Excite Ltd is a new Internet-based company that streams sports films to its customers. Excite has been in business for 20 months and already has paying customers and revenue. Nigel Smith, the founder, has financed Excite so far by using his own financial resources and cash flow from company sales. However, he has run out of personal funds and realises he needs substantial new funding in order to develop the business properly. Nigel has approached your venture capital fund for backing.
Based on his new business plan, Nigel believes he needs £5 million, which he thinks will be enough funding to achieve Net Income (profit after taxes) of £5 million by the end of Year 5 in the business plan. He believes comparable companies would be valued at 20x Net Income at that time. Given the investment risk you perceive, you believe your fund must require an internal-rate-of return (IRR) of 50% in order to justify the investment. Excite already has 1,000,000 shares outstanding (all owned by Nigel).
Before offering a Term-Sheet to Nigel, you decide a stock option pool must be created in order to recruit additional senior managers. After some discussion, it is concluded amongst all parties that the senior management team (not including Nigel) should have options ultimately to own 15% of the company. It is agreed the stock options will not vest until the end of Year 3 (ie, the management team will not be able to exercise their options until the end of Year 3. This means they cannot actually own any shares until then).
During the second year, it becomes apparent – even though Excite is making good progress – the company will require an additional capital injection of £3 million at the beginning of Year 3. The original Year 5 forecasted financial outcome and PE-multiple remain the same. You contact your best friend at Nice Guy Ventures who, after some study, agrees to invest some or all of the required £3 million. They agree that senior managements’ option pool should be maintained at 15%. However, they require a target IRR of only 30%, since the risk is now lower than at the time of the first financing round.
Questions 12-15: Assuming your fund decides to maintain its percentage ownership, what would be the ownership percentages of all the following parties at the completion of the financing at the beginning of Year 3?
· Question 12: Nigel Smith?
· Question 13: Senior Management?
· Question 14: Your Fund?
· Question 15: Nice Guy Ventures?