MGTC39 - New Venture Planning & Creation Winter 2005
MANAGEMENT

 

Lecture 9 - Valuing a Venture Investment

Selling the Security

Ultimate purpose of plan: sell shares to venture capitalist
(rich uncle, business angel, etc.)

Plan must make very clear, early:

How many shares being sold
How many $$ this represents
What % of equity this represents
Timing, and means, of realising investment
Return on Investment to investor

Lets Be Clear:

Selling equity is selling % ownership of firm

Investor becomes co-owner, fellow shareholder

You are selling the piece of the pie

In order to get a bigger pie.

 

Selling Shares - A Simple Example

You need $200,000 to launch the business

You can only raise $40,000

You need $160,000 in additional capital

Your self interest: For $160,000 you will sell 1% of shares

V.C.'s self-interest: For $160,000 he wants 99% of shares

V.C.s / Investors Want a Strong Minority Stake

Venture capitalists are professional investors

They are not operating managers

V.C.s rarely want more than 49.99% of the equity

Unlikely to want less than 20% of the equity

V.C.s want a strong voice, not majority control

V.C. asks: For $160,000 will I get 20% or 49.99%

Initial Capital Structure - ABC Ventures (1)

Dave invests $10,000 gets 10,000 shares 20%
Marlaina invests $15,000 gets 15,000 shares 30%
Steven invests $15,000 gets 15,000 shares 30%

Venture requires $160,000 in additional funding

You propose to sell the investor:

10,000 shares @ $16.00 per share = $160,000

Investor gets 10,000 / 50,000 or 20% ownership

Initial Capital Structure - ABC Ventures (2)

Investor doesn't like proposed deal. Makes counter offer.

Insists on 20,000 shares @ $8.00 per share = $160,000

His proposal:

Dave 10,000 shares 16.7%
Marlaina 15,000 shares 25%
Stefen 15,000 shares 25%
Investor 20,000 shares 33.3%

Investor can now combine with one other shareholder

Is 33.3% of the Business Worth $160,000?

A business has no intrinsic value

Value of a business = f(value that it delivers in future)

Value cash cash cash cash and
of a = flow + flow + flow + flow + so
Business year0 year1 year2 year3 on...

What Will ABC Ventures Deliver in Future Benefits?

Refer to your financial forecasts: income statement

These will forecast sales and profits, e.g.:

Time0 Year1 Year2 Year3 Year4 Year5 Year6

Sales 100 300 600 800 900 1000

Profits -50 0 100 200 250 300

The Business Is Worth What The Investor Can Sell it For

The Investor wants to divest after 5 years

In 5 years, the firm is earning $300,000 in profits

If investor owns 33% of business:

he has an asset (shares) worth at least $100,000 per year

What can he sell an asset worth $100,000 year

If another investor is looking to yield say, 10% on its investment

Value 33% of ABC ventures = $100,000
10%

Known as: Capitalised earnings method

Has This been A Good Deal for The Investor?

$160,000 in year 0 ???? $1,000,000 end of year 5

This equals a return of > 40%

 

Most equities trade within range of Price:Earnings Ratios

Price : Earnings Ratio

The ratio of a share price to the firm's latest historical earnings.

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