3: VC Security Choice Flashcards
- Pre-Seed Funding
- The first funding of the company. Often the founder himself, maybe with help from family, friends etc.
- Seed Funding
- Can be the founder himself, or an “angel” investor who is a rich guy or a group of rich guys that invest in start ups
- Angel-investor face greater risk, hence will demand some form of larger compensation
- Serie A, B, C Funding
- The step after pro-seed funding and seed funding.
- Will try to attract VC’s to invest in their firm
- Raise capital through external funding
- Outside investors
- After “seed”/”angels”
- Partial ownership
- Traditional VC funding
- What is an Angel investor
- A rich individual with lots of capital, or a group of rich guys that invests in start-ups.
- Typical in exchange for ownership in equity
- One time investment to get the firm off the ground
- Types of compensation for early stage investors
- Gets compensated with Convertibles
- Preferred stocks or preferred bonds
- What is a Convertible?
- Starts as a type of debt, can be converted to equity
- Securities such as bonds and stocks
- Hybrid: Mix of equity and debt
- A protection (for VC) against big losses
- What is convertible bonds?
Bonds that can be converted to common shares
- Convertible Debt
• Early-stage investment option
- Provide funds
- Start-up money
• Don’t pay back with money, but with equity (shares) at a later stage at discount (compensation for greater risk)
- Convertible debt with Cap
• Cap sets a max value for investors equity. E.g., investment of $10m with Cap 2x gives max 20m to investor if the % is not larger than 20m
- Preferred Stock
- We have preferred stocks and common stocks
- Preferred will have benefits. This will often be the option to get paid first if the company is sold, liquidated or goes bankrupt.
- This is called liquidation preference
- Negotiable
- Liquidation Preference
• Contract clause
- The right to get paid first if the firm gets sold, liquidated or goes bankrupt.
- Clause on payout order. Who gets paid first, and how much do they get paid when firm gets liquidated, sold or bankrupt
- Protection + Incentive for VC to invest in startups
- Preferred Equity, two main options:
1: Exercise Liquidity
2: Convert to preferred shares
- Participating vs. Non-Participating
- Participating gives the right to first get the preferred sum plus another % of the share. Get an additional part on top of the PR.
- Non-Participating will only get the preferred sum
- What is the purpose of the Cap
- Minimize dilutive impact on common stockholders
- VC does a $10m Series A. VC owns 40% of 1x Participating preferred stock. Company gets sold for 60m
- Gets $10m + 40% * $50m = $30m
- VC does a $10m Series A. VC owns 40% of 1x Non-Participating preferred stock. Company gets sold for 60m
• Two options:
- Get 60m * 40% = 24m
- Get 10m
- VC does a $10m Series A. VC owns 40% of 1x Participating preferred stock. Company gets sold for 15m
$10m + 40%*5m = $12m
- VC does a $10m Series A. VC owns 40% with a 2x Cap. Company gets sold for $60m. What are the different options, and what will the VC do?
• 2x Cap means that the max equity is 20m
Option 1: 210 = 20m
Option 2: 40%60 = 24m
- Mandatory Conversion
- Means that the conversion of preferred stocks to common stock has to happen.
- Will take place through IPO, sold
- Must be converted at some date
20. Firm Value = 18m Have RP at $5m + 5m shares Our total investment is $6m 5 years Volatility = 90% rf = 5%
How is the equation for the Value of the RP?
Value of the RP = V – 2/3 * C(5)
21. Firm Value = 18m Have RP at $5m + 5m shares Our total investment is $6m 5 years Volatility = 90% rf = 5%
What is the value of the RP?
We use Black-Scholes to find the Call price: Spot price = 18 Strike price = 5 Time = 5 Volatility = 90% rf = 5% Call price = $15.74 Our investment is values at: V = 18 – 2/3*15.74 = 7.51
POSITIVE NPV!
22. Firm Value = 18m Have RP at $5m + 5m shares Our total investment is $6m 5 years Volatility = 90% rf = 5%
What equation will we use to find the value of the RP?
In what range will VC not gain anything?
Value of RP = V – C(6) + 1/3 * C(18)
- Between $6m and $18m, the VC does not gain anything.
23. Firm Value = 18m Have RP at $5m + 5m shares Our total investment is $6m 5 years Volatility = 90% rf = 5%
What is the value of the RP with Convertible Preferred setup?
Value of RP = V – C(6) + 1/3 * C(18) Spot price = 18 Strike price = 5 Time = 5 Volatility = 90% rf = 5% Black-Scholes gives: C (6) = 15.44 C (18) = 13.03
Value = 18 – 15.44 + 1/3 * 13.03 = 6.909
- How will the equation differ when we have yearly dividends on 10%, and 5y investment of 5m?
The RP amount becomes 5 * (1,10)^5 = $8,65m instead of $5m
- Convertible Preferred (CO)
A preferred stock that can be converted into common stock on a predetermined date at a specified ratio. Has two options:
1: Convert into a fixed amount of common shares
2: Redeem; and receive all proceeds up to $x
- Convertible Preferred is a hybrid of both debt and equity. Explain this
Debt comes from its fixed guaranteed dividend payment
Equity comes from its ability to convert into common stock
- Redeemable Preferred
- The issuer of the shares can buy them back at a planned price.
- Issuer can buy them back like a call option Will have to pay a “call premium”
- Liquidation preference
- VC has rights before the entrepreneur in case of “liquidating event”
- Has the right to receive all funds up to an specified amount
- Preferred Convertible Participating (PCP)
- Have three main befits:
1) Preferred Dividends
2) Will get $ first in case of deemed liquidation
3) Can convert into planned amount common shares
- Preferred Convertible Participating with Cap
1) Preferred Dividends
2) Will get $ first in case of deemed liquidation
3) Can convert into planned amount common shares
4) If Cap = 3x, can convert 3 times the Original Purchase Price of Common Stock
- Full-ratchet. Explain and give example
• One type of anti-dilution to protect early investor from dilution
- Lets say that A buys 1m shares for $1 per share
- In the next series, B offers to buy 1m shares for 500.000. This equals $ 0,5 per share
- If proceeded, A’s conversion rate will drop from $1 per share to $0,5 as a compensation
- Weighted Average
- Most common type of Anti-Dilution
- Will compensate dilution by giving investor extra amount of common shares
6) Difference between convertible debt and Redeemable Preferred
- The VC does not have the right to force the firm into liquidation
7) LP invests $6m for 5m of 15m total shares. Series B invest 12m with an 20m RP (where NVC has first call/right) for 5m shares. OCV now owns 10m shares. Management also owns 10m shares. When will OCV convert?
Firstly, OCV owned 1/3 shares (5m / 15m)
They now own 2/5 (40%) shares [10m / (10m + 10m + 5m)]
NVC has first right to buy, hence, OVC will convert to stock when
$6m < 40% * ( V – 20)
8) Alpha and Beta is
- NVC’s ownership in % for strike 1 and 2
9) (B – a) gives us
Change in ownership. What the NVC owns after OVC converts
