A potential investor is seeking to invest $500,000 in a venture, which currently has 1,000,000 million shares held by its founders, and is targeting a 50% return five years from now.The venture is expected to produce half a million dollars in income per year at year 5.It is known that a similar venture recently produced $1,000,000 in income and sold shares to the public for $10,000,000.
-What is the percent ownership of our venture that must be sold in order to provide the venture investor's target return?

Question

Quizplus · Accepted Answer

First, we calculate the expected valuation of the venture 5 years from now, using the income and target return:

Valuation at year 5 = Income at year 5 / Target return rate
Valuation at year 5 = $500,000 / 50% = $1,000,000

Next, we use the similar venture as a benchmark to calculate the pre-money valuation of our venture:

Pre-money valuation = (Income at year 5 / Valuation of similar venture at year 5) x Valuation of similar venture at funding
Pre-money valuation = ($500,000 / $1,000,000) x $10,000,000
Pre-money valuation = $5,000,000

The total post-money valuation of the venture after the investment would be $5,500,000 ($5,000,000 pre-money valuation + $500,000 investment).

Finally, we can calculate the percent ownership of the venture that must be sold to the investor:

Percent ownership sold = Investment amount / Post-money valuation x 100%
Percent ownership sold = $500,000 / $5,500,000 x 100%
Percent ownership sold = 9.09% (rounded to two decimal places)

Therefore, the investor must buy 9.09% ownership of the venture to achieve the target return. However, since the investor is seeking to buy $500,000 worth of ownership, we must calculate the number of shares that amount can purchase:

Number of shares purchased = Investment amount / Price per share
Number of shares purchased = $500,000 / ($5,000,000 / 1,000,000 shares)
Number of shares purchased = 100,000 shares

So, the investor must buy 100,000 shares of the venture, which is 7.94% of the total shares (100,000 / 1,000,000). This means that the investor must purchase an additional 68.06% ownership (50% target return - 7.94% initial ownership) to reach the target return. Therefore, the total percent ownership sold to the investor is:

Percent ownership sold = 100% - Initial ownership - Additional ownership needed
Percent ownership sold = 100% - 7.94% - 68.06%
Percent ownership sold = 24% (rounded to two decimal places)

Therefore, choice B is the correct answer, as it is the closest option to 24%.

A Potential Investor Is Seeking to Invest $500,000 in a Venture