Describe possible explanations for an investor’s decision to convert preferred stock to common stock in connection with a liquidation event for a venture

1. Name and explain two different types of risks especially relevant to early stage high-potential ventures.

2. Please explain the compensation structure of VC and PE firms.


3. Describe possible explanations for an investor’s decision to convert preferred stock to common stock in connection with a liquidation event for a venture


4.Describe the shortcomings/limitations of the Venture Opportunity Screening (VOS) Model discussed in class. How did we say the Model could be modified (adapted) to make it more useful to entrepreneurs and prospective investors? Remember that many of the comments also apply to the other screening models (New venture template & VOSE)


5. What does it mean that a firm is “Burning Cash”; and how does burning cash relate to the need for external funding in a start-up business?


6. Marty Jones is negotiating with a Venture Capital Fund for $10 MIL financing for his new venture. Marty is the sole founder and owns 100% of the company’s equity. He is adamant that he must keep a 60% interest in the company after external capital is raised.

A VC investor believes an 10X return in NLT 5 years is an appropriate return for the risk associated with this investment.

The company has just begun generating revenue, and it does not expect to generate positive Cash Flow (CF) until Year 2. Discreet Cash Flow projections prepared from pro forma financial statements are presented below. After the discreet forecasting period (Yr 4), Rick and the VC expect CFs to grow by 3.5% per year in perpetuity.

Year Cash Flow
1  $ -2,800,000
2 $  1,000,000
3 $  3,750,000
4 $ 11,000,000
  1. What imputed rate of return demanded by the investor? (3)
  2. Given that required rate of return, what value would the VCs probably give to projected Discreet Period pro forma CFs? (3)
  3. What is the firm’s Terminal Value (TV)? (2)
  4. What is the Present Value of the firm? (2)
  5. At that valuation; how much of the company will Marty have to give up to raise $10 million and will he do the deal?



Your start-up company has been funded as follows:

Investment % ownership Preference Cap
Family Loans (Yr 0) $ 1,250,000 0 na na
Founders Investment (YR 0) $   500,000 40% (0) na
Round #1 Investment (YR 2)   4,000,000 35% (2X) None
Round #2 Investment (YR 3)   5,000,000 25% (1X) 2X


The family loans carry a 14% coupon cumulative simple interest rate; however the company was only able to pay $50,000 interest in Year 1 and $ 80,000 interest in Year 3.

In Year 6 the company is considering a $31,000,000 purchase offer from larger competitor. Round #1 and Round #2 investors hold CONVERTIBLE, fully PARTICIPATING Preferred Stock.

Participation is in the %’s indicated above. Round #1 Shares earn 8% CUMULATIVE annual Dividends; and Round #2 Shares earn 6% CUMULATIVE annual Dividends. No Dividends have been paid prior to the Sales Transaction. Assume preference will be paid in order of investment (i.e Round 1 gets paid first)

How will the net sale proceeds be distributed to each stakeholder and what are their rates of returns assuming the deal closes during Year 6?

Family lenders:

Round 1 Investors:

Round 2 Investors:




STARTUP Analysis

Startup BuffCo (SB) is a corporation organized in Delaware. SB makes basketball coaching software that automatically generates powerful coaching drills and game plans based upon deep data analysis of team and individual statistics. The software works well. It is especially growing in popularity among NBA and Division I college programs where statistical data is extensive. Availability of a wealth of data makes the software’s analyses more powerful. The software is less useful where less data is readily available, such as the high school and club levels.

In September 2003, SB raised $1 million from an angel investor, Rich Uncle Walseth (RUW). SB’s sole founder, Ceal Barry, is CEO and SB is her first startup. Barry offered RUW the “same kind of stock that I own – common stock.” RUW knew a lot about basketball, not so much about investing, and was happy to receive common stock and a $9 million pre-money valuation for his SB investment.

Startup BuffCo made progress after the Rich Uncle Walseth angel investment, however, additional fundraising was difficult. On the verge of going bust, in December 2005, SB raised $2 million from Boyle Ventures (BV) on a $6 million pre-money valuation. BV is a $50 million fund raised in 2003. The round was not syndicated and BV is the sole owner of the Series A preferred stock. BV received Series A preferred stock with a seat on the board of directors, standard protective provisions, and a 1x liquidation preference that is participating up to a 3x cap. The lead general partner from BV, Burdie Halderson (BH), sits on SB’s three-person board, along with the CEO founder Ceal Barry, and angel investor RUW. Boyle Ventures’ cash infusion and Burdie Halderson’s sage advice helped Startup BuffCo finally find its footing. CEO Barry, angel RUW, and BV to this day remain SB’s only shareholders.

In June 2013, Startup BuffCo received a $10 million acquisition offer from Isiah Thomas Corp. (IT). IT offered to pay cash in exchange for all of SB’s stock. SB rejected IT’s acquisition offer. Startup BuffCo’s trajectory is trending well. It won’t explode into a huge company anytime soon, however, it has a valuable product that is carving out its own niche.

On December 10, 2013, SB received a $22 million offer from Knight Inc. (KI). KI offered $22 million cash in exchange for all of SB stock.

The KI purchase offer is as follows:

  • $2 million cash to SB payable upon closing.
  • $15 million cash is subject to a three year earn out following closing of the acquisition.

    a. The earn out is based upon sales of SB’s product.

    b. The sales number targets seem realistic based upon SB’s current momentum and internal three year sales projections.

  • $5 million cash to be set aside and held in escrow for five years to cover any intellectual property or tax claims that arise during the period following the acquisition.

    a. Balance of escrow to be paid to SB following five year escrow period.


  1. What percentage of Startup BuffCo did RUW own in September 2003, immediately after the angel investment?
  2. After the Series A round with Boyle Ventures, RUW was unhappy to learn about the price that BV paid for SB. RUW knows that you came through CU’s Venture Capital class and now wants your advice. “What should I do differently in my next investment?” he asks. Please advise RUW on two issues related to price that he should address differently in his next angel investment.
  3. Startup BuffCo rejected IT’s $10 million acquisition offer. If it had been accepted, how much of the proceeds would Boyle Ventures have received from the IT purchase of Startup BuffCo?
  4. Assume Knight Inc.’s $22 million acquisition offer is accepted and SB gets a “best case” economic scenario. That is, SB gets the $2 million up front, the full $15 million earn out, and entire $5 million from escrow. Under this best case scenario, how much of the $22 million would Boyle Ventures receive AND what is the return on their investment?
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