I was reading "Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist" by Brad Feld and Jason Mendelson. It's a pretty good book but some parts aren't obvious, like the one below (Chapter4)
A company that has raised $50 million where the investors own 60 percent and the entrepreneurs own 40 percent. Assume the company is being acquired for $100 million.
(My clarification) Assuming a 1x preference levels (for preferred stock), we explore three scenarios for the participation levels (at liquidation) to determine the payoffs of the investors vs entrepreneurs. There are stipulated in the term sheet when the investors first made their investment to the entrepreneur.
Case 1: 1× preference, nonparticipating: Investors get 60 percent, or $60 million, and the entrepreneurs get 40 percent, or $40 million.
Case 2: 1× preference, participating: Investors get the first $50 million, and then 60 percent of the remaining $50 million ($30 million) for a total of $80 million. The entrepreneurs get 40 percent of the remaining $50 million, or $20 million.
Case 3: 1× preference, participating with a 3× cap: Since the investors won't make greater than 3× on this deal, this is the same as Case 1.
Case 1 and Case 2 make perfect sense. But for case 3, shouldn't that highlighted section read as "this is the same as Case 2"? I mean, since the 3x cap ($150 million) isn't hit, participation (in liquidation) should continue, right? Or am I missing something? Or a typo in the book?
Thanks Sid
