15: Venture Finance III (Compensation)

Tuesday, November 14, 2017
Summary: Barbara Arneson must decide which job offer to take. With all other factors being equal, she is now down to a decision based on the value of the equity compensation offered by each company (i.e., the stock options). One company is a public company with easily gathered data on its financial status. The other company is a start-up which has only financial projections. This session is a great chance to learn about the four essentials of stock options: the length of the vesting period, the strike or exercise price, estimating the market price at some future point, and the number of shares currently outstanding at the enterprise.

Quote of the Day: “Fortune sides with him who dares.” Virgil

Guest: Steph Hannon Greylock

Study Questions (Policy on Study Questions.)
  • Review the basic formulas and info regarding venture finance:
      • Earnings per Share (EPS) = Earnings / Number of Shares Outstanding
      • Share Price = Earnings per Share * PE Ratio
      • Market Capitalization = Share price * Number of Shares Outstanding
      • Note: "Earnings" is often called Net Income or After-Tax Profit
  • What is the number of shares outstanding for the public company BioGene at the time of the case (2014)? What is its current PE ratio? Why do you think it is higher than the current average of other bioinformatics companies? Hint: consider the recent annual growth rates of revenues and profits.
  • What is Barbara's percentage ownership in each firm?
  • Compare the firms in 4 years (i.e., 2018) when the stock options will be fully vested. Assuming Barbara remains employed until that time, which stock option offer is better? Make sure to include the cost of the stock options and state all critical assumptions.
  • In addition to compensation matters, what other factors would you suggest Barbara consider in making her decision?
  • For Autumn 2017, let's try a different approach to the case analysis as a learning experiment. After reading the case and study questions carefully, consider these facts and assumptions. In other words, we are asking you to use the following assumptions in arriving at an estimate of each company's valuation (or market capitalization) in 2018.

    1. There are 23 million shares outstanding in the BioGene. This is derived by dividing their current (a la 2014) earnings of $7.6 million with their current EPS of $.33/share. Also, note the current PE ratio is 49 for BioGene. This is derived by dividing their current price of $16.25 by their current EPS of $.33/share. Therefore, the current market capitalization of BioGene is $374 million.

    What is an estimate of BioGene's market cap in 2018 when her option fully vests? Let's say the earnings grow by 50% per year and the PE drops to 25. That would indicate a market capitalization of $962 million for BioGene in 2018 (= (7.6 million * 1.5 ^ 4) * 25).

    2. For InterWeb, let's assume no more dilution in coming years so the number of shares in 2018 remains at 118.6 million. Using the $6.3 million in earnings in 2018 and a PE of 50, that would estimate a market capitalization of $315 million for InterWeb in 2018 (= $6.3 million * 50).

    Using these two estimates for market capitalization in 2018, please consider the rest of the study questions (i.e., Barbara's percentage ownership and her potential gains in 2018). For you homework submission, indicate which offer you think is better.
Required Readings (Policy on Required Readings.)
  • Case: Barbara's Options ... see Files section of Canvas for a copy (also available in the Appendix of the Technology Ventures textbook, pages 538-541).
  • Please also review Section 12.8 (Recruiting and Retention) in the Technology Ventures textbook.
  • Review the E145 slides regarding venture finance from earlier Sessions 9 and 10.
  • How Stock Options Work from Inc. Magazine
  • Notes on PE Ratios from Investopedia
Recommended Readings
Online Assignment (Policy on Case Analyses.) All students submit.

All other factors being equal, and based on the stock option packages only, I would accept the (BioGene/InterWeb -- choose only one) offer because ...

Note: Please submit a numerical analysis along with your assignment. This is an individual assignment. You are encouraged to discuss the case with your teams, but each student must submit his/her own write up reflecting his/her personal decision.