Term Sheet (2) Step-by-Step Explanation of Exit for Angel, Series A, Series B and Series C Investors

Step-by-Step Explanation of Exit for Angel, Series A, Series B and Series C Investors｜How VCs Split the Money?

In the last issue, we talked about the "priority" and "participation in distribution" of liquidation Preferrence, and in this issue, we will introduce the use of Liquidation Preferrence by using the example of North Warrior Technology.

Guo Jing created a Northern Warrior Technology company.

In the first year, he received an angel round investment of ＄3m dollars from Mongolian and the post-money valuation of the company was $12m. The liquidation preference clause was 1X non-participation.

The following year, in the Series A funding round of Jiangnan Seven Monsters, Guo Jing's North Warrior Technology received $24m (new money), led by GP Ke Zhenxiang. The post-money valuation of the company was $72m ($72m). The liquidation preference clause is 1X non-participation.

In the third year, All True Capital raised a Series B round of investment for North Warrior Technology, led by GP Ma Yu, with a new money of $48m and a post-money valuation of the company was $240m, with a liquidation preference clause of 2x participation in the distribution preference.

In the fourth year, North Warrior Technology got Beggar Capital (how does this sound so twisted, rich beggar, beggar capitalist, beggar investor, beggar fund, beggar VC) of the C round of investment, led by GP Hong Qi Gong, with a new money of $160m,and a post-money valuation of the company was $500m. The liquidation priority clause is 3X participation in the distribution preference.

In the fifth year, North Warrior Technology was sold for $800m.1 billion dollars is the price of a unicorn, and North Warrior Technology is also a basic unicorn exit. The following will start to share the money, this time the liquidation preference will play a role.

1. Assuming no liquidation preference conditions of the exit return analysis

We just said that the liquidation preference is not necessarily used, because it is a "right" not an "obligation". So let's assume that if the company sells for $800m, if all VC shareholders' shares are converted 1:1 into common shares (all preferred stock investors have this right), then their return multiples are 24.2x, 6.0x, 2.3x and 1.6x, respectively, according to their respective equity ratios. As shown in the chart below.

But the actual situation, of course, will not be always the same. When it comes to the exit, the later the investor comes in, the earlier the investor cashes out. So we have to look at the tjhe choice of C round of investors, Beggar Capital.

2. Returens of C round investor, Beggar Capital

C round investor, Beggar Capital, has two options. One is in accordance with the 1: 1 conversion ratio of common stock, and get only 256 million U.S. dollars, that is, 1. 6 times the return on investment, which is lower than his investment requirements of 3 times the liquidation preferrence multiples. Therefore, he will certainly implement the liquidation preferrence rights, so that he can first take away: 1.6 X 3 = 480 million dollars. The remaining 320 million dollars, the C round investor, Beggar Capital can also participate in proportional distribution after converted into common shareholder, together with all other shareholders (Participating). But before this, the Series B round investor, All True Capital and Series A round investor, Jiangnan Seven Monster, are still preferred shareholders, so C round investor, Beggar Capital, has to wait for them to decide whether to exercise their respective liquidation preferrence rights. Therefore, the return multiple of Series C investor, Beggar Capital, is 3.0 times for the time being. As shown in the chart below.

3. The return of Series B investor, All True Capital

After C round investor, Beggar Capital, implement the liquidation preferrence right, the B round investor, All True Capital, in accordance with the 1: 1 conversion ratio of common stock, can only get 0.9 times the return according to the proportion of equity distribution of the remaining money, which is lower than his investment requirements of two times the liquidation preferrence multiples. Therefore, B round investor, All True Capital will also execute the liquidation preferrence right. Therefore, All True Capital can take the first 4800x2=96 million dollars, and All True Capital has to distribute the remaining $224 m with all other shareholders in proportion to their equity. But here, he also has to wait for the A round investor, Jiangnan Seven Monsters, to decide whether to execute the priority liquidation rights. Therefore, the return multiple for Series B investors is 2.0 times for the time being. As shown in the chart below.

4. The return of Series A investor, Jiangnan Seven Monster

At this time, we can see that the Series A investor, Jiangnan Seven Monsters' direct 1:1 conversion to common stock return is 1.7 times, which is higher than his requirement of liquidation preferrence, that is 1 times. Therefore, he will certainly not execute the liquidation preferrence rights. Jiangnan Seven Monsters will choose to allocate the remaining money with other remaining shareholders in proportion to their shares according to the proportion of shares that can be converted to common stocks.

Similarly, the angel round investor, Mongolian's stocks, are also converted to common stock in accordance with1: 1 ratio.

In other words, after the Series B and C investors have taken the preferred liquidation money, all shareholders are allocated the remaining224 million dollars in proportion to the shares convertible into common stock. This is shown below.

In the end, the return multiplier of the C round investor, Beggar Capital is 3.4 times, B round investor, All True Capital, 2.6 times, A round investor, Jiangnan Seven Monsters, 1.7 times, angel round investor, Mongolian, 6.8 times, and the entrepreneurs finally get about 0.6 billion dollars. Speaking of which, some people may feel that it looks best to be an angel investor, to get 6.8 times, but you have to think about the earlier the investors come in, the risk is the greater. The Mongolian invests in Guo Jing when Guo Jing is still a child, with a lot of uncertainty, it is likely that the investment will be completely wasted. And after Hong Qi Gong invests in Guo Jing, Guo Jing start to come up,and it is most likely that Guo Jing will achieve success in the end, just a difference between earning more and earning less.

Of course, the above case creation is a very ideal state, simplifying a lot of things, such as dividends and options. From the above analysis, we can see that evena fairly successful project, which the transaction amount reached 800 million U.S. dollars, the founder can only get about 0.6 billion U.S. dollars, or even less than 10%, which is the role of the liquidation preferrence of investors in the later rounds.

So the next time you get the Term Sheet of the investor, do not be silly again and will only look at an investment amount. Please pay attention to see the Liquidation Preference and see whether you have Participation Preferrence Right or not.