Nadya Trojanowski, CEO of the new start-up Ayuda.ai, which develops an AI assistant for household tasks, seeks to raise $1.5 million in a private placement of equity in her early-stage venture. Nadya projects revenue at exit of $25 million, five years from today, and knows that comparable companies at the time of exit trade at a revenue multiple of 3X.

 

Question:

 

What share of the company will a venture capitalist require today if her required rate of return is 60% per year, assuming no future financing rounds will be needed?

Projections:

1. 5 years to exit.

2. $25M revenue at exit

3. $75M exit value (exit multiple of 3x revenue based on recent exits).

- VC Stake: $1.5M * (1+60%)^5 / ($25M*3) = $15.73M/$75M = 20.97%

Question:

2. What is the post-money valuation? 
   1. Post-money valuation = Value of the firm = 20.97% x Value = $1.5 million, Value = $1.5M / 20.97% = $7.15M
5. What is the pre-money valuation? 
   1. The value of our stake before the investment (founders) = 100% - 20.97% = 79.03% > 79.03% x $7.15M = $5.65M or $7.15M - $1.5M (Investment) = $5.65M

Question:

Suppose that, prior to the VC financing, the founder owns 1 million shares and there are no other shares or options outstanding or authorized (no other investors and no employees own stock). The VC and Nadya agree on creating an employee pool representing 20% of the shares after the VC invests (in other words, the pool is 20% on a post-money basis).

2. How many shares should the venture capitalist purchase?
   1. Shares = S/S+1M = 20.97% > S = 1M * (20.97%/1- 20.97%) = 265,342 shares
5. What is the original purchase price per share on an as-converted basis? Assume the investment is in standard convertible preferred stock with a 1X liquidation preference, no participation, no dividends and a conversion rate to common of 1:1, that is, one share of preferred can be converted into one share of common stock.
   1. Share price = Investment/Shares, > Shares = S/S+1M = 20.97% > S = 1M * (20.97%/1- 20.97%) = 265,342 shares. Share price = $1,500,000 / 265,342 shares = $5.65

Question:

On further analysis, the VC and Nadya agree that the company will likely need another round of financing, in addition to the current $1.5 million. The VC thinks the company will need an additional $2 million in equity two years from today (with no further increase in the pool). While the first-round investors still require a 60%/year return, the second-round investors will only require 30%/year.

Based on this new information, what share of the company would Round 1 investors seek today (that is, in the first round)?

• Round 1 investment: $1.5M, Round 2 investment: $2M , Round 1 required return = 60%, Round 2 required return = 30%
• $3.5M x (1+30%)^2/ 75M = 7.89%
• In order to end up with 20.97% at exit, the first-round VC needs P% such that P x (1-7.89%) = 20.97% > P = 22.77%

Question:

Based on the information in Question 4, what share of the company will the founders and employees combined own at exit? Assume that - apart from the two investment rounds - there were no other investors, and the employee pool is fully issued and exercised by the time of exit (and there was no further increase in the pool).

Answer rating: 100% (QA)

In Question 4 it was determined that the firstround investors ... View the full answer