A potential investor is seeking to invest $500,000 in a venture, which currently

Question

A potential investor is seeking to invest $500,000 in a venture, which currently has 1,000,000 shares held by its founders, and is targeting a 50% return five years from now. The venture is expected to produce half a million dollars in income per year at year 5. It is known that a similar venture recently produced $1,000,000 in income and sold shares to the public for $10,000,000.

a.    What is the percent ownership of our venture that must be sold in order to provide the venture investor’s target return?

b.    What is the number of shares that must be issued to the new investor in order for the investor to earn his target return?

c.    What is the issue price per share?

d.    What is the pre-money valuation?

e.    What is the post-money valuation?

Make sure you specifically include a section in your submission that clearly states your answer to each question. I will not hunt through your spreadsheets or calculations to find your answers. If possible, please try to include only one document in your submission and please do not use embedded spreadsheets if you use a word document. Please label your assignment using our assignment labeling convention. Each question is worth three points.

Explanation / Answer

Solution:

We have been given a similar venture to take it as a comparable to our venture. The total shareholder's equity for the other venture (P) = $10,000,000 and the net income (E) = $1,000,000

Hence, Price/Earnings (P/E) for other venture = 10,000,000/1,000,000 = 10.0

Now for our venture, Earnings in the 5th year = $500,000
Assuming that P/E ratio for both the ventures to be equal, P/500,000 = 10.0
hence, total shareholder's value for our venture = $5,000,000 --------------- (1)

Now the investor invested $500,000 and expected 50% return after 5 years, hence the investor's value after 5 years would be equal to                                500,000 * (1+50%) = $750,000 --------------- (2)
Now percent ownership of venture given to investor = (Value of investor's investment after 5 years/total value of all shareholders after 5 years)
Hence, divide (2) by (1)
percent ownership of venture given to investor = 750,000/5,000,000 = 0.15
                                                                           or 15%

hence answer to part (a) = 15%

Part (b) : Now percentage ownership given to new investor = 15%, total number of shares = 1,000,000

Hence, number of shares issued to new investor = 15% * 1,000,000 = 150,000
Hence, answer to part b = 150,000

Part (c): Amount invested by new investor = $500,000 and number of shares issued to him = 150,000

hence issue price of share = Amount invested / Number of shares issued
                                           = 500,000/150,000 = $3.33

Hence, issue price per share = $3.33

Part (d): Pre-money valuation is the value of the company before any external funding. In this case, the number of shares held with the founders before the new investor = 1,000,000 and the equity price = $3.33
hence, Value of the venture = 3.33 * 1,000,000 = $3,333,333.33

Hence, pre money valuation of the venture = $3,333,333.33

Part (e): Post money valuation of a company is the value of the company after external funding. In this case, investor invests $500,000 to the venture increasing the value of the company by the same amount.

Hence post money valuation = pre money valuation + Investment
                                              = 3,333,333.33 + 500,000
                                              = 3,833,333.33
Hence, post-money valuation of the venture = $3,833,333.33

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