MOST IMPORTANT ANSWER IS NUMBER 11 (CAPITALISATION TABLE)!!

John Thompson, CEO of NewVenture, Inc., seeks to raise $5 million in equity for his early-stage venture. Thompson conservatively projects net income of $5 million in year five and knows that comparable companies trade at a price earnings ratio of 20X.

1. Samantha Jones of Gorsuch Capital is considering investing in NewVenture. What share of the company will she require today if her required rate of return is 50% per anum? 2. If the company has 1,000,000 shares outstanding before the investment, how many new shares should she purchase? What will be the share price of the new shares? (Assume investment is in standard convertible preferred stock with no dividends and a conversion rate to common of 1:1) 3. As she does her due diligence, Samantha Jones likes Thompson's plan, but thinks it naive in one respect: the company has not set aside an ESOP (Employee Stock Option Plan) to recruit a senior management team. Samantha believes Thompson will have to grant stock options in addition to the salaries projected in his business plan. From past experience, she thinks management should have the ability to own at least a 15% share of the company by the end of year 5. What share of the company should Samantha insist on today (her required rate of return is still 50%)?

During negotiations between Samantha Jones and John Thompson, Jones proposes using participating convertible preferred stock with 1X liquidation preference. A participating preferred security enables the holder to convert the security to common stock at the previously agreed upon conversion rate and to have the principal amount repaid. The liquidation preference refers to the multiple of principal to be paid at conversion (in this case, 1X implies that the liquidation preference is the principal amount times one). In non-participating preferred stock, the holder gets the maximum of the liquidation preference or the value if converted into common stock.

4. Draw the payoff diagrams for the participating convertible preferred stock and the non-participating convertible preferred stock. 5. What share of the company will Samantha Jones require today if she requires a rate of return of 50% and she uses a participating convertible preferred stock (instead of standard convertible preferred)? 6. If the company has 1,000,000 shares outstanding before the investment, how many new shares should she purchase? What will be the share price of the new shares? 7. How does utilizing participating versus standard convertible preferred change Samantha's perceptions of the risk and reward profile of this deal? 8. A VC using participating convertible preferred stock typically calculates his share using the approach used in (2.) rather than in (5.). Why might an entrepreneur argue that this is unfair?

Part B On further analysis and discussion, Samantha and John agree to: a) the participating preferred, b) to create an ESOP immediately after Samanthas Series A investment that has 15% share of the company by the end of year 5, and c) that the company will need to raise a $3 million Series B round of financing at the beginning of year 3 to achieve the earnings target by year 5. Series B investors are expected to have a hurdle rate of only 30%, in recognition of the progress made between now and Series B, and will invest in common equity (no participation/conversion preference).

9. Based on this new information, what share of the company should Samantha seek today? What price per share should she be willing to pay? 10. What share of the company will the Round 2 investors seek? What price per share will they be willing to pay? 11. Create a capitalization table to depict the pre-money and post-money valuation, the number of shares and the share price: (i) Before Series A (ii) after Series A (iii) after the creation of the ESOP, (iv) after Series B