Question

James is a partner in a very successful Boston-based VC firm. He plans to invest $5 million in a start-up biotechnology venture and must decide what share of the company he should demand his investment.    Projections he developed with company management show net income in Year 7 of $20 million. The few profitable biotechnology companies are trading at an average price-earnings (P/E) ratio of 15. The company currently has 500,000 shares outstanding. James believes that a target rate of return of 50 per cent is required for a venture of this risk.

(i)Calculate the implied pre-money valuation and implied post-money valuation.                  

(ii)James and his partners are of the opinion that three more senior staff will need to be hired.   In James experience, this number of top-calibre recruits would require options amounting to 10 per cent of the common stock outstanding. Additionally, he believes that, at the time the firm goes public, additional shares equivalent to 30 per cent of the common stock will be sold to the public. Calculate the price per new share.         

Answer 1

1).

a. Implied pre-money valuation is $12.5 million

b. Implied post-money valuation is $17.5 million

2). Price per new share is $14.56 per share

CALCULATIONS: -

1).

• Discounted Terminal Value

= Terminal Value / (1+Target) years

= (20*15) / (1+50%)7

= $17.5 million

• Required percent ownership

= investment /discounted terminal value

= 5/17.5

= 28.5%

• Number of new shares

= 500,000/ (1-28.5%) – 500,000

= 200,000

• Price per new share

= $5million/200,000 shares

= $25 per share

• Implied Pre-money valuation

= 500,000 shares*$25 per share

= $12.5 million

• Implied post-money valuation

= 700,000 shares*$25 per share

= $17.5 million

2).

James and his partners are of the opinion that three more senior staff will need to be hired. In James’s experience this number of top caliber recruits would require options amounting to 10% of the common stock outstanding. Additionally, he believes that, at the time the firm goes public, additional shares equivalent to 30% of the common stock will be sold to the public. He amends his calculations as follows:

• Retention ratio

= [1/ (1+.1)]/ (1+.3)

= 70%

• Required current percent ownership

= required final percent ownership /retention ratio

= 28.5%/70%

= 40.7%

• Number of new shares

= 500,000/ (1-40.7%)-500,000

= 343,373

• Price per new share

= $5million/343,373 shares

= $14.56 per share