Venture capital and private equity session 3
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Venture Capital and Private Equity Session 3. Professor Sandeep Dahiya Georgetown University. Course Road Map. What is Venture Capital - Introduction VC Cycle Fund raising Investing VC Valuation Methods Term Sheets Design of Private Equity securities Exiting

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Venture capital and private equity session 3

Venture Capital and Private Equity Session 3

Professor SandeepDahiya

Georgetown University


Course road map

Course Road Map

  • What is Venture Capital - Introduction

  • VC Cycle

    • Fund raising

    • Investing

      • VC Valuation Methods

      • Term Sheets

      • Design of Private Equity securities

    • Exiting

  • Time permitting – Corporate Venture Capital (CVC)


Accel partners vii

Accel Partners VII


Accel partners high level questions

Accel Partners – High Level Questions

  • How are VCs compensated? How does the compensation structure of VCs differ from CEOs or Fund managers

  • Why do we observe the partnership structure?

  • Why do GPs need to put down 1%?

  • Why not take down the entire capital at one go?

  • Why do we see the various restrictions on size and co-investment in previous deals?


Accel partners more general issues

Accel Partners – More General Issues

  • How do Management Fee and Carry interact with Fund size?

    • $20 million fund with 2 partners(2.5% Mgmt fee)

    • $400 million fund with 4 partners (2.5% Mgmt fee)


Accel partners vii1

Accel Partners VII

  • Would you invest in Accel Partners VII

  • Would David Swensen invest ?

  • How they done in the past?

  • How are they likely to do in the future?


Accel partners now

Accel Partners Now

  • Did close Fund VII with 30% carry

  • Accel VIII – mother of all funds $1.6 BILLION proposed in 2000 scaled back to $950 million later

  • Accel IX 400 million

  • Accel X $520 million

  • Now in London, China and India

  • No Idea how the funds are doing but was Series A investor in FACEBOOK.


Vc method for valuation

VC Method For Valuation

Professor Sandeep Dahiya

Georgetown University


Quick review of valuation methodologies

Quick Review of Valuation Methodologies

  • DCF

    • Estimate FCF (EBIAT+Dep-CapEx-ΔNWC)

    • Estimate WACC

    • Estimate Terminal Value (Perpetual growth g)

    • Discount FCF and TV to get Enterprise Value

  • Multiples Based

    • Choose a set of Peers/Comprables

    • Choose the multiple(s) e.g. EV/EBIT, P/E

    • Estimate Median/Average Multiple

    • Apply to target

Please Read “Note on Valuation in Private Equity Settings”


Vc method

VC Method

  • Flavor of both DCF and Multiples but is different.

    • FCF is highly uncertain

    • WACC is almost meaningless

    • Multiples are hard to get by

    • Most firms will NOT survive

    • A few firms would have incredible growth


Vc method implied valuation

VC Method-Implied Valuation

Information you would almost always have

  • I – Amount being raised from VC

  • X- Number of Shares currently owned by entrepreneur

    Information that requires judgment call

  • R – VC’s required return (IRR) usually between 25% to 80%

  • T – Time to exit (When VC gets money back)

  • V – Value of the company at time of exit

    Numbers you need to calculate

  • F – Fraction of company VC would need to get the return

  • Post-Money Valuation – Value of company after funding is received

  • Pre-money Valuation - Value of company before funding is received

  • P – Price per share.

  • Y – Number of shares to be issued to the VC


An example

  • What if VC required 30%?

  • What if need was for $12 million?

An Example

  • Hoya.com is asking for $5 million, Projected income in year 5 is $ 4 million and expected exit multiple is 25x. Company currently has 1 million shares all owned by the entrepreneur. What share of company would a VC require today if VC’s required return is 50%?

Exit Value of Hoya.com = $4 x 25 = $100 million

Exit Value of VC has tobe =$5x(1+50%)5 = 37.97 million

Fraction of Company Needed = 37.97/100=37.97%

Implied POST MONEY Valuation=5/0.3797=13.17 million

Implied PRE MONEY Valuation= 13.17-5=8.17 million

Let us assume Y is the number of new shares that must be issued to the VC, X are the existing number of shares

Y/(X+Y) = F =37.97%; algebraic manipulation yields Y = 612,091 shares.

Price per share = 5,000,000/612,091 = $8.17


Same example alternative approach

  • What if VC required 30%?

  • What if need was for $12 million?

Same Example – Alternative Approach

  • Hoya.com is asking for $5 million, Projected income in year 5 is $ 4 million and expected exit multiple is 25x. Company currently has 1 million shares all owned by the entrepreneur. What share of company would a VC require today if VC’s required return is 50%?

Exit Value = $4 x 25 = $100 million

POST MONEY VALUATION = 100/(1+50%)5 = 13.169 million

PRE MONEY VALUATION = 13.169 – 5 = $8.169 million

Since 1 million shares outstanding Price per share = $8.17

Alternatively VC must get 5/13.17 = 37.97% of the company

Let us assume Y is the number of new shares that must be issued to the VC, X are the existing number of shares

Y/(X+Y) = F =38% algebraic manipulation yields Y = 612,091 shares.

Price per share = 5,000,000/612,091 = $8.17


Vc valuation problem set

VC Valuation Problem Set

  • Hoya.com is asking for $5 million, Projected income in year 5 is $ 4 million and expected exit multiple is 25x. Comapny currently has 1 million shares all owned by the entrepreneur. What share of company would a VC require today if VC’s required return is 30%?

Exit Value = $4 x 25 = $100 million

Value of VC’s 5 million investment at 30% = 5*(1+.30)5 = $18.6 million

VC would ask for 18.6/100 = 18.6% of the firm!

How many shares if VC needs 50% return (would ask for 38% of the firm).

X original number of Shares, Y new shares

Y/(X+Y) =0.38, since X =1, Y=0.612

How many shares if VC needs 30% return (would ask for 18.6% of the firm).

Y = X(F/1-F) = 1*(0.186/1-0.186)

Y = 0.2285 million shares


Multiple rounds exit dilution

Multiple Rounds/ Exit Dilution

  • Imagine that you need 15% of the company at the exit to get your mandated return.

  • Simple case – 100 shares would want 15 shares

  • What if along the way company issues another 50 shares (option/new investor) what happens to your stake?

    • New total shares = 100+50= 150

    • You interest = 15/150 = 10%!! – you have been diluted

  • You would insist on more than 15% today to end with 15% eventually – how to figure that out

  • Expected dilution = 50/150 = 0.333

  • Fraction needed today = Final ownership/(1-Dilution)

  • =15%/(1-0.333)= 22.5% implying 22.5 shares today

  • Check>>> at the end 22.5/150 = 15%


Example contd

Example Contd.

  • Hoya.com is asking for $5 million, Projected income in year 5 is $ 4 million and expected exit multiple is 25x. What share of company would a VC require today if VC’s required return is 50%?

  • Need to reserve 15% of the firm in terminal year for the option pool for mangers.

VC still needs to get $5 million*(1.5)5 = 37.97 million

Only 85 million available after the option pool

VC would want 37.97/85 = 44.67% of the company AT EXIT.

5 million for 44.67% of the company imply Post money valuation of 5/0.4467= 11.193 million and pre-money valuation of 11.19 -5=6.193 million

New Shares to VC =5/6.193=0.807 million shares


Another approach easier

Another Approach (easier).

  • Hoya.com is asking for $5 million, Projected income in year 5 is $ 4 million and expected exit multiple is 25x. What share of company would a VC require today if VC’s required return is 50%?

  • Need to reserve 15% of the firm in terminal year for the option pool for mangers.

VC still needs to get $5 million*(1.5)5 = 37.97 million

At Exit Firm is Still Worth 100 Million

VC still needs 37.97/100 = 37.97% of the Firm AT TIME OF EXIT!

However what VC needs TODAY is higher since extra shares would be issued to the Option Pool causing dilution

VC Current Ownership = 0.3797/(1-0.15) = 44.67%


Multiple rounds of financing

Multiple Rounds of Financing

  • Hoya.com is asking for $5 million, Projected income in year 5 is $ 4 million and expected exit multiple is 25x. What share of company would a VC require today if VC’s required return is 50%?

  • Need to reserve 15% of the firm in terminal year for the option pool for mangers. Would need another $ 3 million at the beginning of year 3 – round 2 investors require 30% return

Round 2 investor need 30% on its 3 million i.e. 3(1.30)3 = 6.59 million

Amount available after option pool is 85 million implying 6.59/85 = 7.75%

Round 1 still needs $38 million to generate 50% but only has (100-6.59-15) million to get it out of implying initial stake = 38/(100-6.59-15)=0.485 or 48.5% stake.


Multiple rounds of financing1

Multiple Rounds of Financing

  • Hoya.com is asking for $5 million, Projected income in year 5 is $ 4 million and expected exit multiple is 25x. What share of company would a VC require today if VC’s required return is 50%?

  • Need to reserve 15% of the firm in terminal year for the option pool for mangers. Would need another $ 3 million at the beginning of year 3 – round 2 investors require 30% return

Round 2 investor need 30% on its 3 million i.e. 3(1.30)3 = 6.59 million

Final value is still 100 million, Thus Round 2 investor need 6.59% of the company AT EXIT Implying that at time of investment it needs to own

Round 2 VC need 0.659/(1-0.15)=7.75%

Round 1 still needs 38% at the time of EXIT

implying initial stake = 0.38/(1-(0.0659+0.15))=0.485 or 48.5% stake.

What is the Post and Pre Money Valuation at round 1?

How many shares need to be issued to Round 1, Round 2 and option pool?

5/0.485=10.32; 5.32

Round 1 = 1x[0.485/(1-0.485)] =941,748

Round 2 = 1.941748x[0.0775/(1-0.0775)]=163,128

Option Pool =(1.942+0.163)X[0.15/(1-0.15)]= 371,448


Tomorrow

Tomorrow

  • How Do VCs Evaluate Investments

  • Term sheet for Trendsetter


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