FINANCIAL RESTRUCTURING, LBOs AND VENTURE CAPITAL

Final exam – MSc in Finance London 7 – May 2014

Christophe Bonnet

INSTRUCTIONS:
Two hours exam
No documents, no PC allowed
Personal calculator (with power function) required
Please hand back subject with copies
Provide your workings and comment your findings
Exam graded on 30 marks

Question 1 (12 marks): Course questions

Maximum 10 lines per question
a) “The LBO is an acquisition technique that can be applied to any kind of company”. Do you agree?
Justify your answer.
(4 marks)
b) What are the main advantages and disadvantages of going public?
(4 marks)
c) What is the underwriting spread? Explain why the underwriting spreads tend to be higher for IPOS
than for seasoned equity offerings.
(4 marks)

Question 2 (3 marks)
Suppose venture capital firm CBC partners raised $100 million of committed capital. The fund will last 10 years
and 2% per year of the committed capital will be used to pay CBC’s management fee. As is typical in the
venture capital industry, CBC will only invest $80 million (committed capital less lifetime management fees).
Assume that at the end of 10 years, the investments made by the fund are worth $360 million. CBC also
charges 20% carried interest on the profits of the fund (net of management fees).
Required:
a) Assuming the $80 million in invested capital is invested immediately (year zero) and all proceeds were
received at the end of 10 years, what is the gross IRR of the investments CBC partners made? That is,
compute IRR ignoring all management fees and carried interest.
b) Of course, as an investor, or limited partner, you are more interested in your own IRR, that is the net
IRR including all fees paid. Assuming that investors gave CBC partners the full $100 million in year zero
(as if all management fees were paid up front) and all the proceeds were received (net of carried
interest) at the end of year 10, what is the IRR for CBC’s limited partners (that is, the IRR net of all fees
paid). Comment.

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Question 3 (3 marks)
Four years ago, you founded your own company. You invested $80,000 of your money and received 4 million
shares of common stock. Since then, your company has been through three additional rounds of financing with
external investors (see table below).

Round Price per share ($) Number of new shares issued

1 0.50 800,000
2 2.00 600,000
3 5.00 400,000

Required:
a) What is the pre-money valuation for funding round 3?
b) What is the post-money valuation for funding round 3?
c) What percentage of the firm do you own after the third funding round?
d) Assuming the company is sold two years after the third funding round for a total value (equity) of
$23.2 million, calculate the cash multiples for you and for the investors in round 3. Comment.

Question 4 (3 marks)
In 2012 Martha Mydear founded Realtec S.A. She is currently negotiating a € 1 million first round of financing
with the venture capital sponsors Sicafin Partners. The present share capital of Realtec is composed of 37,000
ordinary shares of 1 € par value, entirely owned by Martha and two friends (“the founders”). The founders
wish to keep a majority shareholding after the first round.
Sicafin Partenaires have indicated they will base their valuation on the following assumptions:
- First round to take place end 2013 (no other following round nor dividend distribution assumed until
exit)
- Annual IRR required on equity investment: 35 %
- Exit end 2017 on the basis of a P/E ratio of 21
1/3
- Corporate tax rate 33 %
- The pre-tax income for 2017 is forecasted at 1.80 million € in the business plan. However, Sicafin think
that the projections incorporated in the plan are far too optimistic and estimate that the 2017 pre-tax
income will probably not exceed 1.2 million €.
Required:
a) What is the maximum post-money value that Sicafin Partners may accept?
b) Assuming the deal takes place on this basis, indicate (1) the price per share of the new shares issued
at the financing round, (2) the resulting respective shareholdings of the founders and Sicafin.

Question 5 (4 marks)
You are considering making the leveraged acquisition of Pyramid, Inc. and you want to estimate its value by
the debt capacity method. The company is mature and has no financial debt nor cash. You forecast a constant
annual free cash flow of $ 450,000 per year and an EBITDA of $ 600,000 per year. To finance the acquisition,
you will raise a 5 years senior debt paying a 6 % interest. The debt will be repaid in five yearly instalments,
from the end of year one to the end of year five. The income tax rate is 40%. You will provide the equity part of
the financing and you require an 18 % return on your investment.
Required:
a) What is the maximum debt capacity of the company?

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 b) Assuming the bank asks for a minimum “Free cash flow / debt service ratio” of 1.14, indicate the
actual debt capacity of Pyramid and the maximum price you can offer for acquiring the company.
Assume you intend to sell the company at the end of year five for an EBITDA multiple of 6.5 (N.B.:
note that the debt will have been fully repaid at the end of year 5, just before the exit, but the
company may have cash at hand because of the 1.14 covenant ratio) .

Question 6 (5 marks)
In 2012, United Paper Inc. made a rights issue. Each shareholder was attributed one right for each share
owned. Five rights were necessary to subscribe to two new shares, which means that two new shares were
issued for five existing shares. The issue price of the new shares was $14 per share. Before the issue there
were 15 million shares outstanding and the share price on the market was $20.
Required:
a) What was the total amount of new money raised?
b) What was the prospective stock price after the issue?
c) What was the value of one right?
d) Compare the change in wealth induced by the issue for a shareholder owning five shares, in two
cases: (1) he/she decides to subscribe to the issue (2) he/she decides not to subscribe. Comment.
e) Calculate the cost per share for a new shareholder willing to subscribe to two new shares. Comment.

APPENDIX

Annuity formula (PV of a constant cash flow to be received during n years, with discount rate r):

1 1 
PV = CF1 ×  − n
 r r (1 + r ) 

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