Question

1. You are considering a Series A (first round) investment in a new venture with a pre money valuation of $8 million.

1. Suppose you make a $2 million investment.
   1. What is the post money valuation?
   2. How much of the company do you own?
2. The term sheet agreement indicates that your participating preferred shares have a 1.5X liquidation preference and up to a 3X participating cap on common stock.
   1. If the company is sold for $5 million, what is the maximum amount you will receive?
   2. Suppose the company is sold for $20 million. What is the maximum amount you can receive?

   3. At what valuation (exit price) will it no longer make sense to exercise your liquidation preference?  

Answer 1

I a Post money valuation =premoney valuation+ investment = $8 million +$2 million =$10 million

b) Company owned = Investment/ Post money valuation= $2 million/$10 million =20%

II With 1.5X liquidation preference and up to a 3X participating cap on common stock. , the investor can get 1.5 times the investment i.e.$2 million *1.5 = $3 million out first and then participate in the leftover proceeds upto 3 times the investment ie, upto 3 * $2 million = $6 million which is the maximum payout to the Investor

a) So, if the company is sold for $5 million

Payout to investor = $3 million (1.5X liquidation preference)

and from the remaining $2 million , 20% ownership stake = $2 million *0.2 = $400,000, thereby making a total of $3.4 million

Without liquidation preference, the investor receives only 20% of $5 million =$1 million

So, maximum amount received by Investor = $3.4 million

b) If the company is sold for $20 million

Payout to investor = $3 million (1.5X liquidation preference)

and from the remaining $17 million , 20% ownership stake = $17 million *0.2 = $3.4 million

So, maximum amount received by Investor = $6.4 million or $6 million whichever is lower =$6 million

Without liquidation preference, the investor receives only 20% of $20 million =$4 million

So, the maximum investor receives is $6 million

c) Suppose the company is sold for $X million

With liquidation preference, Investor receives $ 3 million and then 20% of $(X-3) million upto  $6 million maximum

Without liquidation preference , Investor receives 20% of $X million

So, 20% of X > $6 million for the liquidation preference option to be meaningless

So, X > $30 million

So, at a valuation of $30 million or higher, it does not make sense to exercise the liquidation preference.