Case 013Early-stage valuationHard

Value Trivenik Biotech's Series A with three scenarios, a 35% discount rate and 40% dilution to exit. What post-money valuation can a Rs 40 crore investor justify?

The situation

Trivenik Biotech is developing a diagnostic test for drug-resistant infections. It is raising a Rs 40 crore Series A. The investor models three futures. Success, with probability 25%: the test is approved and the company sells for Rs 3,000 crore in six years. Sideways, 45%: the test works but adoption is slow, and the company sells for Rs 400 crore in five years. Failure, 30%: the trial fails and the assets sell for Rs 20 crore in three years.

The investor discounts at 35% a year and expects its stake to be diluted by 40% through later rounds before any exit. Ignore liquidation preferences for the main answer.

Your task

What post-money valuation can the investor justify for its Rs 40 crore, which scenario carries the value, and how sensitive is the answer?

Quick check

Before working it: which scenario supplies most of the value?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

The investor can justify a post-money of about Rs 100 crore, buying about 40% for Rs 40 crore. The expected present value of the company at exit is Rs 166 crore, and the investor's diluted stake is 60% of whatever it buys. The success case supplies about 74% of the value, so the price is really a bet on that 25% probability: five points more or less moves it by about Rs 15 crore.

Step 1How do you value a company whose future is three very different stories?

A farmer deciding what to pay for a field before the monsoon thinks in seasons: a good one, an average one, a drought. He weighs each harvest by how likely it is and by how long until it is sold. Scenario valuation does exactly that: value each future at today's rupees, weight it by its probability, and add. Discount each exit by 1.35 raised to its year, because money six years away is worth far less than money three years away.

Success: Rs 3,000 crore over 1.35 to the sixth is Rs 495.6 crore today; times 25% is Rs 123.9 crore. Sideways: Rs 400 crore over 1.35 to the fifth is Rs 89.2 crore; times 45% is Rs 40.1 crore. Failure: Rs 20 crore over 1.35 cubed is Rs 8.13 crore; times 30% is Rs 2.44 crore. The expected present value of the whole company at exit is Rs 166.5 crore, and the success case is 74% of it.

Three futures for Trivenik, each discounted at 35% to today, Rs croreSeries Atoday25%Success: Rs 3,000 crin year 6Today: Rs 496 crx 0.25 = 123.945%Sideways: Rs 400 crin year 5Today: Rs 89 crx 0.45 = 40.130%Failure: Rs 20 crin year 3Today: Rs 8.1 crx 0.30 = 2.4Expected value: Rs 166.5 crore
Discounted at 35% and weighted by probability, the success case contributes Rs 124 crore, the sideways case Rs 40 crore and the failure case Rs 2.4 crore, an expected present value of Rs 166 crore.
Step 2How does that become a post-money for the Series A?

The investor buys a stake today, but later rounds shrink it by 40% before exit, so it receives only 60% of whatever percentage it buys. Its Rs 40 crore must equal its share of the expected value: stake times 0.6 times Rs 166.5 crore. That solves to a stake of 40.0%, which means a post-money of about Rs 100 crore and a pre-money of about Rs 60 crore.

The relationship
Post-money=(1−0.40)×∑ipiExiti1.35ti=0.6×166.5≈99.9\text{Post-money} = (1 - 0.40) \times \sum_i p_i \frac{\text{Exit}_i}{1.35^{t_i}} = 0.6 \times 166.5 \approx 99.9
p_iprobability of each scenario
Exit_isale value in that scenario, Rs crore
t_iyears until that sale
0.40dilution of the investor's stake before exit
What it says in wordsA fair post-money is what today's whole company is worth to an investor who will own 40% less of it by the time it sells.
Step 3How sensitive is the price, and what is the method hiding?

Move the success probability and let failure absorb the change. At 20% the justified post-money is Rs 85 crore; at 30% it is Rs 115 crore. Every five points of success probability is worth about Rs 15 crore of price, so the negotiation is really an argument about one number: the chance the trial works. Diligence money should go to that question, with clinical advisers, not to refining the sideways case.

The price you can pay moves almost one for one with the success odds60901201507115%8520%10025%11530%12935%Base case: 25%Probability of the success caseJustified post-money, Rs crore
Holding the sideways case at 45%, the justified post-money rises from Rs 71 crore at a 15% chance of success to Rs 129 crore at 35%, about Rs 15 crore for every five points of probability.

Two limits deserve a sentence each. First, a 35% rate is a venture hurdle that already allows for failure; using it together with explicit failure probabilities counts the risk twice. At a 20% rate the same scenarios justify about Rs 196 crore, so the 35% answer is conservative. Second, ignoring preferences undervalues the investor's position in the sideways and failure cases, where a 1x preference would pay it ahead of common. Close with the view: Rs 100 crore post is a defensible price only if the investor believes the 25% success probability, and the term sheet should protect the downside with a preference precisely because the value sits in one outcome.

Where candidates lose it

The common loss is forgetting the 40% dilution and pricing as if the investor keeps its stake to exit. That overstates the post-money by two thirds, Rs 166 crore instead of Rs 100 crore.

The second is anchoring on the most likely scenario. The sideways case is the single likeliest future, but it supplies under a quarter of the value; the price rests on the success case.

What the interviewer asks next

  • Give the investor a 1x non-participating preference. How much does that add to the value of its position?
  • The founders argue the success probability is 35%. What post-money does that justify, and how would you test the claim?
  • Why might a healthcare fund use a lower discount rate than 35% for a company with approved revenue?

Company names and figures are illustrative.