Question

Mesa Blanca decides to invest $5 million in Action Technologies. Expected exit valuation is $125 million and time to exit is 5 years. Mesa Blanca wants a 50% / year return and expects future dilution of 60%.

What might lead Mesa Blanca to expect future dilution of 60%?

What would the pre and post money valuation, and % ownership Mesa Blanca require at the time of their investment?

What does this analysis suggest about Action Technologies?

Answer 1

a) Future dilution happens when a firm issue more shares to other investors to raise capital. If you own 100 shares then your ownership is calculated as 100/100 (yours/total). If you give 10% away, that increases your number of shares by around 11 shares. So your stake is now 100/111, which is 90%

Hence, dilution is a common phenomenon in startups. In this case, Mesa Blanca might initially get 50% ownership initially, which might decrease to 30% in next 5 years.

b) Mesa want's to grow her $5 million investment by 50% annually for next 5 years.

That means she would need 5*(1.5)^5= 5* 7.59375= $37.96875 (roughly 38) million dollars in 5 years when she exits from the company.

The exit value of company will be $125 million dollars in 5 years.

Hence, ownership required at the end of 5 years = $38/125= 30.4%

Since she expects 60% dilution, the ownership required at the time of investment is 30.4%+60%=90.4%

Investment=$5 million.

Post money valuation= $5 million/90.4%=$5.53 million

Pre money valuation= Post money valuation - investment amount= $5.53-$5=0.53 million= $530K

c) This analysis show that the company is only worth $530K right now. It is a very small company and Mesa will acquire

a majority stake with her investment