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Entrepreneurship: Investment Of Venture Capitalist

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Question:

Discuss about the Entrepreneurship for Investment of Venture Capitalist.

 

Answer:

Valuing REACH Health Inc.

Calculating value of Reach with the help of Multiplies method:

Multiple Valuation Method

2009

2010

2011

2012

2013

EBITDA

 (1,180,000)

 437,000

4,674,000

9,025,000

14,143,000

Market value of invested capital

 -  

 6,573,976

70,312,966

135,766,906

212,759,152

 

Particulars

Virtual Radiological

NightHawk Radiology

Sales

             93,280,000.00

               166,752,000.00

EBITDA

             17,576,000.00

                 24,824,000.00

MVIC

           255,014,704.00

               386,698,137.00

MV-to EBITDA

   14.51

 15.58

Average MV-to EBITDA

 15.04

 

 Calculating value of Reach with the help of DCF method:

Enterprise Valuation Based on Free Cash Flows from Operations

0

7-Year Competitive Advantage Period (CAP)

Post-CAP

1

2

3

4

5

6

Revenues

 $           1,678,384

 $           3,704,000

 $           8,917,000

 $         16,850,000

 $         26,102,000

 $            36,214,000

 

Net Operating Profit

 

 $         (1,180,000)

 $               437,000

 $           4,674,000

 $           9,025,000

 $            14,143,000

 

Income Taxes

 

 $               (14,278)

 $                    5,288

 $                 56,555

 $               109,203

 $                  171,130

 

Net Operating Profit After Taxes

 

 $         (1,165,722)

 $               431,712

 $           4,617,445

 $           8,915,798

 $            13,971,870

 

Investments

 

 $               240,000

 $               240,000

 $               240,000

 $               240,000

 $                  240,000

 

Depreciation

 

 $                 60,000

 $                 60,000

 $                 60,000

 $                 60,000

 $                     60,000

 

Change in Working Capital

 

 $               321,000

 $               823,000

 $               819,000

 $           1,314,000

 $               1,255,000

 

Free Cash Flows to the Firm

  

 $         (1,666,722)

 $             (571,288)

 $           3,618,445

 $           7,421,798

 $            12,536,870

 $         13,790,557

Residual or Terminal Value

 

 

 

 

 

 $      50,257,130.72

 

Discounted Annual Free Cash Flows

 

 $         (1,307,848)

 $             (351,757)

 $           1,748,254

 $           2,813,754

 $            18,680,536

 

Present Value of Free Cash Flows to Equity

 $         21,582,938

           

Less:  Marketability Discount

 $     6,474,881.47

Intrinsic Value of Equity

 $         15,108,057

Conducting scenario analysis:

Assumptions Box

5-Year Competitive Advantage Period (CAP)

Post-CAP

Year 1

Year 2

Year 3

Year 4

5

Sales growth rate

100.0%

100.0%

100.0%

30.0%

15.00%

0.0%

Operating Profit Margin

2.0%

2.0%

22.00%

31.0%

37.0%

44.00%

Intrinsic Value of Equity

$7,213,676

         

Assumptions Box

5-Year Competitive Advantage Period (CAP)

Post-CAP

Year 1

Year 2

Year 3

Year 4

5

Sales growth rate

140.0%

140.0%

140.0%

70.0%

55.00%

40.0%

Operating Profit Margin

7.0%

7.0%

27.00%

36.0%

42.0%

49.00%

Intrinsic Value of Equity

$(33,847,790)

         

From the decline in sales growth rate the intrinsic value of equity mainly increases, while the increment in sales growth rate it declines. In addition, the sensitivity analysis indicates that revenue growth rate needs to be adequate for improving the intrinsic value of equity.

 

Exit Strategy: The Sale of Hotmail

Why high growth companies need venture capital and not bank loans:

Rapid growing companies such as Hotmail seek venture capital rather than bank loans, as venture capital does not who's the company to pay annual interest on the investment amount.  However, taking a loan from Bank would eventually increase pressure on Rapid growing business, as the profits will be eroded from the interest payments conducted to the bank. Moreover, using savings fund in the capital venture is highly risk, as rapid growing companies would consume the savings capital fast. Therefore, rapid growing companies relatively use venture capital to support their capital requirements, as they need investor for the organization who believe in the objective and future scope of the company (Kirzner 2015).

Why DFJ was chosen instead of Asian investors by JavaSoft:

Stock Holder

Number of shares

Percentage ownership

Owner 1

                 4,000,000

32%

Owner 2

                 4,000,000

32%

Employees

                 2,490,272

20%

DFJ

                 1,867,704

15%

 Total shares

               12,357,976

100%

 

Stock Holder

Number of shares

Percentage ownership

Owner 1

                 4,000,000

26.7%

Owner 2

                 4,000,000

26.7%

Employees

                 2,490,272

16.6%

Asia

                 4,500,000

30.0%

 Total shares

               14,990,272

100%

From the evaluation of above table, changes in ownership can be identified as the main reason, which motivated the founders of JavaSoft to accept original investments from DFJ, while rejecting the proposal of Asian investor. After the inclusion of venture capital from DFJ, the owners share in the company was at 32%, which was highest in percentage, while after allowing the investment from Asian investors the change in percentage of ownership was not favorable for the JavaSoft founders. This was the main reason behind the selection of DFJ as the venture capital and ignoring the proposal of Asian investors (Dees 2017).

Stating the clause of father’s investment in the company:

The inclusion of the provision for the founder’s father to invest $15,000 in the company is proposed by DFJ on the grounds of trust that fathers have on son’s project. This provision was mainly conducted to increase trust of DFJ on the idea and business of JavaSoft.

Advantages of investing in stages rather than all at once:

The main advantages of funding or a young firm like Hotmail in stages rather than all at one is to identifying the progress that is made by the organization. The funds provided in stages would eventually secure investment of venture capitalist, while increasing the number of ownership portion in organization. Conducting investments all at once is a risky endeavor, which might backfire if the company is not able to achieve targeted goals (Drucker 2014).

Depicting why Microsoft bought Hotmail:

The main reason behind the buying of Hotmail by Microsoft was to counter the move of Yahoo one of the leading competitors in the industry. Yahoo had previously bought 11 Corporation which were the biggest competitor of Hotmail that allowed the organization to acquire the market with additional subscribers (Brenkert 2017). However, Microsoft bought Hotmail the biggest and foremost performer and market leader in this segment to reduce the influence of Yahoo on the market. this move mainly costed Microsoft 395 million and generated 9.5 million subscribers for the organization.

 

References:

Kirzner, I.M., 2015. Competition and entrepreneurship. University of Chicago press.

Dees, J.G., 2017. 1 The Meaning of Social Entrepreneurship. In Case Studies in Social Entrepreneurship and Sustainability(pp. 34-42). Routledge.

Drucker, P., 2014. Innovation and entrepreneurship. Routledge.

Brenkert, G.G., 2017. Entrepreneurship, ethics, and the good society. In Entrepreneurship (pp. 85-128). Routledge.

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