Question

ACME Software Company has CURRENT (i.e. today; year "zero") market value of its venture's assets of $250K (effectively its current equity valuation cash flow). Forecasted cash-flows for next 5 years is as follows: Year 1: ($350,000), i.e. negative Year 2: ($100,000) Year 3: $250,000, i.e. positive Year 4: $450,000 Year 5: $500,000 Year 6+: Assume $600K in year 6, growing at 6% annually thereafter Years 1-5 discount rate of 40% Years 6+ assume 15% given company should be more mature, less risky, and more predictable. Given the same information as the previous question, how much %ownership (rounded) would a $250,000 investment fetch assuming the NPV of the ACME Software (the pre-money valuation) you just calculated?

Answer 1

Calculating the %ownership for a $250,000 investment in ACME Software Company requires discounting the forecasted cash flows at appropriate rates, adding this to the company's current market value, and then comparing the total pre-money valuation to the investment amount to determine the percentage of ownership.

Step-by-step explanation:

The process of determining how much %ownership a $250,000 investment would fetch in ACME Software Company involves calculating the present value of the company's forecasted cash flows. We first discount the future cash flows for Years 1-5 using a 40% rate and then use a 15% rate for the cash flows from Year 6 and onwards, assuming the company will be more mature and stable. The cash flow for Year 6 is $600,000, growing at 6% annually thereafter. The Net Present Value (NPV) of these cash flows represents the value of the company's equity just before the new investment, also known as pre-money valuation.

We then compare this pre-money valuation to the amount of new investment ($250,000) to determine the percentage of ownership. If the pre-money valuation is equal to the investment amount, the investor would own 50%. If the pre-money valuation is higher, the percentage ownership for the investor would be less than 50%, and vice-versa.

In reality, expected profits, discount rates, and growth rates are best guesses and not hard data, which is why investors need to perform due diligence and make informed estimations in their calculations to arrive at a valuation that makes sense for both the investor and the company.