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# GRADUATE SCHOOL OF BUSINESS STANFORD UNIVERSITY CASE NUMBER: SM-86 MARCH 2001 SpiffyTerm, Inc. January 2000 January 1, 2000 was not a party day for...

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Spiffy Term, Inc. SM-86 p. 2 Wolf C. Flow had offered to invest \$4 million at a price of \$1 per share, but the founders were not convinced that this was a fair valuation. Instead, they wanted to model what an appropriate valuation might look like. They were quite confident that SpiffyTerm, Inc. would be able to do an IPO after four years, at a valuation of about \$80 million. But they realized that there were risks in their venture, so they thought that everybody would apply a discount rate of 45 percent. Question 1a: What valuation do these assumptions suggest? Question 1b: The founders also wanted to do some sensitive analysis with their assumptions. They wanted to know how the valuations would change if the second round of financing required \$3 million? And what would the valuation be if they raised \$6 million up front with no further round thereafter? Obviously, these valuations differed from the one proposed by Wolf C. Flow. The founders thought that Wolf C. Flow had worked off the same base assumptions, but that he used maybe a different discount rate, or maybe a different IPO value. Question 1c: If Vulture Ventures used the above valuation model, and indeed used a 45 percent discount rate, what implicit valuation after 4 years must they have used? (Hint: for this and many subsequent questions it is helpful to use the “goal seek” command in Excel.) Question 1d: If Vulture Ventures used the above valuation model, and believed the IPO value of \$80 million, what implicit discount rate must they have used? Question 1e: A friend of Bob, called Wuz, was convinced that the investors were using the assumption of 1d, but he reasoned as follows: If Vulture Venture wants to pay only \$1 per share, maybe the founders could simply increase their initial number of shares from 5 million to 10 million, and the option pool from 1.5 million to 3 million? This way everybody would win: the founders get more shares, and the investors get the price per share that they want. Based on this reasoning, should Wuz get an honorary MBA degree? Question 1f: The analysis so far implicitly assumes that the investors are holding straight equity. Under the term sheet proposed by Vulture Ventures, is this a valid assumption? (You don’t need to make any calculations for this part!) SECTION 2: VALUATION WITH ALTERNATIVE SCENARIOS This method of valuation was useful as a first cut. But Krishnuvara was a trained engineer who understood that there was lot of risk in the new venture. He knew that the venture could evolve along a variety of scenarios. One was indeed a very good scenario, in which the company would go public for \$140 million after four years. Another was an intermediate scenario, in which the company would be acquired after four years for \$60 million. And then there was that much- dreaded scenario of failure, in which the company would be worth nothing at all.
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