QUESTION 1:
Why do Everest Partners require a 30% equity stake in Outreach Networks in exchange for an early-stage investment of $30 million? Show how Everest would justify requiring this stake using the Venture Capital valuation methodology.
The valuation of the funding negotiations that are just about to start is a difficult task. There are many methods which can determine the worth of the investment of the Venture Capital. The Venture Capital valuation method was created by the Professor of Harvard Bill Sahlman in the year 1987.
The valuation of the investment of Everest Partners has been done on the basis of Venture capital valuation method. In order to calculate the value of the company or the terminal value at the time of exit, the projected net income of the 6th year has been taken. This year has been assumed to be the exit year for the venture capital firm. The case states that the anticipated return on investment for Everest Partners is 40% to 60%. An average of this range which is 50% has been used as the anticipated return of investment of the venture capital investment till year six. The price-earnings multiple used in this calculation is the industry average price earnings ratio which is assumed as similar to that of Outreach Network company. Based on this information, the valuation of the company has been calculated by discounting the terminal value of the company to present value. The value of the company is $207.96 based on the venture capital valuation method.
As the initial investment by the venture capital company is $30 million, therefore, based on this the equity stake of the venture capital is around 14.43 %. Also the post-money valuation would be $207.96 million. This means that when the venture capital firm will exit in the sixth year, then it could increase the wealth of the shareholder of Outreach Networks by $207.96 million and in this way the venture capital firm can also earn a return on its investment of around 40% to 60%. Based on these calculations the price per share would also be increased by $4.16 by the time the venture capital firm will exit. Venture capital valuation method is normally used in situations when the exit year and the exit value of the venture capital firm could be estimated with certainty. In the case of Everest Partners, we can easily estimate the exit value of the company. Based on these facts, the post money valuation is calculated in present value terms today which take into account the risks and the time the investor takes to earn his target rate of investment return. The calculations performed in the spreadsheet show that the value of the company would increase after the venture capital funding is provided. The calculations justify the equity stake which is required by the venture capital firm in Outreach Networks.
QUESTION 2:
Is Outreach Networks a typical start-up company seeking Venture Capital funding? Can Perez argue that any of its particular characteristics mean that Everest should get a smaller equity stake than the 30% they are asking for? Justify your answer with numerical analysis.
The Outreach Networks’ revenues had grown from around $9 million in the year 2009 to $63 million in the year 2011. This is a very huge and rapid growth and it shows that the company has been in the operations since almost 3 years. The company’s revenues are also dispersed throughout the major geographical areas of the world. 35% of the total revenue for the company comes from Middle East, Europe and Africa, 31 % comes from North America, 26 % comes from South America and the remaining 9% of revenue comes from Asia Pacific.
If the company goes for the venture capital funding options, these funds would be used by the company to expand the scale of the company’s operations and further expand the business in the international markets quickly as compared to the current situation. The company has been successful till date and it was now considering the option for Initial Public Offering in the next few years. As the business was expanding, therefore, it would become necessary for the company to raise equity financing in order to finance its future capital investments and other business expansion needs..................................
