Better Ventures (BV), a venture capital fund, is assessing whether they should invest in a firm called Cloudpay. Cloudpay, a payroll solutions firm, was founded in 2019, issuing 1,550,000 shares at a price of €0.01/share. The company’s employee stock option plan implied that they would need an additional 250,000 shares to help recruit a management team to take charge of the European expansion. In 2020, Cloudpay’s revenues totalled €2,460,000. Now, in May 2021, they want to raise €1,000,000 from Better Ventures so they can expand their operations. Better Ventures have examined Cloudpay’s business plan which forecasts an after-tax profit margin of approximately 25% of sales by 2023. Better Ventures estimate that if they were to invest, they would be able to sell their shares in the company in May 2024. Similar stocks are currently quoted at 18 times their earnings after taxes (PER or P/E ratio of 18x) and the expected market growth within the related industry is 60% annually for the next five years. Better Ventures have a required rate of return of 30%.

(i) What might the value of Cloudpay be at the time of BV’s exit?

(ii) What percentage of Cloudpay’s capital should BVs request in exchange for their two million euros of venture capital financing?

(iii) How many shares should BV receive in return for their investment?

(iv) How much would BV pay per share?

(v) Calculate the pre and post-money valuations?

(vi) Explain how the stake of BV might be impacted if Cloudpay raise additional rounds of funding which BV does not participate in. Show how you might protect BV from a second round of investing expected to take place in 2 years raising €3million.

Answer rating: 100% (QA)

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