Next Round Preferred Investments

Formulas for valuing options tied to preferred investments become slightly more complex with each subsequent investment round.

What needs to be considered here:

Exit diagrams are naturally built based on the contracts with investors from previous rounds. Moreover, the math becomes even more complicated if we’re dealing with convertible shares across different rounds, since it’s necessary to account for when investors from each round decide to convert…

So, to determine the fair value of a Series C convertible preferred share, I need to know if its conversion timing (Conversion Condition) comes before, between, or after the conversion timings of Series A and B.

Fortunately, there are formulas that allow us to map out the timing of conversion events for various series of preferred shares. Once this sequence is understood, building an exit diagram becomes easier.

P.S.

It’s also possible that an investor might consider two different preferred structures, which should be compared using their respective exit diagrams and calculated options.

Below is a link to an Excel model that considers two versions of the second-round investment:

• Structure 1: Redeemable + Common
• Structure 2: Redeemable + Convertible

The corresponding diagrams have been built, and the proposed investment’s breakeven value has been calculated (I found a more convenient solution for RE Options compared to the model I initially used for Series 1 valuation).

Later Round Calculations – RE Options:

P.S.

http://vcvtools.com/auto.php – This is a specially designed calculator that allows for consistent round valuations for various types of preferences.

One more note: The Excel models only contain Random Expiration Call Options. Some preferred structures also require Binary Options calculations, which I will dive into in the future.

Source:

Venture Capital & the Finance of Innovation – by A. Metrick & A. Yasuda