Question

The CEO of Millennium Dairy Product, a small venture among 10 partners each having 100,000 shares, sought to raise an additional Rs.50 million in a private placement of equity in his early stage dairy product company. The CEO conservatively projected net income of Rs.50 million in year 5, and knew that the comparable companies traded at a price earnings ratio of 20X. She approached SBI caps, a venture capitalist with her proposal to seek funds. (10) a) What share of the company would SBI caps require today if their required rate of return was 50%? b) If the company had 1000,000 shares outstanding before the private placement, how many shares should SBI caps purchase? c)What price per share should she agree to pay if her required return was 50%? d)What are the pre money and post valuations? e) What are the Carried interests of the VC and the promoters?

Answer 1

Millennium Dairy Product

a) Share of the company that SBI Caps should require today to get a required rate of return of 50%.

= 50%

b) If the company had 1,000,000 (100,000 x10) shares outstanding before the private placement, SBI Caps should purchase

1,000,000 shares = 50% of (1,000,000 + 1,000,000) shares

Assuming the founding promoters are not giving up their shares, instead, new equity shares are being issued.

c) The price per share SBI Caps should agree to pay, if her required return was 50% is

Rs.50 per share, which will provide the required additional equity financing of (Rs.50 million) since Rs.50 x 1,000,000 equals Rs.50 million.

d) Pre money and post money valuations:

These are based on the calculated Market Price of Rs.1,000 per share from the Price/Earnings Ratio.

Pre money valuation will be Rs.1,000 x 1,000,000 shares = Rs.1 billion

Post money valuation will be Rs.1,000 x 2,000,000 shares = Rs.2 billion

e) Carried interests of the VC and the promoters

VC's carried interest = share of profits = 50% xRs.50 million = Rs.25 million

Promoters' carried interest = Rs.25 million

Explanation:

a) Calculation of share in the company:

SBI Cap's required rate of return is 50%

If she invests Rs.50 million today, her expected return will be equal to Rs.50 million x 50% = Rs.25 million

Since rate of return = Net Income/Initial Investment or (Current value of investment - Initial Investment)/Initial Investment.

This return will be equal to 50% of the total net income of Rs.50 million

b) Price/Earnings P/E ratio = Market price per share/Earnings per share (EPS)

Since P/E ratio of similar companies = 20 times,

The company's P/E = 20 times x EPS

With calculated EPS = Rs.50 million /1,000,000 = Rs.50

Therefore, price per share = 20 x Rs.50 = Rs.1,000

Pre money valuation = Rs.1,000 x 1 million shares = Rs.1 billion

Post money valuation = Rs.1,000 x 2 million shares = Rs.2 billion

c) The carried interest is the share of profits to which the promoters and the Venture Capitalists are entitled. Their respective shares are 50% of the net income = Rs.25 million each.

d) The pre money and post money valuations: The pre money valuation is the valuation of the company before the additional equity financing. The post money valuation is the valuation of the company after the additional equity financing. There are many ways to value a company. In this case, we have used the P/E ratio as a basis for the valuation. However, we did not dilute the earnings per share post money, for simplicity.