OUTREACH NETWORKS: FIRST VENTURE ROUND QUESTION 1:
Why do Everest Partners require a 30% equity stake in Outreach Networks in exchange for an early-stage investent of !30 illion" #how how Everest would $ustify requiring this stake using the e enture nture &a'ital valuation ethodology(
)he valuation of the funding negotiations that are $ust a*out to start is a difficult task( )here are any ethods which can c an deterine the worth of the investent of the enture enture &a'ital( )he enture enture &a'ital valuation ethod was created *y the Professor of +arvard ,ill #ahlan in the year ./( )he valuation of the investent of Everest Partners P artners has *een done on the *asis of enture enture ca'ital valuation ethod( 1n order to calculate the value of the co'any or the terinal value at the tie of exit2 the 'ro$ected net incoe of the th year has *een taken( )his year has *een assued to *e the exit year for the venture ca'ital fir( )he case states that the antici'ated return on investent for Everest Partners is 40% to 0%( 5n average of this range which is 60% has *een used as the antici'ated return of investent of the venture ca'ital investent till year year six( )he 'rice-earnings ulti'le used in this calculation is the industry average 'rice earnings ratio which is assued as siilar to that of Outreach Network &o'any( ,ased on this inforation2 the valuation of the co'any has *een calculated *y discounting the terinal value of the co'any to 'resent value( )he value of the co'any is !70(. *ased on the venture ca'ital valuation ethod( 5s the initial investent *y the venture ca'ital co'any co 'any is !30 illion2 therefore2 *ased on this the equity stake of the venture ca'ital is around 4(43 % under the PE ulti'le ethod and it is 73(03% under the E,1)85 ulti'le ulti'le ethod(( 5lso the 'ost-oney valuation would *e !70(. illion( )his eans that when the venture ca'ital fir will exit in the sixth year2 then it could increase the wealth of the shareholder of Outreach Networks *y !70(. illion 9PE
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ulti'le ethod: or !30(7 illion 9E,1)85 ulti'le ethod: and in this way the venture ca'ital fir can also earn a return on its investent of around 40% to 0%( ,ased on these calculations the 'rice 'er share would also *e increased *y !4( 9! 7( under E,1)85 ulti'le: *y the tie the venture ca'ital fir will exit( enture ca'ital valuation ethod is norally used in situations when the exit year and the exit value of the venture ca'ital fir could *e estiated with certainty( 1n the case of Everest Partners2 we can easily estiate the exit value of the co'any( ,ased on these facts2 the 'ost oney valuation is calculated in 'resent value ters today which take into account the risks and the tie the investor takes to earn his target rate of investent return( )he calculations 'erfored in the s'readsheet show that the value of the co'any would increase after the venture ca'ital funding is 'rovided( )he calculations $ustify the equity stake which is required *y the venture ca'ital fir in Outreach Networks(
QUESTION 2:
1s Outreach Networks a ty'ical start-u' co'any seeking enture &a'ital funding" &an Pere; argue that any of its 'articular characteristics ean that Everest should get a saller equity stake than the 30% they are asking for"
)he Outreach Networks= revenues had grown fro around !. illion in the year 700 . to !3 illion in the year 70( )his is a very huge and ra'id growth and it shows that the co'any has *een in the o'erations since alost 3 years( )he co'any=s revenues are also dis'ersed throughout the a$or geogra'hical areas of the world( 36% of the total revenue for the co'any coes fro >iddle East2 Euro'e and 5frica2 3 % coes fro North 5erica2 7 % coes fro #outh 5erica and the reaining .% of revenue coes fro 5sia Pacific( 1f the co'any goes for the venture ca'ital funding o'tions2 these funds would *e used *y the co'any to ex'and the scale of the co'any=s o'erations and further ex'and the *usiness in the international arkets quickly as co'ared to the current situation( )he co'any has *een successful till date and it was now considering the o'tion for 1nitial Pu*lic Offering in the next few years( 5s the *usiness was ex'anding2 therefore2 it would *ecoe necessary for the co'any to raise equity financing in order to finance its future ca'ital investents and other *usiness
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ex'ansion needs( )he venture ca'ital funding would also hel' the co'any to achieve this o*$ective in future( )he current offer for acquiring the 30% of Outreach Networks total worth has *een decided *y the anageent at !30 illion( +owever2 the &EO and the founder of Outreach Networks had argued that the equity stake of around 30% was very high for an aount of !30 illion( +e 'ro'osed that looking at the success and the 'ast 'erforance and also the ra'id ex'ansion of the *usiness without seeking any venture ca'ital funding2 the!30 illion funding should *e worth only a*out 6 % of the total value of the co'any( )herefore2 in order to $ustify the equity stake of 30% and 6% for !30 illion2 the net 'resent value calculations and the returns on the investents have *een calculated under *oth the scenarios( 1n the first scenario in s'readsheet2 30% stake with !30 illion investent funding2 the net 'resent value of the co'any is found to *e !40(4. illion with a return on investent of around 4%( +owever2 in the second scenario2 the equity stake is considered to *e 6 % for !30 illion( ,ased on this2 the net 'resent value of the co'any is calculated as !6(0. illion with the return on investent of 37%( )herefore2 fro the 'ers'ective of the &EO of Outreach Networks2 it is in the *est interests of the co'any not to avail the venture ca'ital funding *y offering 30% equity stake *ut it should 'ro'ose that Everest Partners acquire 6 % of the stake for !30 illion2 *ut this would then decrease their return on investent which would *e less than their average 60 % return on investent(
QUESTION 3:
&arry out a 8iscounted &ash ?low valuation on Outreach Networks that Pere; could use to deterine the value of the co'any if it acce'ts Everest Partners investent( &ritically co'are the 8&? valuation with the & ethodology( What are soe of the differences *etween a target rate under the & ethod and a arket-ad$usted rate2 such as that o*tained fro the &a'ital 5sset Pricing >odel 9&5P>:2 used in carrying out a 8&? aluation"
)he discounted cash flow valuation is a ethod under which the future cash flows for the *usiness are 'ro$ected *ased on certain assu'tions( )hese are then discounted *ack at an a''ro'riate weighted average cost of ca'ital and a terinal value is also calculated *ased on the
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'er'etuity value of the *usiness in the foreseea*le future( #uing u' all these 'resent values and the terinal values gives us the enter'rise value of the co'any( )he future free cash flows have *een 'rovided in the case exhi*it ( )he cash flows have *een 'ro$ected for years fro 707 to 70( 1n order to discount *ack these free cash flows to 'resent value2 an a''ro'riate discount rate has *een calculated( 1n this case2 the co'any Outreach Networks is 00 % equity financed2 therefore2 cost of equity has *een calculated *ased on the inforation 'rovided in the case( )he risk free rate of 6% and the 'reiu on arket return of around % is given in the case( )he average of *eta of the co'ara*le co'anies has *een used in order to calculate the cost of equity for Outreach Networks( )he average of ,eta has *een taken here for two reasons( )he first reason is that Outreach Networks *eta is not given and there is no valid inforation to calculate its *eta( #econdly2 the co'ara*le of Outreach Networks are o'erating in the sae industry@ therefore2 the systeatic risks would *e ore or less sae( ,ased on this inforation the future cash flows have *een discounted( )he terinal value has also *een calculated and the terinal growth rate of 3% has *een assued in this ty'e of industry taking a conservative a''roach( 5lso the 'resent value of the funds that would *e received has *een calculated for years which is !70(6 illion( 5dding all these 'resent values the total enter'rise value is !743 illion and !64(/ on a 'er share *asis(
DIFFERENCES IN TARGET RATE & COST OF EQUITY
)he target rate of return for a venture ca'ital fir is the rate which easures the $ustifia*le rate of return over the investents ade *y the venture ca'ital co'anies( )his risk incor'orated the risks that are taken *y the venture ca'itals to 'rovide the funding to the newly set-u' co'anies( 5nother difference is that the target rate of return is usually set at a very high level as co'ared to the traditional cost of equity of the co'any( #ince2 ost of the venture ca'ital firs invest in co'anies that are in their early stages and they do not have a long track record and also the future earnings 'ros'ects of the co'any are highly volatile2 therefore2 the venture ca'ital co'anies 'erfor their valuation *ased on the target rate of return at the 'lanned exit date( +owever2 the cost of equity on the other hand is used to discount the cash flows of 00% equity financed co'any(
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QUESTION 4:
Aiven the high equity stake that Everest Partners is deanding2 should Pere; take the & funding" Estiate the 8&? valuation of Outreach if it does not receive the funding fro Everest Partners2 stating your assu'tions( &ritically analy;e whether acce'ting the investent fro Everest Partners in exchange for 30% of the equity akes sense for Pere; and the other shareholders co'ared to choosing a go it alone a''roach(
)he a*ove discounted cash flow valuation for the co'any was 'erfored after incor'orating the 'resent value of the investent funds received *y the venture ca'ital co'any( +owever2 here the discounted cash flow valuation has *een 'erfored on the *asis of the sae free cash flows fro 707 to 70( 5ll the calculation 'erfored here are siilar to the a*ove scenario2 however2 the 'resent value of the venture ca'ital funding has not *een incor'orated in the calculations 'erfored( )he enter'rise value after the incor'oration of the venture ca'ital funding is around !743 illion and without the venture ca'ital funding the enter'rise value is !777 illion( )he enter'rise value is higher with the inclusion of the venture ca'ital funding@ however2 there is no significant increase in the wealth of the shareholders( 5lso2 the 'revious calculation exained the i'act of either acquiring 30% or 6% of the stake also shows that2 if the owners of Everest Partners do not reduce their deand for acquiring 30% of the stake to 6% for !30 illion2 the &EO of Outreach Networks should not acce't this offer( +owever2 if the owners of Everest Partners still deand 30% stake in the co'any2 then the offer should *e declined and the co'any should o'erate on a go alone a''roach( )his would *e in the *est interests of the co'any in the long ter(
&hang2 #(<( 97004:2 Venture Capital Financing, Strategic Alliances and the Initial Public Offerings of Internet Start-ups”, Journal of Business Venturing 2 .2 7-4(
