Case 009Cap tables and round modellingCore
Follow one seed cheque through the whole venture process: a fund buys 15% of Sopanvik Freight for Rs 3 crore, is diluted by three later rounds, and the company sells in year eight. What is the stake worth at each stage, and what is the IRR?
1The situation
A seed fund invests Rs 3 crore in Sopanvik Freight, a digital freight broker for small truck fleets, for 15% of the company, so the post-money is Rs 20 crore. The fund does not invest again.
In year two a Series A sells 20% of the company to new investors at a Rs 100 crore post-money and tops up the option pool by 5% of the post-money; together, existing holders are diluted by 25%. In year four a Series B sells 18% at a Rs 400 crore post-money. In year six a Series C sells 12% at a Rs 1,000 crore post-money. In year eight the company is sold for Rs 1,800 crore. Assume every share converts to common at the sale, so preferences do not bite.
2Your task
Show the fund's ownership, the paper value of its stake and its money multiple after each round, and the IRR at exit.
Quick check
After three rounds of dilution, roughly what share of Sopanvik does the fund own at the sale?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
The fund ends with 8.12% of Sopanvik, worth about Rs 146 crore at the Rs 1,800 crore sale: 48.7x its Rs 3 crore and an IRR of about 63%. Its ownership falls by nearly half across three rounds, but each round is priced far higher than the last, so the value of the stake rises at every step. Dilution is the price of growth, not a loss in itself.
Step 1Why does a seed fund's stake shrink even though it never sells a share?
Imagine you own a slice of a pizza, and every year the cook adds more dough and invites more people to the table. Your slice is a smaller fraction of the pizza, but the pizza is much bigger. Each new round creates new shares for new investors, so every existing holder owns a smaller fraction, while a higher price per share makes that fraction worth more. The question is always which effect wins.
DilutionThe fall in an existing holder percentage of a company when new shares are issued. The holder keeps all its shares; there are simply more shares in total. multiplies, it does not subtract. The Series A takes 20% and the pool takes 5%, so existing holders keep 75%: the fund goes from 15% to 11.25%. The Series B keeps 82% of that, 9.225%. The Series C keeps 88%, 8.118%. The fund ends with 54% of the stake it started with, about 8.1% of the company.
| Stage | Year | New money, Rs cr | Post-money, Rs cr | Fund owns | Stake value, Rs cr | Multiple |
|---|---|---|---|---|---|---|
| Seed | 0 | 3 | 20 | 15.00% | 3.0 | 1.0x |
| Series A | 2 | 20 | 100 | 11.25% | 11.2 | 3.7x |
| Series B | 4 | 72 | 400 | 9.22% | 36.9 | 12.3x |
| Series C | 6 | 120 | 1,000 | 8.12% | 81.2 | 27.1x |
| Exit | 8 | 1,800 | 8.12% | 146.1 | 48.7x |
Step 2What is the stake worth at each stage?
Mark the stake at each round's post-money. After the Series A it is 11.25% of Rs 100 crore, Rs 11.25 crore, 3.75x. After the B, 9.22% of Rs 400 crore is Rs 36.9 crore, 12.3x. After the C, Rs 81.2 crore, 27.1x. Each of those is a paper value: it is real only if a buyer later pays at least that price, and none of it is cash until the sale.
Step 3What is the return at the sale?
At Rs 1,800 crore the fund's 8.118% is worth Rs 146.1 crore, 48.7 times its money. Over eight years that is an IRR of about 62.5%. A single seed cheque like this can return a small fund on its own, which is exactly why seed funds accept that most of their other companies will fail. A Rs 100 crore seed fund needs only one or two of these to return its capital.
| 0.75, 0.82, 0.88 | the share of its stake the fund keeps at the A, B and C |
| 1,800 | the sale price, Rs crore |
| 3 | the seed cheque, Rs crore |
| 1/8 | eight years from cheque to sale |
Name the limits. This assumes every holder converts to common at the sale. If the Series C had a 1x preference and the sale had been weak, the later money would be paid first. It also assumes the fund did nothing after the seed. Most seed funds reserve money to follow on in the next round, which slows the dilution but puts more money at a higher price, and that trade is the next question an interviewer will ask.
Where candidates lose it
The usual loss is subtracting the round sizes from the stake: 15% minus 20% minus 18% minus 12% goes negative, which tells you the method is wrong. Each round dilutes what is left, so the factors multiply.
The second is forgetting the pool top-up at the Series A. It is not money in, but it dilutes existing holders exactly like new shares, and leaving it out overstates the final stake by about half a point.
What the interviewer asks next
- The fund had reserved Rs 5 crore to take its pro rata in the Series A. What does it own at exit, and what is the multiple on Rs 8 crore?
- The sale price is Rs 600 crore and the Series C holds a 1x preference. What does the seed fund get?
- Why is IRR a poor measure for comparing this investment with one returned in year three?
Asked at Warburg Pincus, Venture Capital, New York, 2013 (Wall Street Oasis): ascertained my understanding of how the VC process works/develops over time
Company names and figures are illustrative.