Comparison of equity financing schemes - Pickwick
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Venture Capital.
Pickwick Electronics is a new high-tech company financed entirely by 1 million ordinary shares, all of which are owned by George Pickwick. The firm needs to raise $1 million now for stage 1 and, assuming all goes well, a further $1 million at the end of 5 years for stage 2.
First Cookham Venture Partners is considering two possible financing schemes:
1. Buying 2 million shares now at their current valuation of $1.
2. Buying 1 million shares at the current valuation and investing a further $1 million at the end of 5 years at whatever the shares are worth.
The outlook for Pickwick is uncertain, but as long as the company can secure the additional finance for stage 2, it will be worth either $2 million or $12 million after completing stage 2. (The company will be valueless if it cannot raise the funds for stage 2).
Show the possible payoffs for Mr. Pickwick and First Cookham and explain why one scheme might be preferred. Assume an interest rate of zero.
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Solution Summary
The 700 word solution examines possible sources of funding and then compares two scenarios.
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Sources of funding can be categorized into three groups (ignoring bank financing):
1. Financing from the '3 Fs' (friends, family and fools)
2. Angel investors (gap investors between the 3 Fs and true venture capitalists)
3. Venture capital funds
Costs involved in each of the above can vary considerably. I expect the problem would like you to figure out what it would cost in the long run in each of Cookham's two options. Then compare the possible outcomes for Pickwick personally and for Cookham.
We can assume that option one has already been used. This transaction is probably one in which an angel investor could be interested because true venture capitalists probably wouldn't bother with only $1-2M. The truth is that the most risk appears to be in projects in which Angel investors would be interested, and the higher risk demands a higher return. The following article suggests 10-20 times the original investment in five years. http://en.wikipedia.org/wiki/Angel_investor
"Because of the strict requirements venture capitalists have for potential ...
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