Problem Set: Venture Capital Deals

Valuation, Capitalization Table, and Term Sheet

Tianshu Lyu ${?}^1$

Song $M{a}^2$

Allen Scott is the CEO and founder of AIshop, an AI$-$powered APP to facilitate more

convenient online shopping. It seeks to raise $$36$ million in equity in Series A$.$ Scott

projects an $($after$-$tax$)$ net income of $$30$ million in year five.

Part A: VC method

Linda Chow from Whitney Evans Capital is considering an investment. Assume that the

investment committee of Whitney Evans Capital does some market research and finds

that comparable companies trade at a price$-$to$-$earnings ratio of $30x.$

a$.$ What percent of shares will Chow require today if her target return is $50\%$ per annum?

b$.$ If the company has $10$ million shares outstanding before Series A$,$ how many shares

will be created for Whitney Evans Capital to purchase? What share price should Chow

agree to pay if again her target return is $50\%?$

c$.$ After some more detailed capital budgeting, Scott thinks that he just needs to raise $$18$

million of outside financing from Whitney Evans Capital this round. What is the

percentage of shares Chow will require in this new case, assuming the same target

return of $50\%$ per annum? What will be the share price in this case?

d$.$ Explain the relationship between share required, investor target return, and share

price.

e$.$ Back to the scenario with $$36$ million capital to be raised: Linda mentioned to Scott

that there is one important aspect that Scott does not take into account. To further

develop the business, Scott needs a larger senior management team. She believes that

Scott needs to grant generous stock options in addition to the salaries to attract

candidates. From past experience working with consumer technology startups, Chow

thinks that the management needs to own at least $18\%$ share of the company by the

end of year five $-$ thus an option pool of this size should be created with the round.

Given her belief, what share of the company should Chow insist on today if the option

pool is created in this round in a post$-$money sense $($so Evans Whitney is diluted by

the option pool$)$ and her target return is $50\%?$