VALUATION

Case Study: Fibra Optica Express

Maria Salam, founding partner of leading venture capital firm M&M Venture Partners
(M&M), was pretty happy that Friday. The weekend was looking good, sun was forecast for
both days and, on top of that, she had just received a very interesting business plan
recommended to her by a friend.

The entrepreneurial team was composed of three Bireit MBA students and two engineers
from the Polytechnic University. A quick read-through of the executive summary was
enough for her to realize that Fibra Optica Express (FOE) was a promising venture.

Additionally, it fitted well with M&M’s investment criteria and was within its area of
expertise. She thought that maybe by working a little bit over the weekend, she could
present a preliminary report on the company for the Monday morning Investment
Committee.

The Opportunity

After reviewing in detail FOE’s Business Plan, and being impressed by the CVs of the
founders, Maria decided to start with the valuation of the business. It was the type of
venture she liked to analyze: early stage, with a prototype ready and some initial sales. Best
of all, FOE’s technology was protected by a national and international patent.

An early-stage company brings with it a high risk to investors; however, it was the type of
investment M&M were looking for. In fact, high risk means high return. For this type of
company, the target IRR was 40 per cent and the investment would last for around four
years. The IRR was high, but it needed to compensate for the for the risk involved and the
probability of the startup not surviving at all.
FOE’s valuation

After a careful analysis of the financial plan and its main assumptions, Maria had a better
understanding of FOE’s full potential. In order to estimate the value of the company, she
slightly modified some of the assumptions.

Maria thought that FOE could be making a profit of between $4 and $6 million after tax by
the expected exit year. Additionally, she had just read a market report from some well-
known investment bankers that indicated that 15 to 20 times was the average PER (price-
earnings ratio) for this type of business.

The amount of capital that the entrepreneurs were trying to get in this round was $3
million. Maria was sure that this money would only last for the next 12 months. Therefore,
she forecast that in one year’s time, if FOE was performing according to its business plan,
the entrepreneurs would need to raise more funds to grow the company internationally.
According to her experience of working with similar startups, FOE would need an additional
$5 million one year from now.

She thought that the second round multiplier would be around three times the price of the
first round. M&M only invested in seed and startup rounds. Much of the value of their
investments came from the increase in value in the second and later rounds of financing. In
fact, they knew that if the current business plan was not met, the maximum price for the
second round would be twice the current round.

The MBA students had already incorporated the company. Its equity was divided into
5,000,000 shares, one million per founder, and the book value of the equity was $50,000.
The founder team had also reserved 500,000 shares for the employee stock options plan.

Monday Morning’s Investment Committee Meeting

Maria was pretty satisfied. She had not enjoyed the sunny weekend as much as she had
hoped given the arrival of FOE’s business plan. However, she would be surprising her
colleagues at the Investment Committee meeting with an excellent investment proposal.
She had anticipated some of the questions she would be asked after her presentation of
FOE’s investment proposal:

 What would be the price range per share that G&M should be negotiating with the
entrepreneurs?
 How many shares should G&M be getting to ensure its IRR target?

Maria could not miss this wonderful opportunity, so even though it was Sunday evening and
she was tired, she decided to prepare two cases; an ‘optimistic case’, where everything
went well, and a ‘negative case’ , where everything went badly.

Your Role:
Prepare a short report answering the above two questions. Make sure to have two
scenarios (you decide the numbers for the best case and worst-case scenarios from the
numbers above).

The Answer:
Round one:

Best Case:

EAT PER IRR Years of investment VC investment

6M 20 40% 4 3M

1. EV = EAT * PER

6,000,000*20 = 120,000,000

2. Future value = VC investment* (1+IRR)^years of investment

3,000,000*(1+40%) ^4 = 11,524,800

3. FR = Stap 2 ÷ Step 1

11,524,800 ÷ 120,000,000 = 0.10

4. SM = (FR * Shares pre)/ 1- FR

= ( 0.10* 5,500,000)/ 1-0.10
= 611,111

 Shares pre = number of shares + stock option

= 5,000,000 + 500,00 = 5,500,000
 5. Price per share = VC investment ÷ SM

3,000,000 ÷ 611,111 = 4.90$

EV Future value FR SM Price per share

120,000,000 11,524,800 10% 611,111 4.9 $

Worst case:

EAT PER IRR Years of investment VC investment

4M 15 40% 4 3M

1. EV = 4,000,000*15
= 60,000,000

2. FV = 3,000,000*(1+40%) ^4
= 3,000,000* 3.8416 = 11,524,800

3. FR = 11,524,800/60,000,000
= 0.19

4. SM = (0.19208*5,500,000)/ (1-FR)
= 1,307,604.7

5. Price per share = 3,000,000/ 1,307,604

= 2.3

6. SM/share pre = 1,307,604/ 5,500,000

= 0.238

EV Future value FR SM Price per share SM/ Share pre

60,000,000 11,524,800 19% 1,307,604.7 2.3 0.24

Round two

Best Case:

EAT PER IRR Years of investment VC investment

6M 20 40% 3 5M

Shares pre = 5,500,000 – 611,111 =4,888,889

1. EV = 6,000,000*20
= 120,000,000

2. FV = 5,000,000*(1+40%) ^3
5,000,000*2.744
= 13,720,000

3. FR = 13,720,000/ 120,000,000
= 0.11

4. P2 = Price of share from best case scenario of round one* PER

= 4.90*20
= 98

5. SM2 = VC investment /P2

= 5,000,000/$98
= 51,020.4082

EV Future value FR P2 SM2

120,000,00 13,720,000 11% 98 51,020.4082

 0

Worst case
EAT PER IRR Years of investment VC investment

4M 15 40% 3 6M

1. EV = 4,000,000* 15
=60,000,000

2. FV = 6,000,000* *(1+40%) ^3
=16,464,000

3. FR = 16,464,000/ 60,000,000
=0.2744

4. P2 = P1* PER
= 2.3*15
= $34.5

5. SM2 = 6,000,000/$34.5
= 173,913.043

EV Future value FR P2 SM2

60,000,000 16,454,000 27% 34.5 173,913.043

• What would be the price range per share that G&M should be negotiating with the
entrepreneurs?

Number of shares for the best scenarios = Sm1 + Sm2

= 611,111 + 51,020.4082= 662,131.408
Number of shares for the worst scenarios = Sm1 + Sm2
= 1,307,604.7+ 173913.043 = 1,481,517.74

Price range for the best scenarios = P R1 +P R2 / 2= ($4.9 * $98) /2 = $240.1

Price Range for the worst scenarios = P R1 + P R2 /2 = ($2.3 * $34.5) /2 = $39.7