How to think about this real life VC scenario
Let's say you have a friend who approaches you asking for some money to start his small business (ie: pharmacy store that your friend will be running as the head pharmacist or whatever). You both project revenue to be $1mm per year, with $400k per year in cash flow (after paying for all employees except your friend). The startup cost will be $2mm.
He asks for you to contribute as much as you want, preferably the whole $2mm cost. What terms would you agree to? What stake of the pharmacy would you own, and how much of the $2mm would you pay?
A startup cost of $2 Mn producing a cash flow of 400k a year is only an IRR of 10%. A typical VC's gonna be looking at a firm with a much higher IRR, to compensate for the higher risk of typical venture capital target firms.
So... why would you buy into this deal at all _ >_>
What assumptions are you using to calculate that IRR? At a high discount rate of 10% and growth rate of 3%, the series of cash flows is worth $5.7mm, so if you sell the $2mm stake in year 1 for $5.7mm, that's an IRR of 186% (with zero growth, it's still an IRR of 100%). I set it up so that it's obviously a good investment idea so we could talk about how people would think about when to exit, what ownership terms to agree to, etc.
Well, fuck me. Brain fart while doing my napkin math.
There is nothing really VC about this deal. Any idiot can start a pharmacy. If my friend wanted me to fund this venture, then I would want 100% of it. Then, I could just hire a pharmacist or manager to run it.
But, I will play ball, just for shits and giggles. A pharmacy probably trades at 4-6x revenue. Let's call the value of this firm $5mm. If I was going to fund the entire $2mm, I would want at least 40%. If I were to settle for 40%, I would insist on $2mm pref equity (converting to common at an exit) with an 8% accrued dividend. I would also want some minority protective provisions:
1) his share of the stock would vest over 3-5 years (assuming that he is essential to the organization) 2) pref equity would be granted an unlocking provision in order to force a sale after 3 years 3) put option on my equity after 5 years at 2x preference
I'm with heebbanker...if you have the money to just open a pharmacy, why wouldn't you just do it, have 100% of the equity and just employ the head pharmacist?
I guess if you wanted to help make your friend money, while taking money out of your own pocket...it's a nice thing to do.
My major concern would be how to exit? I don't know much about the pharmacy space, but I would question how likely, or quickly, a sale would/could be.
Regards
Well the main reason would be to give my friend an incentive to work hard and make his pharmacy successful. Also because if I own 100%, I would be 100% responsible for setting up the pharmacist, whereas if I owned 60% and my friend owned 40% he would have enough of an incentive to set up the pharmacy on his own, make it run well, etc.
As for exit, I was thinking some sort of sunset provision where I sell the pharmacy to my friend after 5 years for some multiple.
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