On further analysis and discussion, Benedicta and Roger agree that the company will probably need another round of financing in addition to the current $5 million. Benedicta believes that Bestafer will need an additional $3 million in equity at the beginning of year 3. While the first round investors (including herself) will require a 50% return, Benedicta feels that round 2 investors, in recognition of the progress made between now and then, will probably have a hurdle rate of only 30%. As before, management should have the ability to own a 15% share of the company by the end of year 5.

a. Based on this new information, what share of the company should Benedicta seek today? What price per share should she be willing to pay?

b. What share of the company will the Round 2 investors seek? What price per share will they be willing to pay?

c. Suppose it was apparent in the beginning of year 3 that Bestafer would meet it’s financial targets, but not until the end of year 7. How would your answers to parts 3a and 3b change? If Benedicta took her pro-rata share of the round (e.g. to keep her percentage ownership of the company the same after the offering as it was before), what overall internal rate of return could she expect?

Question 4. In her term sheet, Benedicta has proposed using a hybrid security called participating preferred stock. Participating preferred acts in part like standard preferred, in that at conversion common stock is issued at a previously agreed upon conversion rate, and in part like debt, in that at conversion the entire original principal amount is also repaid to the holder of the security. As far as Roger can tell, Benedicta has also priced the deal assuming only one round of financing would be required and as if standard preferred stock with a 50% required rate of return were used (as described in Question 1a). a. What effect does using the security Benedicta proposed have on her effective rate of return? Defacto, how much of the company does Benedicta own? b. If Roger agrees to use the participating preferred security, what terms (e.g. price per share and number of shares) should he propose in his counter-offer? What percentage of the company should he be prepared to give up in order to still meet Benedicta’s 50% required rate of return? c. How does utilizing participating versus standard preferred change Roger and Benedicta’s perceptions of the risk and reward profile of this deal?