?
d. If Jones accepts Thompson’s proposal, what is the implied pre-and post-money
valuation?
2 See footnote 1 for the distinction between Standard Convertible Preferred Stock and Participating
Convertible Preferred Stock.
Question 3: Multi-Stage Financing
Samantha and John agree to the simple convertible preferred security. Upon further reflection,
they also agree that the company will need another round of financing in addition to the current
$5 million as well as an option pool.
Samantha believes that NewVenture will need an additional $3 million in equity in January
2018. While she will require a 50% IRR, Samantha feels that round-two investors will require
an IRR of only 30%.
Assume that the management option pool (created before Samantha’s Series A investment)
should have the ability to own a 10% share of the company by the end of year 5.
a. What share of the company will the Round 2 investors seek?
b. Based on this, what share of the company should Samantha seek in January 2016
assuming she still needs her 50% IRR?
c.
Create a capitalization table to depict percentage ownership for Samantha, the option
pool, and the two investors at the end of year 5, assuming no further rounds of
financing.