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Table 13.

Panel (a)

Entrepreneur's Assumptions - Financial Model Based on Business Plan

Harvest Value Forecast


Success with Both Groups
Success with First Group
Failure

Conditional

Scenario

Round

Round

Cash Flows

Probabilities

One

Two

$35,000,000
$15,000,000
$0

40%
25%
35%

Expected Cash Flow at Harvest


Standard Deviation of Cash Flows
Investment
Burn Rate per Year
Years
Total Investment
Present Value of Unconditional Total Investment
Present Value of Expected Investment

$14,000,000
$3,750,000
$0

$21,538,462
$5,769,231

$17,750,000
$15,204,851

$27,307,692
$9,730,085

$2,000,000
1

$3,000,000
0.5

$3,500,000
$3,442,308
$2,937,500

Panel (b)

Investor's Assumptions - Financial Model Based on Business Plan

Harvest Value Forecast


Success with Both Groups
Success with First Group
Failure

Conditional

Scenario

Round

Round

Cash Flows

Probabilities

One

Two

$28,000,000
$13,500,000
$0

Expected Cash Flow at Harvest


Standard Deviation of Cash Flows
Investment
Burn Rate per Year
Years
Total Investment
Present Value of Unconditional Total Investment
Present Value of Expected Investment

$4,750,000
$4,630,391
$3,487,803

32%
20%
48%

$8,960,000
$2,700,000
$0

$17,230,769
$5,192,308

$11,660,000
$12,303,430

$22,423,077
$7,054,312

$1,800,000
1.25

$2,500,000
1

Panel (a)

Venture Capital Method (Single Round Financing)


Entrepreneur's Assumptions
3
$35,000,000
18.00%

$21,302,081

$3,442,308
16.16%

Number of years until your projected harvest date


Harvest-date value of the venture assuming success
annual hurdle rate Customary discount rates for Seed to Start-up ventures
are 50-100% per year. Discount rates are lower for more established
ventures, declining gradually to tares of 20-30% for expansion-stage
financing. The discount rate for turnaround financing is comparable to that
of a start-up.

Post-money valuation of the venture

Amount of financing required


Fraction of harvest-date equity needed to justify the financing.

Panel (b)

Venture Capital Method (Single Round Financing)


Investor's Assumptions
4
$28,000,000
40.00%

Number of years until your projected harvest date


Harvest-date value of the venture assuming success
annual hurdle rate Customary discount rates for Seed to Start-up ventures
are 50-100% per year. Discount rates are lower for more established
ventures, declining gradually to tares of 20-30% for expansion-stage
financing. The discount rate for turnaround financing is comparable to that
of a start-up.

$7,288,630

Post-money valuation of the venture

$4,360,391

Amount of financing required

59.82%

Fraction of harvest-date equity needed to justify the financing.

Table 13.4

Figure 13.1

Staged Investment Decision Model

Success

Success with
Both Groups

Failure

Success with One


Group

Fund Stage 2:
Aircraft Owners

Fund Stage 1:
Avionics OEM
Failure

Success

Abandon

Failure

Round 2

Exit

Financing:
Round 1

Table 13.5

Valuation of Unstaged Investment - Venture Capital Investor


Entrepreneur's
Assumptions

Investor's
Assumptions

1. Market and Contract Data


Annual Risk-free Rate
Annual Market Rate
Standard Deviation of Market
General Partner's Annual Fee
General Partner's Carried Interest
Correlation of Venture with Market

4.0%
10.0%
20.0%
2.5%
20.0%
0.25

4.0%
10.0%
20.0%
2.5%
20.0%
0.25

$3,442,308
3.00

$4,630,391
4.00

$17,750,000
$15,204,851
$10,257,406

$11,660,000
$12,303,430
$5,843,845

20.06%

18.85%

2. Single-Stage Investment and Timing


Total Investment Committed
Years to Harvest
3. Investor Valuation of Harvest Cash Flows
Expected Harvest Value
Standard Deviation of Harvest Cash Flows
Value of Venture at Time of Investment
4. Investor's Required Rate of Return
Annualized VC Cost of Capital

Investor Ownership Requirement


5. Ownership Requirement
Round 1 Investment
Value at Round 1
Share of Incremental Value Required

$3,442,308
$10,257,406
33.56%

$4,630,391
$5,843,845
79.24%

Valuation of Entrepreneur's Interest in Venture


6. Entrepreneur's Wealth
Entrepreneur's Wealth in Market
7. Valuation of Harvest Cash Flows
Venture (Entrepreneur's Financial Claim)
Expected Harvest Value
Standard Deviation of Venture Cash Flows
Market
Expected Harvest Value
Standard Deviation of Market Cash Flows
Portfolio
Expected Portfolio Value
Standard Deviation of Portfolio Cash Flows
Value of Entrepreneur's Portfolio
Value to Investment in Market
Value of Entrepreneur's Interest in Venture
8. Entrepreneur's Required Rate of Return
Annualized Portfolio Cost of Capital
Annualized Venture Cost of Capital

$1,700,000

$1,600,000

$11,793,235
$10,102,219

$2,421,159
$2,554,765

$2,262,700
$588,897

$2,342,560
$640,000

$14,055,935
$10,265,291
$7,065,242
$1,700,000
$5,365,242

$4,763,719
$2,784,591
$2,321,104
$1,600,000
$721,104

25.77%
30.02%

19.69%
35.36%

Table 13.6

Valuation of Staged Investment - Venture Capital Investor


Entrepreneur's
Assumptions

Investor's
Assumptions

4.0%
10.0%
20.0%
2.5%
20.0%
0.25
3.00

4.0%
10.0%
20.0%
2.5%
20.0%
0.25
4.00

Round 1 - Aircraft OEM


Burn Rate per Year
Years to Complete

$2,000,000
1.00

$1,800,000
1.25

Round 2 - Aircraft Owners


Probability of Stage 1 Success
Burn Rate per Year
Years to Complete

65%
$3,000,000
0.50

52%
$2,500,000
1.00

Round 2
Expected Harvest Value
Standard Deviation of Harvest Cash Flows
Value to Investor at Time of Investment

$27,307,692
$9,730,085
$18,481,990

$22,423,077
$7,054,312
$14,421,393

Round 1
Expected Harvest Value
Standard Deviation of Harvest Cash Flows
Value of Round 1 at Time of Investment

$17,750,000
$15,204,851
$10,257,406

$11,660,000
$12,303,430
$5,843,845

20.06%
21.55%

18.85%
17.41%

1. Market and Contract Data


Annual Risk-free Rate
Annual Market Rate
Standard Deviation of Market
General Partner's Annual Fee
General Partner's Carried Interest
Correlation of Venture with Market
Time from first investment to harvest (years)

2. Staged Investment Timing and Burn Rates

3. Valuation of Harvest Cash Flows

4. Investor's Implicit Cost of Capital at Each Round


Round 1
Round 2

Table 13.7

Valuation-based Contracting Model of Ownership Shares


Ownership Requirement
Entrepreneur's
Assumptions

Investor's
Assumptions

Investor's Round 2 Investment


Venture Value at Round 2
Incremental Equity Required
Investor's Value from Round 1
Investor's Value Required With Investing
Investor's Required Ownership after Investing

$1,500,000
$18,481,990
8.12%
$3,603,638
$5,103,638
27.61%

$2,500,000
$14,421,393
17.34%
$5,552,531
$8,052,531
55.84%

Investor's Round 1 Investment


Venture Value at Round 1
Investor's Required Ownership after Investing

$2,000,000
$10,257,406
19.50%

$2,250,000
$5,843,845
38.50%

Required Percentage Increases in Investor's Shares if New Shares are Issued


Round 2 - New Shares to Investor (percent of shares owned)

57.50%

101.95%

Table 13.8

Risk and Return of Entrepreneur's Financial Claim


Based on Entrepreneur's Projections
Ownership by Round
Round 2
Round 1

Investor Share Entrep. Share


27.61%
72.39%
19.50%
80.50%

Harvest Value Forecast


Success with OEMs
Success with Both Groups
Failure

Venture
Conditional
Cash Flows
$35,000,000
$15,000,000
$0

Scenario
Probabilities
40%
25%
35%

Entrepreneur's
Conditional
Cash Flows
$25,335,059
$10,857,883
$0

Expected Cash Flow of Entrepreneur's Claim


Standard Deviation of Entrepreneur's Claim

Probability
Weighted
Cash Flows
$10,134,024
$2,714,471
$0
$12,848,494
$11,006,166

Based on Investor's Projections


Ownership by Round
Round 2
Round 1

Investor Share Entrep. Share


55.84%
44.16%
38.50%
61.50%

Harvest Value Forecast


Success with OEMs
Success with Both Groups
Failure

Conditional
Cash Flows
$28,000,000
$13,500,000
$0

Expected Cash Flow of Entrepreneur's Claim


Standard Deviation of Entrepreneur's Claim

Scenario
Probabilities
32%
20%
48%

Entrepreneur's
Conditional
Cash Flows
$12,365,527
$5,961,951
$0

Probability
Weighted
Cash Flows
$3,956,969
$1,192,390
$0
$5,149,359
$5,433,515

Table 13.9

Valuation of Entrepreneur's Interest in Venture


Market Data and Entrepreneur's Wealth

Entrepreneur's
Assumptions

Investor's
Assumptions

Annual Risk-free Rate


Annual Market Rate
Standard Deviation of Market
Correlation of Venture with Market
Time from first investment to harvest (years)
Entrepreneur's Wealth in Market

4.0%
10.0%
20.0%
0.25
3.00
$1,700,000

4.0%
10.0%
20.0%
0.25
4.00
$1,600,000

Round 1 - Aircraft OEM


Years to Complete

1.00

1.25

Round 2 - Aircraft Owners


Years to Complete

0.50

1.00

$12,848,494
$11,006,166

$5,149,359
$5,433,515

$2,262,700
$588,897

$2,342,560
$640,000

$15,111,194
$11,167,956
$7,525,846
$1,700,000
$5,825,846

$7,491,919
$5,627,735
$2,865,420
$1,600,000
$1,265,420

Timing of Staged Investments

Valuation of Harvest Cash Flows


Venture (Entrepreneur's Financial Claim)
Expected Harvest Value
Standard Deviation of Venture Cash Flows
Market
Expected Harvest Value
Standard Deviation of Market Cash Flows
Portfolio
Expected Portfolio Value
Standard Deviation of Portfolio Cash Flows
Value of Entrepreneur's Portfolio
Value to Investment in Market
Value of Entrepreneur's Interest in Venture