Problem
Suppose a VC fund invests $10M for 20% of a startup in the form of convertible preferred stock with a 1x liquidation preference. There is also an automatic conversion provision that takes effect in the case of a "qualified IPO," defined as an IPO at a pre-money valuation above $100M.
I. Assume that the startup does not issue any additional shares in the future, except for potentially in an IPO. In other words, there are no future rounds of VC financing and no future employees paid with stock-based compensation.
II. Assume that in the case of an IPO, only newly-created shares are sold to the public, and the stock price remains at the IPO price (i.e., the price set the night before the IPO and paid by the original institutional investors) until the point when the VC sells its shares 6 months later.
III. Remember, an IPO is a financing event and thus has a pre- and post-money valuation associated with it, defined just like in a VC round.
1. How much will the VC fund get if the startup is acquired for $40M? Explain why.
2. How much will the VC fund get if the startup is acquired for $200M? Explain why.
3. How much will the VC fund get if the startup goes public at a $200M pre-money valuation, with the startup raising $20M in the IPO? Explain why.
4. How much will the VC fund get if the startup goes public at a $200M post-money valuation, with the startup raising $20M in the IPO? Explain why.
Now suppose everything is the same except the VC fund invests using convertible participating preferred stock rather than convertible preferred stock:
5. How much will the VC fund get if the startup is acquired for $40M? Explain why.
6. How much will the VC fund get if the startup is acquired for $200M? Explain why.
7. How much will the VC fund get if the startup goes public at a $200M pre-money valuation, with the startup raising $20M in the IPO? Explain why.
8. How much will the VC fund get if the startup goes public at a $200M post-money valuation, with the startup raising $20M in the IPO? Explain why.
Now suppose everything is the same except the VC fund invests using convertible participating preferred stock with a 2x participation cap:
9. How much will the VC fund get if the startup is acquired for $40M? Explain why.
10. How much will the VC fund get if the startup is acquired for $200M? Explain why.