Roger Harkel, CEO of Bestafer Inc., sought to raise $5 million in a private placement of equity in his early stage dairy products company. Harkel conservatively projected net income of $5 million in year five, and knew that comparable companies traded at a price earnings ratio of 20X.
a. What share of the company would a venture capitalist require today if her required rate of return was 50%? What if her required rate of return was only 30%?
b. If the company had 1,000,000 shares outstanding before the private placement, how many shares should the venture capitalist purchase? What price per share should she agree to pay if her required rate of return was 50%? 30%? (Note: Assume investment is in standard preferred stock with no dividends and a conversion rate to common of 1:1)
c. Roger feels that he may need as much as $12 million in total outside financing to launch his new product. If he sought to raise the full amount in this round, how much of his company would he have to give up? What price per share would the venture capitalist be willing to pay if her required rate of return was 50%? 30%?
Question 2.
Benedicta Jones of Gorsam Capital liked Harkel’s plan, but thought it naive in one respect: to recruit a senior management team, she felt Harkel would have to grant generous stock options in addition to the salaries projected in his business plan. From past experience, she felt management should have the ability to own at least a 15% share of the company by the end of year 5. Given her beliefs, what share of the company should Benedicta insist on today if her required rate of return is 50%? 30%?
Given that Roger Harkel aims to raise funds through a private placement, the valuation and subsequent dilution hinge on future income projections and the required rates of return stipulated by the VC. The company’s anticipated net income in year five stands at $5 million, with a price-earnings (P/E) ratio of 20X, suggesting a future company valuation of $100 million ($5 m x 20=$100m).
For the $5 Million Investment:
For Raising $12 Million: