13. Entrepreneur Analysis

Overview

In this lesson, we examine the personal motivations of the entrepreneur and help her structure the deal with Ventura in her favor.

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Summary

  1. Lesson Goal (00:04)

    The goal of this lesson is to analyze the impact on the stakeholders of restructuring the proposed investment.

  2. Reasons for Maintaining a Cash Balance (00:14)

    Investments in a startup often go towards funding losses as the company grows. However, in our case study, this is not the case. Instead, the cash balance is used to cover various risks, such as an economic downturn, a change in the market, etc. For startups, projections for years further into the future are often quite uncertain, due to the rapid pace of the company’s growth. A cash balance can help deal with this uncertainty.

  3. Restructuring the Investment (01:06)

    If the company does not appear to need the proposed cash injection, then it may make sense to restructure the investment. In our case, it was proposed that Ventura, the venture capital firm, would invest $20m in TrackerTime, and would take $20m worth of new shares in the company. Instead, we propose that TrackerTime purchase $5m of shares directly from Mary Hernandez, the CEO of TrackerTime, and then purchase $15m of new shares. This affects the different stakeholders in different ways:

    • For Mary Hernandez, this change is largely positive. She receives $5m in cash in exchange for some of her shares in TrackerTime.
    • For SeedCo, the existing investors in TrackerTime, this change is positive. As fewer new shares will be issued, their existing stake will be less diluted.
    • For Ventura, this change could be negative. They will still own the same stake in TrackerTime, but not all of their investment will go into the company. They might also worry that the CEO would be less committed to the business after receiving a large lump sum. This could impact the future success of the company.

Transcript

In the previous lesson, we examined TrackerTime's cash balance and saw that the 20 million investment that Ventura was proposing might not all be needed. We decide to share out thoughts with TrackerTime's CEO.

When we explain our analysis to Mary, she offers up some interesting insights. Firstly, she's very confident of reaching the projections for 2017 and 2018, but she has relatively little visibility on the next three years, primarily because the projections are growing so fast. She also mentions that she prefers to operate with a cash safety net, in case there's an economic downturn, a change in the market, or other risks, such as legal cases, etc. She also mentions that Ventura want the minimum of 10% in the company, and that she currently values the business at 190 million. This means that Mary will need to take 20 million for Ventura to realize their minimum requirement.

We then ask Mary an interesting question. Would she be interested in selling in some of her shares personally to Ventura? It turns out that this is very interesting to Mary. Although an experienced entrepreneur, she has never had a very big exit, and an injection of cash at this stage in her career would be very welcome. To do this, we simply split the methods in which Ventura receives its shares.

Mary will sell five million personally, and the company will issue the remaining 15 million in new shares. This 15 million will end up on the company's balance sheet, and the five million will end up in Mary's bank account. When Mary puts this to Ventura, they would prefer that all 20 million in cash stays in TrackerTime but they're open to the suggestion.

SeedCo on the other hand are happy to accept Mary's demands because it actually benefits their situation. SeedCo currently owns 15% of the company. If Mary sells five million of her shares, SeedCo will only be diluted by the 15 million of newly issued shares. It will not be diluted by the full 20 million. While there will be less cash in the bank, they will own more of the company. However, for Ventura, they will still only own 10% of the business, but there will be five million less in the bank account then there would otherwise be under the original proposal. Ventura are also worried that Mary may be less motivated if she receives a big lump sum payout now before all the big milestones are met. In the next lesson, we will try to add further light to this conversation by calculating the exact ownership structures of each party under our model.