Dec 12, 2012 VC
Solution: Leonardo Needs Return Of 30% Instead Of 50%

Remember from our last post.

- Carlos told us that his company has 5,000,000 shares outstanding.

Leonardo wants 30% of return rate instead of 50%.

Let X be the number of shares purchased by the VC.

Let’s figure out the TOTAL number of shares once Leonardo invested.

X / (5,000,000 shares + X) = VC’s share which is 24.7% of the company

A quick explanation: after the VC invested in the company, we will have the 5,000,000 shares and the VC’s shares of the company which we call it TOTAL now. Leonardo needs to have 24.7% of the TOTAL.

X = 0.247(TOTAL)  , TOTAL means 5,000,000 shares + X

X =0.247(5,000,000 shares + X)

X = 1,235,000 + 0.247X

X – 0.247X = 1,235,000

0.753X =1,235,000

X = 1,640,106 shares

Leonardo needs to have1,640,106shares of the company. Actually, the company issues 1,640,106 new shares to get the $ 2 M.

Now, how should we calculate the price per share?

We need to assume that the shares do not gives dividends and we have a conversion of common stock of 1:1.

$ 2,000,000 /1,640,106 shares =$ 1.22/ share

If Leonardo agrees with everything else, he will state in his contract that he will pay $1.22/share for 1,640,106 shares of the company. Carlos will issue 1,640,106 shares to have $ 2M.

Imagine that this deal was done and everyone is happy, how Carlos can brag how much his company was value at?

Carlos has 5,000,000 shares, just because he succeed in selling his new shares at $ 1.22, so his shares value at 5,000,000 X $ 1.22 = $ 6,100,000 – This is what we called pre-money valuation.

OK, this is much better the valuation with 50% of rate of return from Leonardo! Remember that the pre-money was only $ 1,950,000!!!

What is the value of the company after all of this calculations?

This is what we call it post-money valuation.

We add simply the pre-money valuation and the VC’s investment: $ 6,100,000+ $ 2,000,000 = $ 8,100,000

As you can see, the rate of return is extremely important for valuation purpose. The new value is double the amount of the last valuation.

This is one of the reason Finance skill is so important.

In the next posts, I will use some real world news and apply this Venture Capital method to see some “hidden” information.

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