Chapter
14
The Deal: Valuation,
Structure, and
Negotiation
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duplicated, forwarded, distributed, or posted on a website, in whole or part. 14-1
Valuation Methods
• The Venture Capital Method
• Appropriate for investments in a company with negative
cash flow at the time of the investment, but which in a
number of years is projected to generate significant
earnings
• The Fundamental Method
• Simply the present value of the future earnings stream
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Valuation Methods
• The First Chicago Method
• Employs a lower discount rate, but applies it to an expected
cash flow
• Discounted Cash Flow
• Three time periods are defined (1) Years 1-5, (2) Years 6-
10, (3) Year 11 to infinity
• Operating assumptions include initial sales, growth rates,
EBIAT/sales, and (net fixed assets + operating working
capital)/sales; also note relationships and trade-offs
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What is a Deal in
Entrepreneurial Finance?
Deals—economic agreements between at least two parties
that involves the allocation of cash flow streams (with
respect to both amount and timing), the allocation of risk,
and hence the allocation of value between different groups
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Deal Characteristics
Characteristics of successful deals
• They are simple
• They are robust
• They are organic
• They take into account the incentives of each party to the
deal under a variety of circumstances
• They provide mechanisms for communications and
interpretation
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Deal Characteristics
Characteristics of successful deals
• They are based primarily on trust rather than on legalese
• They are not patently unfair
• They do not make it too difficult to raise additional capital
• They match the needs of the user of capital with the needs of
the supplier
• They reveal information about each party
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Deal Characteristics
Characteristics of successful deals
• They allow for the arrival of new information before
financing is required
• They do not preserve discontinuities
• They consider the fact that it takes time to raise money
• They improve the chances of success for the venture
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Beyond “Just the Money”
Critical aspects of the deal
• Number, type, and mix of stocks and various features that
may go with them that affect the investor’s rate of return
• The amounts and timing of takedowns, conversions, and
the like
• Interest rate in debt or preferred shares
• The number of seats, and who actually will represent
investors, on the board of directors
• Possible changes in the management team and in the
composition of the board of directors
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Beyond “Just the Money”
Critical aspects of the deal
• Registration rights for investor’s stock
• Right of first refusal granted to the investor on subsequent
private or initial public stock offerings
• Stock vesting schedule and agreements
• The payment of legal, accounting, consulting, or other fees
connected with putting the deal together
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Burdensome Issues for
Entrepreneurs
• Co-sale provisions
• Ratchet anti-dilution protection
• Washout financing
• Forced buyout
• Demand registration rights
• Piggyback registration rights
• Key-person insurance
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