Venture Capital and the Finance of Innovation, Second Edition

324 CHAPTER 18 COMPLEX STRUCTURES
(b) Using the IVpost of $24.26M and the same base-case assumptions as in part (b), we can
use FLEX Calculator to compute the partial valuation of the carve-out (Equation (18.1) as
$1.52M. ’
The previous example used a proportional carve-out. It is also possible to
have discrete payouts at preset trigger points. The next example illustrates this case.
EXAMPLE 18.2
We use the same setup as in Example 18.1, but this time with a different structure for the
management carve-out. Now, following the $12M Series E investment from Vulture Ventures
(50M shares of CP with a 3X liquidation preference), management is promised the
following incentives: If Newco has an exit of at least $50M, then the employees will receive
$5M from these proceeds. If Newco has an exit of at least $80M, then the employees will
receive an additional $5M from these proceeds. The earlier investors have 40M shares of
common, and the employees have claims on a further 10M shares.
Problems
(a) Draw and read the exit diagrams for the management carve-out, for the Series E, and for
all other investors combined.
(b) Compute the breakeven valuation for the Series E investment under base-case assumptions.
(c) Compute the implied valuation for the management carve-out under base-case assumptions.
Solutions
We begin by drawing the exit diagram for the carve-out in Exhibit 18-4. Here, we have
discrete jumps in the payouts to management at $50M and $80M.
We can read this diagram as
Partial valuation of management carve-out 5 5 BCð50Þ 1 5 BCð80Þ: ð18:6Þ
We next turn to the Series E stake. Now the main complication is to adjust properly for
the discrete payouts. Without doing some calculations, we cannot tell whether the jumps
occur below or above the conversion point. In principle, it is possible that neither payout
occurs before conversion (if W E , 50), that only the first one does (50 , W E 80), or that both
do (WE . 80). The only way to know for sure is to compute all the cases and look for logical
contradictions. For example, Series E conversion condition, if occurs below the first payout
(W E , 50):
1=2 W . 36M-WE 5 $72M: ð18:7Þ
This condition gives us a contradiction, because if WE is equal to $72M, we should
have to include a payout (because W E . 50). Thus, Equation (18.7) is not a proper conversion
condition.
We next consider the possibility that $50M , WE , $80M.