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VC > 3: VC Security Choice > Flashcards

3: VC Security Choice Flashcards

1
Q
  1. Pre-Seed Funding
A
  • The first funding of the company. Often the founder himself, maybe with help from family, friends etc.
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2
Q
  1. Seed Funding
A
  • 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
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3
Q
  1. Serie A, B, C Funding
A
  • 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
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4
Q
  1. What is an Angel investor
A
  • 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
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5
Q
  1. Types of compensation for early stage investors
A
  • Gets compensated with Convertibles

- Preferred stocks or preferred bonds

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6
Q
  1. What is a Convertible?
A
  • 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
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7
Q
  1. What is convertible bonds?
A

Bonds that can be converted to common shares

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8
Q
  1. Convertible Debt
A

• 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)

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9
Q
  1. Convertible debt with Cap
A

• 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

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10
Q
  1. Preferred Stock
A
  • 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
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11
Q
  1. Liquidation Preference
A

• 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
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12
Q
  1. Preferred Equity, two main options:
A

1: Exercise Liquidity
2: Convert to preferred shares

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13
Q
  1. Participating vs. Non-Participating
A
  • 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
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14
Q
  1. What is the purpose of the Cap
A
  • Minimize dilutive impact on common stockholders
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15
Q
  1. VC does a $10m Series A. VC owns 40% of 1x Participating preferred stock. Company gets sold for 60m
A
  • Gets $10m + 40% * $50m = $30m
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16
Q
  1. VC does a $10m Series A. VC owns 40% of 1x Non-Participating preferred stock. Company gets sold for 60m
A

• Two options:

  • Get 60m * 40% = 24m
  • Get 10m
17
Q
  1. VC does a $10m Series A. VC owns 40% of 1x Participating preferred stock. Company gets sold for 15m
A

$10m + 40%*5m = $12m

18
Q
  1. 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?
A

• 2x Cap means that the max equity is 20m
Option 1: 210 = 20m
Option 2: 40%60 = 24m

19
Q
  1. Mandatory Conversion
A
  • 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
Q 
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?

A

Value of the RP = V – 2/3 * C(5)

21
Q 
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?

A 
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
Q 
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?

A

Value of RP = V – C(6) + 1/3 * C(18)

  • Between $6m and $18m, the VC does not gain anything.
23
Q 
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?

A 
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

24
Q
  1. How will the equation differ when we have yearly dividends on 10%, and 5y investment of 5m?
A

The RP amount becomes 5 * (1,10)^5 = $8,65m instead of $5m

25
Q
  1. Convertible Preferred (CO)
A

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

26
Q
  1. Convertible Preferred is a hybrid of both debt and equity. Explain this
A

Debt comes from its fixed guaranteed dividend payment

Equity comes from its ability to convert into common stock

27
Q
  1. Redeemable Preferred
A
  • 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
28
Q
  1. Preferred Convertible Participating (PCP)
A
  • Have three main befits:
    1) Preferred Dividends
    2) Will get $ first in case of deemed liquidation
    3) Can convert into planned amount common shares
29
Q
  1. Preferred Convertible Participating with Cap
A

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

30
Q
  1. Full-ratchet. Explain and give example
A

• 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
31
Q
  1. Weighted Average
A
  • Most common type of Anti-Dilution

- Will compensate dilution by giving investor extra amount of common shares

32
Q

6) Difference between convertible debt and Redeemable Preferred

A
  • The VC does not have the right to force the firm into liquidation
33
Q

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?

A

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)

34
Q

8) Alpha and Beta is

A
  • NVC’s ownership in % for strike 1 and 2
35
Q

9) (B – a) gives us

A

Change in ownership. What the NVC owns after OVC converts

VC (6 decks)

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