Rick Smith, CEO of XYZ, Inc, wants to raise S5 million in a private equity in hi

Question

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 On further analysis and discussion, Marie and Rick agree that the company will probably need another round of financing in addition to the current S5 million. Marie believes that NewVenture will need an additional S3 million in equity at the beginning of year 3. While Marie, the only first round investor, will require a 50% return, Marie feels that round 2 investors, in recognition of the progress made between now and then, will probably have a hurdle rate of only 30%. As before, a professional management team should have the ability to own a 11.00% share of the company by the end of year 5 a. Based on this new information, what percent of the company should Marie seek today (as percent with two decimal places (EX: 12.34%)? b. What price per share should she be willing to pay? c. What percent of the company will the Round 2 investors seek? d. What price per share will they be willing to pay?

Explanation / Answer

Value of the company at end Year 5: Given, Price/Earnings=16 So, Price or Value= 16*Earnings ie. Price/Value= 16*8=128 millions a. For a company worth 128 million, Marie is willing to pay 5 million. So, she is seeking 5/128= 3.91% share of the company's equity b.Price, she should be willing to pay Market Price/Earnings =16 Price/(800000*50%)=16 Price=(800000*50%)*16 6400000 ie. 6400000/5000000= 1.28 1.28 times c. For a company worth 128 million, Round 2 investors are willing to pay 3 million. So, it is 3/128= 2.34% share of the company's equity d.Price, Round 2 investors should be willing to pay Market Price/Earnings =16 Price/(800000*30%)=16 Price=(800000*30%)*16 3840000 ie.3840000/3000000= 1.28 times

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