Venture Capital and the Finance of Innovation, Second Edition

EXHIBIT 18-8
EXIT DIAGRAM FOR THE SERIES A
Series A
Slope 1/2
10 20 150
$W
Usually, the part of this diagram that confuses people is the drop of $20M at W 5 150.
This drop is due to the combination of two effects. First, when Techco exercises their options,
they immediately receive 1/3 of the proceeds, which reduces the value of the EBV stake from
one-half of $150M (5 $75M) to one-third of $150M (5 $50M). This causes a drop of $25M.
This drop is somewhat cushioned by one-third of the proceeds from the exercise cost (1/3
$15M 5 $5M), leaving a total drop of $25M 2 $5M 5 $20M. Note that this kind of binary
call does not occur when “regular” preferred stock converts, because there is no windfall
profit or loss at the time of such conversions. In this example, however, Techco’s options are
well in-the-money before they are allowed to convert them at W 5 $150M. When they are
finally able to convert, the resulting profits cause the jumps in the diagrams.
(b) To compute the breakeven valuation (5 implied valuation) for the Series A, we first
subtract the GP valuation from Equation (18.16) to obtain
LP valuation of Series E 5 9=10 ½V 2 Cð10Þ 1 1=2 Cð20Þ
2 20 BCð150Þ 2 1=6 Cð150ÞŠ:
ð18:17Þ
The LP cost is ($100M/$80M) $10M 5 $12.5M. As in the previous examples, it is
necessary to use the FLEX Calculator to compute the IVpost. Under base-case assumptions for
a Series A investment, we find an IVpost of $30.52M.
(c) Using the IV post of $30.52M and the same base-case assumptions as in part (b), we
can use FLEX to compute the partial valuation of Techco’s options (Equation (18.13))
as $4.58M. ’
18.3 A COMPLEX EXAMPLE
Slope 1/3
Next, we try to solve a real messy problem. If we can do this, we can do (almost)
anything.
20
18.3 A COMPLEX EXAMPLE 329