Lecture 7

Question 1

Where does the PCP differs from RP + Common stock ?

Answer 1

Often includes mandatory conversion clause into common

Question 2

What is this mandatory conversion clause ?

Answer 2

When price per share on an as converted basis reaches prespecified threshold (QPO trheshold) then stock converts into common
Mandatory nature of conversion can lead to downward gaps in exit diagram

Question 3

How to price PCP ?

Answer 3

Express exit payoff as portfolio of stock, call options + binary options with random expiration

Question 4

What is a binary option ?

Answer 4

Gives payoff 1 at maturity T iff price of underlying S(T) exceeds fixed strike price X

Question 5

What does the time at which QPO threshold is met uncertain imply ? What is the solution ?

Answer 5

Binary component of PCP execution not known ex-ante

→ Use random expiration binary option with maturity distributed exponentially

Question 6

What happens when a cap is imposed in redemption value of PCPC ?

Answer 6

Voluntary conversion to common may occur before mandatory value → no gap at exit diagram and no binary options used for valuation

Question 7

What is the value of VC-backed firm ?

Answer 7

• Widespread method report post money valuation until new round of financing → not accurate method
• Different exit diagrams between Founders and VCs → value reported needs to correspond to portfolio describing exit payoff
→ Value of VC-backed firm changes every year

Question 8

How to improve reporting quality ?

Answer 8

Assumption VC market = Competitive

Question 9

What does it mean that VC market = competitive ?

Answer 9

• Positive NPV > GP cost → LPs making profits
o More money into VC industry
o More VC funds
o More competition → NPV↓

• If VC → losses
o No financing attracted
o Competition ↓
o NPV ↑

• LPs should break even : NPV should compensate for GP cost