Let me give an example. Suppose three engineers come to you
Let me give an example. Suppose three engineers come to you with a… Let me give an example. Suppose three engineers come to you with a plan for a disruptive, yet-to-be developed software program that seems compelling. They are asking for $10 million, the amount they think they will need over the next three years to reach cash flow positive. They have a pitch deck that includes a proposed deal. They are offering you 25% of the company. The founders own the remaining 75%. You will buy common stock, and are entitled to one of four seats on the board of directors; they hold the other three seats. One slide in the deck contains a detailed prediction of the value of the company. If you invest $10 million, you will own shares that are worth at least $50 million at the end of the third year. Scenario 1Suppose you decide to accept the deal. Many other venture firms are eager to invest, and it seems likely the entrepreneurs will get the terms they have offered. Twelve months after you wire the $10 million, the CEO calls. The company is progressing nicely but Oracle has offered to buy it for $20 million. They intend to pay your firm $5.0 million in cash. The founders will be paid $15.0 million immediately for their shares and each founder has the potential to receive a $5.0 million bonus after one year.” The founders have decided to accept the offer. Question 1: How do you feel? What do you tell your partners? What valuation was paid in the acquisition? Why did Oracle structure the deal with a separate bonus for the founders? Scenario 2Again, suppose you accept the deal terms. Twelve months later, you get a call from the entrepreneurs saying that there are delays in developing the software. The venture has consumed $8 million in cash, and will hit a fume date in a few months. The entrepreneurs send you an updated capitalization table that reveals that the company has issued stock options to employees, equivalent to 25% of the total shares. And, one of the founders has resigned and gone back to work at his former employer. All of that employee’s shares are fully vested and there is no provision for repurchasing the shares. Question 2: How do you feel? What do you tell your partners? What valuation was paid in the acquisition? Why did Oracle structure the deal with a separate bonus for the founders? Business Entrepreneurship MMM 241
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