gs503 vcf lecture 3 valuation i 020215
TRANSCRIPT
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VALUATION I :VALUATION I :PROCESS, PROCESS,
TERMSHEET & TERMSHEET & PREFERRED PREFERRED
STOCKSTOCKProf.Stephen OngProf.Stephen Ong
BSc(Hons)Econs (LSE), MBA (Bradford)BSc(Hons)Econs (LSE), MBA (Bradford)
Visiting Professor, Shenzhen UniversityVisiting Professor, Shenzhen UniversityAcademic 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
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Today’s Overview Today’s Overview
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LEARNING OBJECTIVESLEARNING OBJECTIVES
To analyse the investment process by To analyse the investment process by VC;VC;
To understand the features of a VC To understand the features of a VC term sheet;term sheet;
To discuss the different types of To discuss the different types of preferred stock structures and their preferred stock structures and their anti-dilution protection for investors.anti-dilution protection for investors.
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1.Analysis of Venture Capital Investments
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PORTFOLIO COMPANY STATUS OVER TIME: PORTFOLIO COMPANY STATUS OVER TIME: FIRST ROUNDSFIRST ROUNDS
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PORTFOLIO COMPANY STATUS OVER TIME, ASSUMING NO PORTFOLIO COMPANY STATUS OVER TIME, ASSUMING NO
PRIVATE COMPANIES AFTER TEN YEARS, 1PRIVATE COMPANIES AFTER TEN YEARS, 1STST ROUNDS ROUNDS
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VALUE MULTIPLES FOR FIRST-ROUND INVESTMENTS:VALUE MULTIPLES FOR FIRST-ROUND INVESTMENTS:IPOS AND ACQUISITIONSIPOS AND ACQUISITIONS
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VALUE MULTIPLES ALL FIRST-ROUND INVESTMENTS
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PORTFOLIO COMPANY STATUS OVER TIME, ASSUMING NO PORTFOLIO COMPANY STATUS OVER TIME, ASSUMING NO PRIVATE COMPANIES AFTER TEN YEARS (2PRIVATE COMPANIES AFTER TEN YEARS (2NDND ROUNDS) ROUNDS)
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VALUE MULTIPLES FOR SECOND-ROUND VALUE MULTIPLES FOR SECOND-ROUND INVESTMENTS: IPOS AND ACQUISITIONSINVESTMENTS: IPOS AND ACQUISITIONS
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VALUE MULTIPLES FOR ALL VALUE MULTIPLES FOR ALL SECOND-ROUND INVESTMENTSSECOND-ROUND INVESTMENTS
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PORTFOLIO COMPANY STATUS OVER TIME, ASSUMING NO PORTFOLIO COMPANY STATUS OVER TIME, ASSUMING NO PRIVATE COMPANIES AFTER TEN YEARS (3RD ROUNDS)PRIVATE COMPANIES AFTER TEN YEARS (3RD ROUNDS)
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VALUE MULTIPLES FOR THIRD-ROUND VALUE MULTIPLES FOR THIRD-ROUND INVESTMENTS: IPOS AND ACQUISITIONSINVESTMENTS: IPOS AND ACQUISITIONS
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VALUE MULTIPLES FOR ALL THIRD-ROUND INVESTMENTS
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10-YEAR AVERAGE VC FINANCINGS AND 10-YEAR AVERAGE VC FINANCINGS AND IPO EXITS, BY ENDING YEARIPO EXITS, BY ENDING YEAR
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THE INVESTMENT PROCESSTHE INVESTMENT PROCESS
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2.Term Sheets
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Term Sheets – The BasicsTerm Sheets – The Basics
ExpropriationExpropriation
CharterCharter
Investor Rights AgreementInvestor Rights Agreement
RoundsRounds
Series A, Series B, etc.Series A, Series B, etc.
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Capitalization TableCapitalization Table
Pre-Financing Post-Financing Security # of Shares % # of Shares % Common – Founders
7,750,000 77.5 7,750,000 51.7
Common – Employee Stock Pool Issued Unissued
2,250,000 300,000
1,950,000
22.5 3.0
19.5
2,250,000 300,000
1,950,000
15.0 2.0
13.0
Series A Preferred
0 0.0 5,000,000 33.3
Total
10,000,000 100 15,000,000 100
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Investors and PricesInvestors and Prices
$investment$investmentFully diluted share countFully diluted share countProposed ownership percentageProposed ownership percentageOriginal purchase price (OPP)Original purchase price (OPP)Aggregate purchase price (APP)Aggregate purchase price (APP)TrancheTranche
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Post-Money ValuationPost-Money Valuation
Post-money valuation = Post-money valuation = price-per-price-per-share * fully-diluted share count.share * fully-diluted share count.
oror
Post-money valuation = Post-money valuation = $investment $investment / proposed ownership percentage./ proposed ownership percentage.
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Pre-Money ValuationPre-Money Valuation
Pre-money valuation = Pre-money valuation = post-money post-money valuation - $investment.valuation - $investment.
oror
Pre-money valuation = Pre-money valuation = price-per-price-per-share * pre-transaction (fully diluted) share * pre-transaction (fully diluted) share count.share count.
(But be careful in down rounds!)(But be careful in down rounds!)
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Liquidation Liquidation
Deemed liquidation eventDeemed liquidation event
Liquidation preference (2X, 3X, Liquidation preference (2X, 3X, etc.)etc.)
Qualified public offering (QPO)Qualified public offering (QPO)
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DividendsDividends
Dividend PreferenceDividend PreferenceCumulative vs. non-cumulative Cumulative vs. non-cumulative
dividendsdividendsAccrued cash dividendsAccrued cash dividendsSimple interest, compound interestSimple interest, compound interestStock dividends = Payment-in-kind Stock dividends = Payment-in-kind
(PIK) dividends(PIK) dividends
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Restricted Stock & Registration RightsRestricted Stock & Registration Rights
Registration rightsRegistration rightsDemandDemandS-3S-3PiggybackPiggyback
Redemption rightsRedemption rightsIn-kind distributionsIn-kind distributionsRule 144, rule 144ARule 144, rule 144AQualified Institutional Buyers (QIBs)Qualified Institutional Buyers (QIBs)Lockup restrictionsLockup restrictions
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Other issuesOther issues
Step vesting, cliff vestingStep vesting, cliff vestingRight of first refusal, Right of first Right of first refusal, Right of first
offerofferDrag-along rightsDrag-along rightsTake-me-along = tag-along rightsTake-me-along = tag-along rightsAnti-dilution rights, down roundsAnti-dilution rights, down roundsPay-to-PlayPay-to-PlayNo ShopNo Shop
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3.Preferred Stock
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Preferred StockPreferred Stock
Convertible preferred (CP)Convertible preferred (CP)In our exampleIn our example, conversion point, conversion point ( (WWAA) ) occurs whenoccurs whenCP (conversion value) = 1/3 * $W = CP (conversion value) = 1/3 * $W = CP (redemption value) = Min ($5M , CP (redemption value) = Min ($5M , $W).$W).
Conversion ConditionConversion Condition:: 1/3 * W > 5 1/3 * W > 5 →→ W WAA = 15. = 15.
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CP, in picturesCP, in pictures
$W
CP
5 15
WA5
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Exit Diagram for CPExit Diagram for CP
$W
CP
5
5
15
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Other types of preferred stockOther types of preferred stock
Redeemable Preferred (RP)Redeemable Preferred (RP)
Participating Convertible Preferred Participating Convertible Preferred (PCP)(PCP)
PCP with cap (=PCPC)PCP with cap (=PCPC)
Key threshold for PCP is a qualified Key threshold for PCP is a qualified public offering (QPO)public offering (QPO)
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AlternativesAlternativesStructure IStructure I: 5M shares of common;: 5M shares of common;Structure IIStructure II: RP ($5M APP);: RP ($5M APP);Structure IIIStructure III: RP + 5M shares of common;: RP + 5M shares of common;Structure IVStructure IV: PCP with participation as-if 5M : PCP with participation as-if 5M
shares of common, QPO at $5 per share; shares of common, QPO at $5 per share; Structure VStructure V: PCPC with participation as-if : PCPC with participation as-if
5M shares of common, with liquidation return 5M shares of common, with liquidation return capped at four times OPP, QPO at $5 per capped at four times OPP, QPO at $5 per share;share;
Structure VIStructure VI: RP ($4M APP) + 5M shares of : RP ($4M APP) + 5M shares of CP ($1M APP).CP ($1M APP).
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Structure I : 5M shares of Structure I : 5M shares of commoncommon
$W
Co
mm
on
n
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Structure II : RP ($5M APP)Structure II : RP ($5M APP)
$W
RP
5
5
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Structure III : Structure III : RP + 5M shares of commonRP + 5M shares of common
$W
Ser
ies
A
5
5
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Structure IV : Structure IV : PCP with participation as-if 5M shares PCP with participation as-if 5M shares
of common, QPO at $5 per shareof common, QPO at $5 per share
$W
PC
P
5 75
Drop= 10/3
28 1/3
25
5
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Structure V : PCPC with participation Structure V : PCPC with participation as-if 5M shares of common, with as-if 5M shares of common, with
liquidation return capped at four times liquidation return capped at four times OPP, QPO at $5 per share;OPP, QPO at $5 per share;
$W
PC
PC
5 50 60
Conversion Point
20
5
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Structure V, continued
$W
PC
PC
5 50 60
5
20
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Structure VI : RP ($4M APP) Structure VI : RP ($4M APP) + … component+ … component
$W
RP
in S
erie
s A
4
4
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Structure VI : …+ 5M shares Structure VI : …+ 5M shares of CP ($1M APP) componentof CP ($1M APP) component
$W
CP
in
Se
rie
s A
4 5 7
1
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Structure VI : RP ($4M Structure VI : RP ($4M APP) + 5M shares of CP APP) + 5M shares of CP
($1M APP)($1M APP)
$W
Se
rie
s A
5 7
5
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Anti-Dilution ProtectionsAnti-Dilution Protections
Down roundDown round
Full-ratchet vs. weighted averageFull-ratchet vs. weighted average
Broad base vs. narrow baseBroad base vs. narrow base
Adjusted conversion price, adjusted Adjusted conversion price, adjusted conversion rateconversion rate
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Broad-base weighted average anti-dilutionBroad-base weighted average anti-dilution
CPCP22 = adjusted conversion price = CP = adjusted conversion price = CP11 * (A+B) / (A+C) * (A+B) / (A+C)
wherewhereCPCP22 == New Series A Conversion PriceNew Series A Conversion PriceCPCP11 == Series A Conversion Price in effect immediately Series A Conversion Price in effect immediately
prior to new issueprior to new issueAA == Number of shares of Common Stock deemed to be Number of shares of Common Stock deemed to be
outstanding immediately prior to new issue (includes all outstanding immediately prior to new issue (includes all shares of outstanding common stock, all shares of outstanding shares of outstanding common stock, all shares of outstanding preferred stock on an as-converted basis, and all outstanding preferred stock on an as-converted basis, and all outstanding options on an as-exercised basis; does not include any options on an as-exercised basis; does not include any convertible securities from this round of financing) convertible securities from this round of financing)
BB == Aggregate consideration received by the Corporation Aggregate consideration received by the Corporation with respect to the new issue divided by CPwith respect to the new issue divided by CP11
CC == Number of shares of stock issued in the subject Number of shares of stock issued in the subject transactiontransaction
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Narrow-base weighted average anti-dilutionNarrow-base weighted average anti-dilution
Everything the same as in the broad-base Everything the same as in the broad-base formula, except,formula, except,
A (narrow-base) = Number of shares of Common A (narrow-base) = Number of shares of Common Stock deemed to be outstanding immediately prior to Stock deemed to be outstanding immediately prior to new issue (including all shares of outstanding new issue (including all shares of outstanding preferred stock on an as-converted basis,preferred stock on an as-converted basis, butbut excludingexcluding all shares of outstanding common stock all shares of outstanding common stock and all outstanding options on an as-exercised basis; and all outstanding options on an as-exercised basis; does not include any convertible securities from this does not include any convertible securities from this round of financing) round of financing)
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EXERCISEEXERCISE
Anti-dilution:Anti-dilution:Exercise 9.2 (Metrick 2011)Exercise 9.2 (Metrick 2011)
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ExampleExampleSuppose that EBV makes a $6M Series A investment in Suppose that EBV makes a $6M Series A investment in Newco for 1M shares at $6 per share. One year later, Newco Newco for 1M shares at $6 per share. One year later, Newco has fallen on hard times and receives a $6M Series B has fallen on hard times and receives a $6M Series B financing from Talltree for 6M shares at $1 per share. The financing from Talltree for 6M shares at $1 per share. The founders and the stock pool have claims on 3M shares of founders and the stock pool have claims on 3M shares of common stock.common stock.
Consider the following cases:Consider the following cases: Case I: Case I: Series A has no anti-dilution protection.Series A has no anti-dilution protection. Case II:Case II: Series A has full-ratchet anti-dilution protection. Series A has full-ratchet anti-dilution protection. Case III:Case III: Series A has broad-base weighted-average anti-dilution Series A has broad-base weighted-average anti-dilution
protection.protection. Case IV:Case IV: Series A has narrow-base weighted-average anti-dilution Series A has narrow-base weighted-average anti-dilution
protection.protection.
For each of these cases, what percentage of Newco (fully For each of these cases, what percentage of Newco (fully diluted) would be controlled by EBV following the Series B diluted) would be controlled by EBV following the Series B investment? What would be the post-money and pre-money investment? What would be the post-money and pre-money valuations? (See Example 9.2 in the textbook.)valuations? (See Example 9.2 in the textbook.)
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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
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QUESTIONS?