Transcript Company Capitalization Scenario

Company Capitalization Scenario
Raising Capital and Ownership Value
The Founders
• Founders: you and partners
– Have a concept for an exciting new business
– Have sketched a general business model
– Prospects for success appear promising
– Need financing to pursue your dream
Round #1 Financing
• Start-up financing or seed capital needed:
– To produce persuasive and professional business plan
– To do some research on market and competition
– For travel expenses to raise working capital
• Round #1 Friends and Family
– Objective: Raise minimum $100,000 to cover expenses above.
Round #1 Financing - Friends & Family
• You decide to seek $100,000 from F&F.
• You negotiate with F&F and give them 10% ownership (equity).
– Ten percent of the shares of the company’s stock.
• Company has imputed value of $1 million.
– F&F own 10% of company, invest $100,000.
• Founders own 90% -- no cash investment (Sweat Equity).
Round #2 Financing
(A Round)
• Seek venture capital from venture capital (VC) firms.
– Must decide how much money is needed.
– With interested VCs, founders must negotiate the company valuation
and percent of VC ownership.
– Pre-money Valuation—Company Value Before VC Investment
• Assume $2 million.
• Assume you are successful in raising $2 million at $2m premoney valuation.
– Post-money Valuation: $4 million ($2m pre-money valuation + $2m put
in by VC.
• The new VC investor owns 50% of company.
Post Round #2 Ownership
• New ownership valuation: Capitalization Table
– Referred to as Cap Table:
– VC owns 50% of company -- $ 2m of $4m company valuation. Value of
original owners = $2m.
– F&F now own 5% (diluted from 10%) -- 5% x $4m. Value of F&F
ownership = $200,000.
– Founders now own 45% (remaining after VC’s 50% and F&F’s 5%). Value
of founders’ ownership = $1.8 million.
Round #3 Financing
(B Round)
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Your company has been in business 2-3 years.
Revenue is growing; profits are foreseeable.
Seek larger VC or a strategic investor to accelerate growth
You are successful in raising $4m at a pre-money valuation of
$10m.
– The new investor is a large VC firm (LVC)
• Company valuation now $14m after the B Round, but still no
liquid market for private company shares.
Post Round #3 Ownership
• LVC now owns 28.6% ($4m/$14m=28.57%). Value of LVC’s
ownership = $4m.
• Original VC owns 35.7%, or 50% of the remaining 71.43%. Value
of original VC’s ownership = $5m.
• F&F own 3.57%, or 5% of the remaining 71.43%. Value of F&F
ownership = $.5m ($500,000)
• Founders own 32.14%, or 45% of remaining 71.43%. Value of
founder’s ownership = $4.5m
Round #4 Ownership Liquidity
• Assume:
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Company now 5+ years in business
Annual revenues = $50m
Operating income for that year = $10m
Shareholders want liquidity -- to be able to sell some of their shares for
cash.
Three Liquidity Options
Borrow money from bank (debt).
• Banks reluctant to loan for shareholder liquidity.
2. Sell to strategic buyer (another company, such as Yahoo or
Google).
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Strategic buyers often bargain tough on price and usually want
control.
Sell shares to public: IPO
3.
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Public usually pays a premium price, driven by Wall Street bankers and
brokers, and all shareholders would now have liquidity -- a market in
which to sell their shares.
IPO
• IPO Steps:
– Valuation of company — investment bankers participate
– Your company: $50m revenues and $10m operating income.
– Media companies values today range from 1.5-2.5x revenues- and 8-12x
operating income.
– Assume 2x revenues and 10x operating income:
• $100 million valuation -- pre-money and pre-IPO
– Company raises $25M in shares sold to public for a 20% share in the
company (25/125=20%).
Post-IPO Company Value & Ownership
• Company now valued at $125 million
– $100m pre-IPO + $25m post-IPO
• Ownership: (Cap Table):
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Public: 20% -- $25/$125m = $25m
LVC: 22.88% -- 80% x 28.6% = $28.6m
VC: 28.56% -- 80% x 35.7% = $35.7m
F&F: 2.86% -- 80% x 3.57% = $3.57m
Founders: 25.7% -- 80% x 32.14% = $32.14m
Return on Investment: IPO Day
• Valuation of each investor at close of IPO (Assuming price of all
stock sold is the same as offered) and ROI:
– Founders: Invested $0 cash. Current value = $32.14m
– F&F: Invested $100,00. Current value = $3.57m (3470% ROI)
• $3,570,000-100,000=$3,470,000/100,000=34.7 or 3470%
– VC: Invested $2m. Current value = $35.7m (1685% ROI)
– LVC: Invested $4m. Current value = $28.6m (612.5% ROI)
– Public: Invested $25 m. Current value: $25m (0 ROI)
• Obviously, current investors are gambling that current growth pattern continues.
• In 2004 Google’s IPO stock price was $85. It is now at about $565 after a 2-for-1
stock split in April, 2014, or an ROI of what?