Gs503 vcf lecture 6 partial valuation ii 160315

PARTIAL VALUATION II:PARTIAL VALUATION II:
PCP STOCK,PCP STOCK,
IMPLIED VALUATIONIMPLIED VALUATION
& COMPLEX& COMPLEX
STRUCTURESSTRUCTURESProf.Stephen OngProf.Stephen Ong
BSc(Hons)Econs (LSE), MBA (Bradford)BSc(Hons)Econs (LSE), MBA (Bradford)
Visiting Professor, Shenzhen UniversityVisiting Professor, Shenzhen University
Academic Fellow, Entrepreneurship & Innovation,Academic Fellow, Entrepreneurship & Innovation,
The Lord Ashcroft International Business School,The Lord Ashcroft International Business School,
Anglia Ruskin University Cambridge UKAnglia Ruskin University Cambridge UK
MSC TECHNOPRENEURSHIP :MSC TECHNOPRENEURSHIP :
VENTURE CAPITAL FINANCINGVENTURE CAPITAL FINANCING

Today’s OverviewToday’s Overview

LEARNING OBJECTIVESLEARNING OBJECTIVES
To understand the features ofTo understand the features of
Participating ConvertibleParticipating Convertible
Preferred stock;Preferred stock;
To understand the methods forTo understand the methods for
implied valuation;implied valuation;
To discuss complex structures.To discuss complex structures.

1.Participating Convertible
Preferred Stock

Binary Options
$W
BinaryCallatExpiration
X
K

Binary Option Pricing formulas
2* ( , ) ( )rT
K BC X T Ke N d−
=
2
0
* ( ) ( )*rT qT
K BC X Ke N d qe dT
∞
− −
= ∫
Plain Binary Option
Random-Expiration Binary Option

Example 1Example 1
Suppose that EBV offers theSuppose that EBV offers the
employees of Newco a bonus pool ofemployees of Newco a bonus pool of
$5M upon any exit where firm value$5M upon any exit where firm value
exceeds $200M. Currently, the firmexceeds $200M. Currently, the firm
value of Newco is $40M, and base-casevalue of Newco is $40M, and base-case
option pricing assumptions (Series A)option pricing assumptions (Series A)
apply.apply.
ProblemProblem
What is the current value of this bonusWhat is the current value of this bonus
incentive?incentive?

Example 2Example 2
EBV considering $6M Series AEBV considering $6M Series A
investment in Newcoinvestment in Newco
PCP ($6M APP) for 5M shares, with aPCP ($6M APP) for 5M shares, with a
QPO threshold at $6 per share.QPO threshold at $6 per share.
Pre-money shares = 10MPre-money shares = 10M
Question: What is the breakevenQuestion: What is the breakeven
valuation?valuation?

Example 3Example 3
Talltree is considering a $12M Series BTalltree is considering a $12M Series B
investment in Newcoinvestment in Newco
5M shares of PCP, with a QPO at $12 per5M shares of PCP, with a QPO at $12 per
share.share.
Employee shares = 10MEmployee shares = 10M
EBV (Series A) has 5M shares of PCPCEBV (Series A) has 5M shares of PCPC
($6M APP) a $6 per share QPO, and a 4X($6M APP) a $6 per share QPO, and a 4X
cap.cap.
Questions:Questions:
1) What is the exit diagram for the Series A?1) What is the exit diagram for the Series A?
2) What is the breakeven valuation?2) What is the breakeven valuation?

Example 4Example 4
XYZ ventures is considering a $20M Series F in Newco forXYZ ventures is considering a $20M Series F in Newco for
10M shares of PCP with a QPO threshold of $6 per share.10M shares of PCP with a QPO threshold of $6 per share.
 Employees have claims on 20M shares of commonEmployees have claims on 20M shares of common
 Series A: 10M shares of CP ($6M APP)Series A: 10M shares of CP ($6M APP)
 Series B: 10M shares of CP ($10M APP)Series B: 10M shares of CP ($10M APP)
 Series C: 10M shares of CP ($4M APP and 3X liquidationSeries C: 10M shares of CP ($4M APP and 3X liquidation
preference)preference)
 Series D: 10M shares of PCPC ($10M APP) with 3X capSeries D: 10M shares of PCPC ($10M APP) with 3X cap
and $5 QPOand $5 QPO
 Series E: 10M shares of CP ($10M APP)Series E: 10M shares of CP ($10M APP)
 All venture investors have $250M committed capital andAll venture investors have $250M committed capital and
$50M in lifetime fees.$50M in lifetime fees.
QuestionsQuestions
1)1) What is the exit diagram for the Series D PCPC.What is the exit diagram for the Series D PCPC.
2)2) What is the breakeven valuation?What is the breakeven valuation?

Implied post-valuation, Series A
Employees
Series A LP
Valuation
Series A GP
Valuation
When Series A LP Valuation = Series A LP Cost, then the value of
the whole pie = breakeven valuation = implied valuation = IVpost

Implied pre-valuation, Series B
Employees
Series A LP
Valuation
Series A GP
Valuation
Series B LP
Valuation
Series B GP
Valuation
IVpre = IVpost – Series B GP implied valuation – Series B LP implied valuation
= IVpost – (1 / (1 – GP%) )* Series B LP cost

Walnut, revisitedWalnut, revisited
Considering a $2M Series A investment inConsidering a $2M Series A investment in
RBS for RP (1.8M APP) and CP (convertsRBS for RP (1.8M APP) and CP (converts
to 55,556 shares), with 8% accrued cashto 55,556 shares), with 8% accrued cash
dividends.dividends.
Fully-diluted share count = 200KFully-diluted share count = 200K
Prior “round” of investment was $400K forPrior “round” of investment was $400K for
10% of the common stock.10% of the common stock.
ProblemProblem
What is IVWhat is IVprepre? How does it compare to? How does it compare to
O’Connor’s (CEO) expectations?O’Connor’s (CEO) expectations?

Example
Talltree invests $10M in Series B for 8M shares of
CP.
Other investors are EBV (Series A), with 6M shares
of CP ($6M APP) and employees (with 10M shares
of common).
Problems
What is IVpost and IVpre?
What the LP implied valuation of the Series A?

Down rounds?
What is the proper way to assess a down round?
Usually, the contract is explicit, and we can just
compare the conversion prices across rounds.
What if the new round does not have a conversion
price? Or, what if we really want to get it “right”?

Example
 Same Setup as previous example.
 One year later, and Owl invests $12M for RP ($2M
APP with 5X liquidation preference) and 8M shares
of common.
Problems
 What is IVpost and IVpre?
 What the LP implied valuation of the Series B?
 Do you think this really represents a down round for
the Series B?

MetapathMetapath
 Series A: Securicor Telesciences, Jan 95: 600K RP with cash dividendSeries A: Securicor Telesciences, Jan 95: 600K RP with cash dividend
(LIBOR + 1%)(LIBOR + 1%)
 Series B: Bessemer Venture Partners (BVP), Jan 95: 1M RP withSeries B: Bessemer Venture Partners (BVP), Jan 95: 1M RP with
cash dividend (8% simple starting Jan 2000)cash dividend (8% simple starting Jan 2000)
 Series C: BVP, Sept 1995, 1M CP ($1.05 OPP, 950K shares), same divSeries C: BVP, Sept 1995, 1M CP ($1.05 OPP, 950K shares), same div
as Series Bas Series B
 Series D: BVP, USVP, Norwest, April 96: 7M CP ($1.62 OPP, 4.32MSeries D: BVP, USVP, Norwest, April 96: 7M CP ($1.62 OPP, 4.32M
shares), same div as Series Bshares), same div as Series B
 12.66M total shares prior to Series E12.66M total shares prior to Series E
 Series E: Omega, TCV, and others:Series E: Omega, TCV, and others:
 Structure 1: 11.75M PCP at OPP of $6 (1.96M shares) (assume QPOStructure 1: 11.75M PCP at OPP of $6 (1.96M shares) (assume QPO
at $15 per share)at $15 per share)
 Structure 2: 11.75M CP at OPP of $5.50 (2.14M shares)Structure 2: 11.75M CP at OPP of $5.50 (2.14M shares)
 Assume total valuation = $115M + $11.75M = $126.75M as base caseAssume total valuation = $115M + $11.75M = $126.75M as base case

Series E vs. Merger?Series E vs. Merger?
Cell Tech (not real name)Cell Tech (not real name)
offering $115M in stock.offering $115M in stock.
How should BVP andHow should BVP and
Metapath compare this offer toMetapath compare this offer to
the Series E?the Series E?

Management Carve-OutManagement Carve-Out
 Newco has received four rounds of investments (Series A,Newco has received four rounds of investments (Series A,
B, C, and D) for a total of 40M shares of CP plus 10MB, C, and D) for a total of 40M shares of CP plus 10M
shares of common claimed by the employees.shares of common claimed by the employees.
 $12M Series E investment with Vulture Ventures (VV) for$12M Series E investment with Vulture Ventures (VV) for
50M shares of CP and a 3X liquidation preference.50M shares of CP and a 3X liquidation preference.
 As part of this agreement, all previous investors (Series AAs part of this agreement, all previous investors (Series A
through Series D) give up all their preferred rights andthrough Series D) give up all their preferred rights and
are converted to common stock, so the capital structure ofare converted to common stock, so the capital structure of
Newco is now 50M shares of common plus the Series ENewco is now 50M shares of common plus the Series E
CP.CP.
 As part of the investment, Vulture creates a carve-out:As part of the investment, Vulture creates a carve-out:
management will receive 10 percent of all exit proceeds,management will receive 10 percent of all exit proceeds,
with a value of this carve-out capped at $5M. Vulturewith a value of this carve-out capped at $5M. Vulture
Ventures has $250M of committed capital, $50M ofVentures has $250M of committed capital, $50M of
lifetime fees, and 20 percent carried interest.lifetime fees, and 20 percent carried interest.
What is the implied valuation of the management carve-out?What is the implied valuation of the management carve-out?

Management Carve-Out (2)
 Same setup as in the previous example, but thisSame setup as in the previous example, but this
time with a different structure for thetime with a different structure for the
management carve-out. Now, following the $12Mmanagement carve-out. Now, following the $12M
Series E investment from Vulture Ventures (50MSeries E investment from Vulture Ventures (50M
shares of CP with a 3X liquidation preference),shares of CP with a 3X liquidation preference),
management is promised the following incentives:management is promised the following incentives:
If Newco has an exit of at least $50M, thenIf Newco has an exit of at least $50M, then
Vulture will transfer $5M to the employees. IfVulture will transfer $5M to the employees. If
Newco has an exit of at least $80M, then VultureNewco has an exit of at least $80M, then Vulture
will transfer an additional $5M to the employees.will transfer an additional $5M to the employees.
The earlier investors have 40M shares ofThe earlier investors have 40M shares of
common, and the employees have claims on acommon, and the employees have claims on a
further 10M shares.further 10M shares.
What is the implied valuation of the managementWhat is the implied valuation of the management
carve-out?carve-out?

Dealing with PartnersDealing with Partners
 EBV makes a $10M Series A investment in Newco forEBV makes a $10M Series A investment in Newco for
10M shares of CP.10M shares of CP.
 The employees of Newco have claims on 10M shares ofThe employees of Newco have claims on 10M shares of
common stock.common stock.
 At the same time as this transaction, Newco enters into aAt the same time as this transaction, Newco enters into a
transaction with Techco to obtain licenses for sometransaction with Techco to obtain licenses for some
Techco patents. As consideration for providing theseTechco patents. As consideration for providing these
licenses, Techco receives an option to purchase 10Mlicenses, Techco receives an option to purchase 10M
shares of common stock for $1.50 a share, but this optionshares of common stock for $1.50 a share, but this option
can only be exercised upon an exit above $150M. (Assumecan only be exercised upon an exit above $150M. (Assume
that this $150M would be adjusted for any future dilution,that this $150M would be adjusted for any future dilution,
so that the threshold is effective for the proceeds owed toso that the threshold is effective for the proceeds owed to
the current shareholders.) EBV is aware of the deal withthe current shareholders.) EBV is aware of the deal with
Techco at the time that they make their Series ATechco at the time that they make their Series A
investment.investment.
What is the implied valuation of Techco’s options?What is the implied valuation of Techco’s options?

Putting it all togetherPutting it all together
Newco at the time of the Series F:Newco at the time of the Series F:
 Employees have claims on 20M shares of commonEmployees have claims on 20M shares of common
 Series A: 10M shares of CP ($6M APP)Series A: 10M shares of CP ($6M APP)
 Series B: 10M shares of CP ($10M APP)Series B: 10M shares of CP ($10M APP)
 Series C: 10M shares of CP ($4M APP and 3X liquidationSeries C: 10M shares of CP ($4M APP and 3X liquidation
preference)preference)
 Series D: 10M shares of PCPC ($10M APP) with 3X cap and $5 QPOSeries D: 10M shares of PCPC ($10M APP) with 3X cap and $5 QPO
 Series E: 10M shares of CP ($10M APP)Series E: 10M shares of CP ($10M APP)
 Series F: 10M shares of PCP ($20M APP) with QPO at $6 per share.Series F: 10M shares of PCP ($20M APP) with QPO at $6 per share.
 Management carve-out for 20% of the first $50M in proceeds. (atManagement carve-out for 20% of the first $50M in proceeds. (at
time of Series F)time of Series F)
 Acquisition of Subco for 20M shares plus upside bonus of 10M sharesAcquisition of Subco for 20M shares plus upside bonus of 10M shares
of common for exits above $1B. (at time of Series F)of common for exits above $1B. (at time of Series F)
 All venture investors have $250M committed capital and $50M inAll venture investors have $250M committed capital and $50M in
lifetime fees.lifetime fees.
QuestionsQuestions
1)1) What is the implied valuation for the management carve-out?What is the implied valuation for the management carve-out?
2)2) What is the implied valuation for the Subco stake?What is the implied valuation for the Subco stake?

Further ReadingFurther Reading
 Metrick, Andrew and Yasuda, Ayako (2011) Venture
Capital & the Finance of Innovation. 2nd
Edition. John
Wiley & Sons.
 Lerner,Losh, Hardymon, Felda and Leamon, Ann
(2012). Venture Capital and Private Equity : A
Casebook. 5th
Edition. John Wiley & Sons.
 Dorf, R.C. and Byers, T.H. (2008) Technology
Ventures – From Idea to Enterprise 2nd
Edition,
McGraw Hill

Gs503 vcf lecture 6 partial valuation ii 160315

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