Question

Problem 1. A start-up company called “COMM387” is raising it’s Series A round at a $12M pre-money valuation and a $10 price per share. The amount raised in the Series A round is $1M. Two years before the Series A round, the company raised its seed round by issuing a convertible note with a $3M valuation cap and a 20% discount. The principle amount of the convertible note is $1M, with an annual non-cumulative interest rate of 5%.

1. What is the number of shares held by founders and management team?

2. Without taking the seed financing round into consideration, what is the fraction of shares that Series A investors intend to get with IA = $1M and P RE = $12M?

3. What is the fraction of shares held by Series A investors if the seed investor chooses to convert its convertible note using pricing discount?

4. What is the fraction of shares held by Series A investors if the seed investor chooses to convert its convertible note using valuation cap?

5. Series A investors realize that the pre-money valuation ($12 million) does not take into account the shares that are converted from convertible note, and understand that their fraction of shares will depend on the seed investor’s conversion choice. They are unhappy with it and they propose to invest $1,000,000 for 7.69% of the shares at the closing of Series A round. Compute the number of shares Series A investors will get in this case.

Answer 1

1. Assuming the seed investors do not exercise their conversion option, the founder and the management currently hold all the shares. The company has valued each share at $10 and the valuation is $12 Million. Hence number of Shares = 12,000,000 / 10 = 1.2 Million Shares

2. If the seed investors do not exercise their conversion, then the total value of the company after the investment by the Series A investors will be = $ 12 Million + $ 1 Million = $ 13 Million. Therefore, the % of company they want to obtain = $ 1 Million / $ 13 Million = 7.69%

3. Price Discount of 20% on current valuation = $10 - 20% *10 =$8 /share. Assuming only the principal gets converted into shares, the number of shares in the company will increase by 1,000,000/8 = 125,000 new shares. Total number of shares now = 1,200,000 + 125,000 = 1,325,000. Hence, total valuation of the company increases. Series A investor gets 1,000,000/10 = 100,000 shares. Therefore % of company Series A investor holds = 100,000/(1350000+ 100,000) = 7.02%

4. Valuation Cap of 3 Million means the seed investors will receive shares at the max of the valuation cap in case of valuation exceeding the cap. Hence, the number of shares the seed investor gets if the opt for valuation cap = 1,000,000/3,000,000 = 33.33% of the company. Therefore, 1.2 million shares now constitute only 66.67% of the company. Hence, the new share capital of the company = 1,200,000 * 100/66.67 = 1,799,910 shares. Therefore the Series A investor now holds 100,000 / (1,799,910 + 100,000) = 5.26%