The Venture Capital Method of Valuation… The Venture Capital Method of Valuation…

Valuation of a venture using one financing round involves three steps:

1) Estimate the ventures value at some future date, often based on a
conventional “comparable trades” analysis.
2) Discount this future value to the present at the VC’s target internal rate of
return.
3) Divide the VC’s investment by the venture’s present value to calculate the
VC’s required percentage ownership.
Extending this reasoning to an arbitrary number of financing rounds the
retention ratio for the ith financing round is:
Ri = 1/(1-di+1)(1-di+2)…(1-dn),
where di+1 is the percentage ownership given to the ith + 1 round investors,
and n is the total number of financing rounds.
The calculations must be done recursively from the most distant
financing round to the present.
Because the retention ratio for each round depends on dilution created
by all subsequent rounds, it is impossible to calculate the initial
percentage ownership of early-round investors without knowing that of
all later rounds.
Once the percentage ownership at each financing round is known, it is
easy to calculate stock prices as well as pre- and post-money values.

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Mezzanine Capital versus Debt and Equity

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Comparative Features of Mezzanine Capital Advantages and Disadvantages of Mezzanine

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1
 The Market of Mezzanine Finance
The traditional market of mezzanine finance is upper-tier SMEs. These
are high-rated companies, with an approximate rating of BBB+ or better.
They often have a demand for larger mezzanine tickets, over € 2 million.
To obtain mezzanine finance SMEs have to fulfill strict criteria: like a
sound track, stable cash-flows and an experienced management team.
Middle-tier SMEs are companies with approximately a B- to a BBB
rating. The mezzanine tickets demanded by these SMEs are frequently
smaller than those demanded by upper-tier SMEs, i.e. € 250,000 to € 2
million. In this group there are SMEs striving for further expansion, as well
as mature family-owned companies with a requirement for succession
planning and a need to plan for the eventual transfer of ownership.
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Risk-Return Characteristics of Mezzanine Instruments
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Risk-Return Characteristics of Mezzanine Capital…
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The Market of Mezzanine Finance…
Low-tier SMEs are companies with at most a B-rating. Often, though,
these SMEs do not have a rating assigned by an independent rating
agency but rather a credit-scored ‘internal’ rating assigned by their bank.
Low-tier SMEs have a financing need for smaller amount, often less than €
250,000. Mezzanine finance to low-tier SMEs can include companies in the
early phase of their development.
Enabling the supply of hybrid finance to this group of companies often
involves public support. Many issuers of mezzanine finance to low-tier
SMEs can be found amongst public promotional banks, development
agencies or equity investment companies run by mutual guarantee
institutions.
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Risk-Return Characteristics of Mezzanine Capital…
Depending on the structure mezzanine financing can be treated like
equity on a company's balance sheet and may make it easier to obtain
standard bank financing. These structures include debt with an equity
"kicker“. The equity "kicker" is usually a contingent common equity
interest, either by way of warrants or a conversion option.
Interest payments usually involve both a cash pay portion and pay-in-
kind (PIK) portion. The total stated interest rate usually ranges between
14%-16% (depending on structure and borrower), with the cash portion
of interest generally ranging between 12%-14% and the remainder
interest portion in PIK. The interest is tax deductible in most
jurisdictions.
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Mezzanine Financing Instruments
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