A.Assuming it is a seed stage firm with no existing investors, what annualized return is embedded in their anticipation?r = (300,000,000/15,000,000)^(1/5)-1 = 82.0564%B.Suppose the founder wants to have a venture investor inject $15,000,000 in three r-15-15ounds of $5,000,000 at time 0, 1 and 2 with time 5 exit value of $300,000,000. If the founder anticipates returns of 70%, 50% and 30% for round 1, 2 and 3, respectively, what percent of ownership is sold during the first round? During the second round? During the third round? What is the founders’ year-five ownership percentage?First Round FV: 5,000,000 x (1.7)^5 = 70,992,850Second Round FV: 5,000,000 x (1.5)^4 = 25,312,500Third Round FV: = 5,000,000 x (1.3)^3 = 10,985,000Total FV = 107,290,350First Round % of Total FV = 23.66% = 70,992,850/300,000,000Second Round % of Total FV = 8.44% = 25,312,500/300,000,000Third Round % of Total FV = 3.66% = 10,985,000/300,000,000)Founder final ownership = 1 – 23.66% - 8.44% - 3.66% = 64.24% = 192,709,650/300,000,000C.Assuming the founder will have 10,000 shares, how many shares will be issued in rounds 1, 2 and 3 (at times 0, 1 and 2)?173
Chapter 10: Venture Capital Valuation MethodsFounder shares = 10,000Total shares at year 5: =10,000 / .6424 = 15,567Round one shares = .2366 x 15,567 = 3684Round two shares = .0844 x 15,567 = 1313Round three shares = .0366 x 15,567 = 570D.What is the second round share price derived from the answers in Parts B and C?Second Round Price = 5,000,000 / 1313 =3808/shareE.How does the answer to part D change if 10% of the year-five firm is set aside for incentive compensation?How many total shares are outstanding (including incentive shares) by year 5?Founder final ownership = 1 -23.66% - 8.44% - 3.66% -10% = 54.24%Total shares at year 5 = 10,000 / .54.24 = 18,438Round two shares = .0844 x 18,438 = 1556 Round two price = 5,000,000 / 1556 = 3213/share5. [Rates of Return] Suppose a venture fund wishes to base its required return (used in discounting future terminalvalues) on its historical experience and suggests merely averaging the rates on the last three concluded deals.These deals realized total returns of –67% at the end of 2 years, 50% at the end of 5 years and 70% at the endof three years, respectively. A.Assuming no intermediate flows before the terminal payoff, verify that the associated annualized rates are –42.55%, 8.45% and 19.35%. 2 years: (1-.67)^.5 – 1 = -42.55%5 years: (1+.50)^.2 -1 = 8.45%3 years: (1+.7)^(1/3) -1 = 19.35%B.What is the equally weighted average annualized return? (-42.55% + 8.45% +19.35%) / 3 = -4.92%C.Does it make sense to use this as a single discount rate to apply across scenarios involving differentdurations?The returns have been realized over a total of 10 investment years. However, the simple average here isonly dividing by the three outcomes (not their years). Consequently, it is open for debate whether thissimple project averaging is the best way to calibrate a required return for projects of widely varying knowndurations. However, at the time the venture is funded, it is not known what the duration will be and if it islike a small replication of all of the previous funded ventures, it is reasonable to use the hybrid discount ratefor all of the venture’s possible outcomes.2.[Multiple Financing Rounds] Rework the two-stage example of section 10.5 with 1,000,000 initial founders’ shares (instead of the original 2,000,000 shares). What changes?