Rick Smith, CEO of XYZ, Inc., wants to raise S5 million in a private equity in his early stage venture. Smith conservatively projects net income of S8 million in year five (five years from now) and knows that comparable companies trade at a price to earnings ratio of 16X. Marie Wolf of ABC Capital likes Smith\'s plan, but thinks it naive in one respect: to recruit a senior management team, she believes Smith will have to grant generous stock options in addition to the salaries projected in his business plan. From past experience, she thinks management should have the ability to own at least a 11.00% share of the company at the end of year S. If Ms. Wolf now insists that professional managers own 11.00% of the company at the end of year 5, how much of the company is left for investors to own (as a dollar value)? If Ms. Wolf wants her investment in the company to be worth S30 million, what percent of the company\'s equity should she insist on owning? a. b. ..Remember, calculations are performed as if today is after the close of business in year 0 and tomorrow is the start of business for year 1. So, an investmentycars from now would be at the end of year 5.
1. a) Earnings at end of year 5 = 8 million
P/E multiple = 16X
So Value of company = 16 * 8 = 128 million
b) Investment by venture capitalist = 5 million
With rate of return =50%
VC requirement at Year 5 = 5 * ( 1+50%)5 = 37.96875
Percentage of Company required by VC = 37.96875/128 = 29.66%
c) Amount of outstanding shares = 1000000,
Percentage of company required by VC
Number of shares =(37.96875/128 )* 1,000,000 = 296630.85 or 296631.0
d)
Investment by venture capitalist = 5 million
With rate of return =30%
VC requirement at Year 5 = 5 * ( 1+30%)5 = 18.56465
Percentage of Company required by VC = 18.56465/128 = 15.503%
e) Capital to be raised = 12 million
With rate of return =50%
VC requirement at Year 5 = 12 * ( 1+50%)5 = 91.125
So he has to give up 91.125
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