LOS l: Calculate pre-money valuation, post-money valuation, ownership fraction, and price per share applying the venture capital method in terms of IRR.

Q1. A private equity firm makes a $10 million investment in a portfolio company and calculates that the firm’s investors should hold 1,000,000 shares at a price of $15.00 per share using the IRR approach. The founders of a portfolio company currently hold 300,000 shares. The appropriate post-money (POST) valuation is:

A)   $19.5 million.

B)   $15 million.

C)   $13 million.

Q2. The primary difference between the venture capital method using the IRR and NPV approach is that:

A)   the IRR approach starts by calculating the investor’s expected future wealth.

B)   the IRR method does not use exit values.

C)   the NPV approach does not require fractional ownership calculations.

Q3. The Milat Private Equity Fund (Milat) makes a $35 million investment in a promising venture capital firm. Milat expects the venture capital firm could be sold in four years for $150 million and determines that the appropriate IRR rate is 40%. The founders of the venture capital firm currently hold 1 million shares. Milat’s fractional ownership in the firm and the appropriate share price, respectively, is closest to:

           Fractional ownership         Share price

A)        89.64%                          $4.05

B)        23.33%                         $115.00

C)      89.64%                             $3.63

LOS l: Calculate pre-money valuation, post-money valuation, ownership fraction, and price per share applying the venture capital method in terms of IRR. fficeffice" />

Q1. A private equity firm makes a $10 million investment in a portfolio company and calculates that the firm’s investors should hold 1,000,000 shares at a price of $15.00 per share using the IRR approach. The founders of a portfolio company currently hold 300,000 shares. The appropriate post-money (POST) valuation is:

A)   $19.5 million.

B)   $15 million.

C)   $13 million.

Correct answer is A)

Since we have no information on exit value or the IRR rate, but the share price and number shares held by each party is given, the post-money valuation (POST) is calculated as:
POST = shares price x total number of shares = $15 × (1,000,000 + 300,000) = $19.5 million.

Q2. The primary difference between the venture capital method using the IRR and NPV approach is that:

A)   the IRR approach starts by calculating the investor’s expected future wealth.

B)   the IRR method does not use exit values.

C)   the NPV approach does not require fractional ownership calculations.

Correct answer is A)

The IRR approach in venture capital firm valuations can be thought of as a reverse NPV calculation, where the IRR rate is used to first calculate the investor’s expected future wealth.
Both the IRR and NPV approach use exit values and fractional ownership calculations.

Q3. The Milat Private Equity Fund (Milat) makes a $35 million investment in a promising venture capital firm. Milat expects the venture capital firm could be sold in four years for $150 million and determines that the appropriate IRR rate is 40%. The founders of the venture capital firm currently hold 1 million shares. Milat’s fractional ownership in the firm and the appropriate share price, respectively, is closest to:

           Fractional ownership         Share price

A)        89.64%                          $4.05

B)        23.33%                         $115.00

C)      89.64%                             $3.63

Correct answer is A)

The calculation requires four steps:

Step 1: Calculate the expected future value of Milat’s $35 million investment in four years using an IRR rate of 40%:

W = ($35 million) × (1.40)4 = $134.46 million

Step 2: Milat’s fractional ownership of the venture capital firm is the future expected wealth divided by the exit value:

f = $134.46 million / $150 million = 0.8964, or 89.64%

Step 3: Calculate the number of shares required by Milat (S_pe) for its fractional ownership of 89.64%:

S_pe = 1,000,000 [0.8964 / (1 – 0.8964)] = 8,652,510

Step 4: The share price is the value of Milat’s initial investment divided by the number of shares Milat requires:

P = INV₁ / S_pe = $35 million / 8,652,510 = $4.05

(Note that both the NPV and IRR approach will yield the same answers.)

CBA