Question

Roger Harkel, CEO of Bestafer, Inc. seeks to raise $2 million in a private placement of equity in his early stage venture. Harkel conservatively projects net income of $5 million in year 5 and knows that comparable companies trade at a price earnings ratio of 20X.

Benedicta Jones of Gorsam Capital likes Harkel’s plan, but thinks it is naïve in one respect: to recruit a senior management team, she believes Harkel will have to grant generous stock options in addition to the salaries projected in his business plan. From past experience, she thinks management should have the ability to own at least 15% share of the company by the end of year 5.

Given her beliefs, what share of the company should Benedicta insist on today if her required rate of return is 50%? 30%?

Answer 1

After 5 year, market capitalization (value of total equity) = Price Earnings Ratio of comparable company x Net income = 20*5 = 100 million

If Benedicta targets 50% rate of return, then target value of equity for Benedicta = 2*(1.5)^5 = 15.1875$

Benedicta can target an equity share = 15.1875/100 = 15.1875%

If Benedicta targets 30% rate of return, then target value of equity for Benedicta = 2*(1.3)^5 = 7.4259 $

Benedicta can target an equity share = 7.4259/100 = 7.4259%