Financial Management

Seminar + Homework, Week 5

1. Starware Software was founded last year to develop software for gaming applications. Initially, the founder invested $800,000 and received 8 million shares of stock. Starware now needs to raise a second round of capital, and it has identified an interested venture capitalist. This venture capitalist will invest $1 million and wants to own 20% of the company after the investment is completed.

a. How many shares must the venture capitalist receive to end up with 20% of the company? What is the implied price per share of this funding round?

b. What will the value of the whole firm be after this investment (the post-money valuation)?

Answer:

a. After the funding round, the founder’s 8 million shares will represent 80% ownership of the firm. To solve for the new total number of shares (TOTAL):

8,000,000 = 0.80 TOTAL

So TOTAL = 10,000,000 shares. If the new total is 10 million shares, and the venture capitalist will end up with 20%, then the venture capitalist must buy 2 million shares. Given the investment of $1 million for 2 million shares, the implied price per share is $0.50.

b. After this investment, there will be 10 million shares outstanding, with a price of $0.50 per share, so the post-money valuation is $5 million.

2. Three years ago, you founded your own company. You invested $100,000 of your money and received 5 million shares of Series A preferred stock. Since then, your company has been through three additional rounds of financing.

a. What is the pre-money valuation for the Series D funding round?

b. What is the post-money valuation for the Series D funding round?

c. Assuming that you own only the Series A preferred stock (and that each share of all series of preferred stock is convertible into one share of common stock), what percentage of the firm do you own after the last funding round?

Answer:

a. Before the Series D funding round, there are (5,000,000 + 1,000,000 + 500,000 = 6,500,000)