Venture Capital Limited (VCL) proposes to invest an amount “$X” today in a cloud-based accounting software company. In exchange the VCL will receive a 49% interest in the company. Assume the company will have no debt and issue no other securities other than ordinary shares. The cash provided by the VC will be paid to the company in exchange for the issue of new ordinary shares. There will be no cash inflow returns to VCL or any other shareholder, other than when exit is expected
to take place.
VCL has or expects:
• An Exit (horizon) time equal to three years.
• Required return = 30% per annum.
• At the end of three years the business is expected to earn earnings before interest and tax, (‘EBIT’) of $10 million.
• Shares in comparable, more established accounting technology companies currently sell at around twenty times EBIT.
In answering the following questions, state any other specific assumptions you may need to make.
a) Calculate the expected business or enterprise value at the end of three years.
b) Based on your calculations in part a) above, what dollar value of investment today (i.e., $X) would VCL be expecting to invest to obtain a 49% interest in the Company? Assume an all equity company.
c) Based on your calculations in parts a) and b) above, what is VCL’s implied pre-money valuation of the Company as at today?
d) Assume the VCL invested in the Company based on its valuation at the time of the investment. If a 100% interest in the business at the end of three years sold at an actual price of $50 million (i.e., a price different to the expected price at exit at the end of three years), what rate of return will VCL actually receive?
