Transcript Venture_Capital_Method

Venture Capital Financing
The Venture Capital Method
B.G. Bisson
Valuation and Pricing
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Magnitude of investment
Staging of investment
Syndication
Target IRR
Investment time horizon
Terminal value of firm
% ownership required
Deal structure
Future financing and dilution – “The Venture Capital
Method”
Magnitude of Investment
Typically >$1.0 million for institutional
 Small deals too costly
 Typically less than $10 million in Canada
 Most deals $1.0-$3.0
 Based on business plan pro formas
 Free cash flow (EBIAT, working capital,
capital expenditures)
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Investment Time Horizon
4-7 years
 How long will it take to create value?
 Years to cash flow breakeven
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VC Investments and IRR
Target IRR
25-80 %
 Stage of company
 Use of funds
 Deal structure
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VC Target IRR
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Seed
Startup
First stage
Second stage
Bridge
Restart
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IRR>80%
50-70%
40-60%
30-50%
20-35%
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The Venture Capital Method
Step 1
Given the VC investment, the target IRR
and the investment time horizon,
determine the future value of the VC
investment
 FV = PV(1+i)^n
 i = target IRR
 N = time horizon to exit
 Eg. FV = $1.0m(1+0.35)^5 = $4.5m
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The Venture Capital Method
Step 2
Given the projected earnings at exit and
an appropriate Price Earnings ratio (PER)
for the company, calculate the projected
terminal value of the company at exit
 Eg. TV = $1.0m(15) = $15m
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The Venture Capital Method
Step 3
Determine the % ownership required by dividing
the required future value of the investment at
exit by the projected terminal value of the
company at exit
 Eg. FV= $4.5m/TV$15m = 30%
 Or divide the VC investment by the present
value of the projected terminal value of the
company at exit
 Eg. PV=$15m/(1+0.35)^5=$3.33m ;
$1.0m/$3.33m=30%
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% Ownership Required
% Ownership Required
Magnitude of investment
 Duration of investment
 Target IRR
 Terminal value of firm
 Room for future investment?
 See spreadsheet (VC Investment
Perspective)
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The Venture Capital Method
Step 4
Determine number of new shares (NS) to
be issued to VC.
 Find number of shares outstanding before
investment (old shares (OS) eg. 1.0m)
 VC % Ownership = NS/(NS +OS)
 Eg. 30% = NS/(NS + 1.0m)
NS= 430,000
Price per share = $1.0m/430,000 = $2.33
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The Venture Capital Method
Step 5
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Determine pre and post-money valuation
If 30% of the company is acquired for a $1.0 VC
investment, this implies a post-money valuation
of $1.0/0.30 = $3.33m
Give a post-money valuation of $3.33m and an
investment of $1.0m, the pre-money valuation is
$2.33m
Carried interest = (post-money valuation) x (%
ownership post-money)
Does this valuation make sense? Is it realistic?
The Venture Capital Method
Step 6
Assess future dilution due to issuance of
additional shares prior to exit.
 Shares to management, future investors
 Estimate retention ratio = 100% - % of
ownership issued to others in future
 Eg. If a future investor negotiates a 10%
ownership, the retention ratio is 100%10%=90%
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The Venture Capital Method
Step 7
Calculate adjustment to required ownership %
due to expected future dilution
 Adjusted ownership % = % ownership without
dilution divided by retention ratio
 Eg. Adjusted % = 30%/90% = 33.3%
 If VC owns 33% after investment and gets
diluted by 10% before exit, the final ownership
% will be 30%, ie. the required ownership % to
realize target IRR given projected terminal value
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Sensitivity Analysis
Due Diligence
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Terminal Value
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Target IRR
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Future Earnings (Sales, Expenses, Profits)
PER
Risk
Deal Structure
Liquidity
Dilution
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Future Rounds (Amounts, IRR, Horizon)
Management incentives
Staging of Investment
All up front
 Two or three tranches
 Contingent on meeting milestones/targest
 Option to abandon
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Syndication
Sharing the deal with other VC firms
 Diversify the risk
 Broaden the network
 Increase size of portfolio
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