Question

Roger Harkel, CEO of Bestafer, Inc. seeks to raise $2 million in a private placement of equity in his early stage venture. Harkel conservatively projects net income of $5 million in year 5 and knows that comparable companies trade at a price earnings ratio of 20X.

What share of the company would a venture capitalist require today if her required rate of return was 50%?

What if her required rate of return was only 30%?

If the company had 1M shares outstanding before the private placement, how many shares should the venture capitalist purchase?

What price per share should she agree to pay if her required rate of return was 50%? 30%?

(Note: Assume investment is in standard prefferred stock with no dividends and a conversion rate to common of 1:1)

Roger feels that he may need as much as $12M in total outside financing to launch his new product. If he sought to raise the full amount in this round, how much of his company would he have to give up?

What price per share would the venture capitalist be willing to pay if her required rate of return was 50%? 30%?

Answer 1

Following information is given

• The amount to be raised is $2 million in private placement
• The net income in year five is estimated at $5 million
• The PE ratio is 20 X

The total value of company in year 5 is

Total value of company = $5 million x 20 = $100 million

What share of the company would a venture capitalist require today if her required rate of return was 50%?

Ans

To calculate the share required by venture capitalist on $2 million private placement of equity

The rate of return required is 50%

The future value of $1 invested now at 50% after 5 years will be $ 7.59375 or can be calculated (1.50)⁵

The future value of $2 million invested at 50% interest at end of year 5 will be

=$2 million x 7.59375

=$ 15.1875 million

The percentage of share today at 50% interest rate will be

= Future value at end of year 5 / total value of company at year 5

=($15.1875 /$100)x 100

=15.1875%

What if her required rate of return was only 30%?

Ans

To calculate the share required by venture capitalist on $2 million private placement of equity

The rate of return required is 30%

The future value of $1 invested now at 30% after 5 years will be $ 3.71293 or can be calculated (1.30)⁵

The future value of $2 million invested at 30% interest at end of year 5 will be

=$2 million x 3.71293

=$ 7.42586 million

The percentage of share today at 30% interest rate will be

= Future value at end of year 5 / total value of company at year 5

=($7.42586 /$100)x 100

=7.4259%

If the company had 1M shares outstanding before the private placement, how many shares should the venture capitalist purchase?

What price per share should she agree to pay if her required rate of return was 50%? 30%?

(Note: Assume investment is in standard preferred stock with no dividends and a conversion rate to common of 1:1)

Ans

Following assumptions are taken at 30% rate of return

Let X be the shares purchased

The number of shares after x purchased

X / 1,000,000 +X = VC shares = 7.4259%

The equation to solve x will be

X / 1,000,000 +X = 0.074259

X = 0.074259(10,00,000 + X)

X = 74258.6 + 0.074259X

1X – 0.074259X = 74258.60

0.925741X = 74258.60

X = 74258.60 /0.925741

X=80215 SHARES

The total shares purchased will be 80215

The value of each share will be

= amount invested / total shares purchased

= $2,000,000 / 80215

=$24.93

The value of each share will be $24.93 rounded of to 2 decimals

Following assumptions are taken at 50% rate of return

Let X be the shares purchased

The number of shares after x purchased

X / 1,000,000 +X = VC shares = 15.1875%

The equation to solve x will be

X / 1,000,000 +X = 0.151875

X = 0.151875(10,00,000 + X)

X = 151875 + 0.151875X

1X – 0.151875X = 151875

0.848125X = 151875

X = 151875 /0.848125

X=179071 SHARES

The total shares purchased will be 179071

The value of each share will be

= amount invested / total shares purchased

= $2,000,000 / 179071

=$11.16872

The value of each share will be $11.17 rounded of to 2 decimals

Roger feels that he may need as much as $12M in total outside financing to launch his new product. If he sought to raise the full amount in this round, how much of his company would he have to give up?

Ans

If 12 million is required from outside the total value after at 50% rate of return

The present value at year 5 at 50% interest rate will be

$12 million x (1.50)⁵

$12 million x 7.59375

=$91.125

The percentage share at $100 million total value will be

= ($91.125/$100)x 100

= 91.125%

Roger has to give up 91.125% of equity for 12 million financing at 50% rate of return required

If 12 million is required from outside the total value after at 30% rate of return

The present value at year 5 at 30% interest rate will be

$12 million x (1.30)⁵

$12 million x 3.71293

=$ 44.55516

The percentage share at $100 million total value will be

= ($44.55516/$100)x 100

= 44.55516% or 44.56%

Roger has to give up 44.56% of equity for 12 million financing at 30% rate of return required