Problem 23-3 on Implied Price of Funding based on Chapter 23
Starware Software was founded last year to develop software for gaming applications. Initially, the founder invested $800,000 and received 8 million shares of stock. Starware now needs to raise a second round of capital, and it has identified an interested venture capitalist. This venture capitalist will invest $1 million and wants to own 20% of the company after the investment is completed.
a. How many shares must the venture capitalist receive to end up with 20% of the company? What is the implied price per share of this funding round?
b. What will the value of the whole firm be after this investment (the post–money valuation)?
Problem 23-4 on IRR of Venture Capital based on Chapter 23
Suppose venture capital firm GSB partners raised $100 million of committed capital. Each year over the 10-year life of the fund, 2% of this committed capital will be used to pay GSB’s management fee.
As is typical in the venture capital industry, GSB will only invest $80 million (committed capital less lifetime management fees). At the end of 10 years, the investments made by the fund are worth $400 million. GSB also charges 20% carried interest on the profits of the fund (net of management fees).
a. Assuming the $80 million in invested capital is invested immediately and all proceeds were received at the end of 10 years, what is the IRR of the investments GSB partners made? That is, compute IRR ignoring all management fees.
b. Of course, as an investor or limited partner, you are more interested in your own IRR, that is, the IRR including all fees paid. Assuming that investors gave GSB partners the full $100 million up front, what is the IRR for GSB’s limited partners (that is, the IRR net of all fees paid)?
Problem 23-13 on IPO based on Chapter 23
Your firm has 10 million shares outstanding, and you are about to issue 5 million new shares in an IPO. The IPO price has been set at $20 per share, and the underwriting spread is 7%. The IPO is a big success with investors, and the share price rises to $50 on the first day of trading.
a. How much did your firm raise from the IPO?
b. What is the market value of the firm after the IPO?
c. Assume that the post–IPO value of your firm is its fair market value. Suppose your firm could have issued shares directly to investors at their fair market values in a perfect market with no underwriting spread and no underpricing. What would the share price have been in this case, if you raise the same amount as in part (a)?
d. Comparing part (b) and part (c), what is the total cost to the firm’s original investors due to market imperfections from the IPO?