TacoCorp is considering a first round of venture capital investment. Taco is the majority shareholder with 1000 shares. Jenny and Kevin each have 250 shares in TacoCorp. Taco’s initial investment is $10000.
a) A venture capital firm is considering a purchase of 2000 shares. If the purchase takes place, what are the ownership stakes of each of the owners?
b) The VC firm is valuing TacoCorp at $70000. What is the size of their investment?
c) What is the price per share of TacoCorp stock?
d) If Jenny and Kevin initially invested $2000 per person, what is their capital gain on their investment? What is Taco’s capital gain?
e) Given the firm’s prospective valuation, Taco is considering an initial public offering. He hires an underwriter to consider an offering of 2000 shares. In the IPO, Taco wishes to issue 2000 in new stock but also wants to reduce his stake from 1000 shares to 100 shares. His underwriter strongly recommends against that action. Why? Discuss your answer with respect to Modigliani-Miller.