Venture Capital Interview Question Help?

Could someone please help me better understand this sample interview question as I try to prep for VC interviews?

A company raises $10mm at $50mm pre-money valuation. Terms are 1x participating preferred at 2x cap. This is the only capital raised. Between what range of exit valuations is an investor indifferent?

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Dec 31, 2019 - 11:14pm

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The investor would have 16.67% equity at the time of sale. The investor is indifferent at the exit values where returns at the 2x cap (with 1x preferred) are equal to returns on an as-converted basis to common stock (aka just 16.67% of the exit value).

For the lower bound - the 2x cap is $20M (2x the invesed capital). $10M is covered by the liquidation preference. The other $10M will covered by participation at 16.67% of the remaining equity. Thus the valuation is $10M (contributed to the liquidation preference) + 10/16.67% = $10M + $60M = $70M.

For the upper bound, the exit value is where $20M is 16.67% of that value. $20M/16.67% = $120M.

Thus the range of indifference for the investor is $70M to $120M (max returns will be $20M). Anything below $70M, the preferred/participation has the advantage on returns; anything above $120M, conversion to common stock has the advantage.

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