Notes on Final Exam
Overall
This was a difficult exam and was be graded on a
curve. The highest grade was a 95 (no perfect score),
the mean was 76 and the median 79.
Question 1
Almost everybody got this question correct.
Question 2
Many people were confused by the wording of this one, but most
people had the correct intuition that employee stock options dilute
existing shareholders. If you issue new options after a
financing, it dilutes everybody, but if you issue them
pre-financing, it only dilutes the old shareholders (in this case,
the founders). In order to get the same return as in question
1, the exit would have to be higher or the valuation of the Series
A investment lower.
We gave full credit to anyone who clearly explained their
interpretations and assumptions, and drew the correct conclusion
based on those.
Question 3
Most people did well on the payoff diagrams. Note that
the issue of conversion upon an IPO could be taken a couple of
ways, and we gave full credit for well-explained (correct)
answers. We did not double-penalize if the incorrect VC
payoff led to an incorrect Founder payoff.
Some common mistakes:
-
Forgetting that the conversion point for the 2x liquidation
preference happens at $30M, not $15M
-
Not realizing that the Redeemable Preferred stock still gets its
$5M back in an IPO (like debt), so its payoff is actually higher
than Participating Convertible Preferred
Question 4
Most people correctly identified the payoffs at each amount,
as well as correctly discussed the downside protection for the
investors. However in order to get full credit, you need to
discuss how the different structures affected the entrepreneurs’
and VC’s incentives, which few people did.
Question 5
Almost everyone got this correct. Some people thought
this was an intrinsic value problem and tried to used Black-Scholes
to calculate the replicating portfolio. All that was
necessary was the see that the distribution of exits had to be
above the conversion value of $15M.
Question 6
Most people got this right and we gave full credit to those
who showed just the nominal payoffs as well as those who calculated
the PV of the LP’s payout. Common mistakes:
-
Stating that the VCs get the full $75M exit value
-
Calculating the 20% carry based on the $25M payout (and not the
$20M profit)
-
Forgetting about the management fee, or only showing 1 year’s
fee
-
Calculating the management fee off of some number other than $5M
without explaining it (if you stated “I assume the total fund size
is $50M and will calculate the fee at $1M/yr,” you got full
points)
-
Forgetting that the LPs also get their $5M principal back
Question 7
Most people correctly identified that if you wait too long to
raise money, you may be in a cash crunch. However in order to
receive full credit you had to also recognize that a startups
builds value over time- eg through hitting milestones, and there is
a penalty to raising money too early.
Question 8
Most people showed they understood what a pay-to-play clause
does to investors who do not participate pro-rata in a future
financing. However it was discussed in class that this is a
matter between the investors and generally does not add value to
the founders. To get full points you had to recognize that
VCs will not give in to this term ‘for free’ and will demand
something in return that is a downside to the entrepreneur (even if
you ultimately recommend pushing for the P2P provision).
Question 9
Most people got this right- you had to realize there was a
full ratchet anti-dilution in the term sheet and correctly
calculate its effect. Common mistakes:
-
Forgetting about the anti-dilution clause
-
Forgetting to include the Series B’s shares in the new cap
table
-
Assuming that full ratchet preserves Series A’s stake at 33.3%- in
fact it lowers the conversion value and in this case will raise A’s
stake to 34.5%
Announced on
29 May 2008
11:50
a.m.
by Simcha Blaustein