Venture Capital puzzles, solved step by step
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009A company has two preferred series. Series A invested Rs 20 crore for 20% of the shares and Series B invested Rs 60 crore for another 20%. Both are 1x non-participating and rank pari passu; common holds the other 60%. The company sells for Rs 200 crore. Which series converts, and what does each class receive?Series A to C VCMulti-stage VC
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What does Series A receive?
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Series B takes its Rs 60 crore preference and Series A converts. Converting would give Series B at most Rs 45 crore, so it takes its money back. That leaves Rs 140 crore for Series A and common, who hold 20% and 60% of the shares; Series A's quarter is Rs 35 crore, beating its Rs 20 crore preference. Common receives Rs 105 crore.
How does a non-participating holder decide?
Think of a refund policy: you can take your money back, or keep the product and its resale value, but not both. A non-participating preferred holder takes the larger of its preference or what its shares are worth as common, never both. Two series holding the same 20% each face very different choices here, because Series B paid Rs 60 crore for its 20% and Series A paid Rs 20 crore. Series B's refund is worth three times as much, while their shares are worth the same.
Why does Series B not convert, whatever Series A does?
Test its best case. If Series A takes its preference, Series B converting would share Rs 180 crore with common, 20 parts of 80, which is Rs 45 crore. If Series A also converts, Series B would get 20% of Rs 200 crore, Rs 40 crore. Both are below Rs 60 crore, so Series B takes its preference however Series A behaves. That settles the order: take B's Rs 60 crore off the top first, then decide A.
At a Rs 200 crore sale, Series B takes its Rs 60 crore preference because converting would pay it at most Rs 45 crore, and Series A converts into a quarter of the remaining Rs 140 crore, Rs 35 crore, leaving common Rs 105 crore. Where are the break points if the sale price moves?
Series A converts once a quarter of what is left after Series B exceeds Rs 20 crore, which is any sale above Rs 140 crore. Series B converts only once 20% of the whole sale exceeds Rs 60 crore, above Rs 300 crore. Between Rs 140 crore and Rs 300 crore, the two series that own the same stake are treated differently, and Rs 200 crore sits inside that band. Below Rs 80 crore, pari passu means the two preferences share the proceeds in proportion to Rs 20 crore and Rs 60 crore, one part to three.
Sale value, Rs crore Series A Series B Common Below 80 A quarter of the sale Three quarters Nothing 80 to 140 Rs 20 crore preference Rs 60 crore preference The rest 140 to 300 (incl. 200) Converts: 25% of sale less 60 Rs 60 crore preference 75% of sale less 60 Above 300 Converts: 20% Converts: 20% 60% Who takes what across the range of sale values, with both series 1x non-participating and pari passu. Where candidates lose it
The common answer is that everyone converts and each series gets Rs 40 crore. It ignores that Series B paid three times as much per share and would be giving up Rs 20 crore by converting.
The other loss is letting Series A take its Rs 20 crore preference out of habit. Once B is paid, A's shares are worth Rs 35 crore as common; check each series separately, starting with the one whose choice does not depend on the other.
What the interviewer asks next
- At what sale value does Series B start to convert?
- If Series B were 1x participating, what would each class receive at Rs 200 crore?
- If the series were stacked, with Series B senior, what changes below Rs 80 crore?
049Investors hold 40% of a company and Rs 150 crore of 1x non-participating preferences. The founders hold 50% and employees 10%. The company sells for Rs 160 crore. What do the founders receive?Series A to C VCIndia VC
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How much of the Rs 160 crore do the founders take home?
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About Rs 8.33 crore, roughly 5% of the sale, although they own half the company. The investors compare their Rs 150 crore preference with 40% of Rs 160 crore, Rs 64 crore, and take the preference. That leaves Rs 10 crore for common shareholders. Founders hold 50 of the 60 points of common, so they get five sixths of Rs 10 crore, and employees get Rs 1.67 crore.
Why do founders who own half the company get so little?
If you own half a house with a large loan against it and sell it for slightly more than the loan, the bank is paid first and your half of the small remainder is all you get. A liquidation preference works like that loan: investors are paid their Rs 150 crore before common shareholders see anything, so in a sale close to the preference, ownership percentages barely matter. This is the preference overhangThe total of liquidation preferences ahead of common shareholders. Until a sale exceeds it by a wide margin, common holders receive little, whatever their ownership. founders worry about after raising a lot of money at high valuations.
Investors take their Rs 150 crore preference from the Rs 160 crore sale because converting would give them only Rs 64 crore, so the founders, who own half the company, receive Rs 8.33 crore, about 5% of the price. The relationship150 the investors' 1x preference, in Rs crore 0.40 x 160 what investors would get by converting to common, Rs 64 crore 50 / (50 + 10) the founders' share of the common stock alone What it says in wordsInvestors take the better of their preference and their converted share; whatever is left is split among the common holders only.At what sale price does ownership start to matter again?
Investors convert when 40% of the sale beats Rs 150 crore, which happens above Rs 375 crore. Between Rs 150 crore and Rs 375 crore every extra rupee goes to common, so founders get five sixths of each rupee; above Rs 375 crore everyone shares by ownership and founders get half. At exactly Rs 375 crore the two rules give the same answer: founders take five sixths of Rs 225 crore, Rs 187.5 crore, which is half the sale. That is the price at which the founders' 50% stake finally means 50% of the money.
What does this mean for an investor sitting on the board?
A founder team facing Rs 8 crore from a Rs 160 crore sale has little reason to work for it, and a board that needs the founders to close the deal has a problem. That is why sales near the preference overhang often include a management carve-out, a slice of proceeds set aside for the team ahead of or alongside the preferences. The limits of the clean answer: real stacks have several series with different seniority, and any carve-out, transaction costs or debt come off the top first, which leaves common with even less.
Where candidates lose it
The common loss is answering Rs 80 crore, half the sale, as if preferences did not exist, or forcing the investors to convert. Non-participating investors choose the better of the two, and here the preference wins by a wide margin.
The second loss is splitting the Rs 10 crore by whole-company stakes, giving founders Rs 5 crore. After the investors take their preference, only common shares are left, and founders hold five sixths of those.
What the interviewer asks next
- What would the founders receive if the preferences were participating?
- How large a management carve-out would give the founders Rs 25 crore at this price?
- At what sale price do the founders receive exactly Rs 50 crore?
083An investor puts in Rs 20 crore for 20% of a company, with a 1x participating preference capped at a total return of 3x. Map the investor's payout for exits from Rs 0 to Rs 400 crore. Where does the cap bite, and where does converting to common take over?Series A to C VCGrowth equity
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Between which exit values does the investor's payout stay flat?
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The cap bites at an exit of Rs 220 crore and converting takes over above Rs 300 crore; in between, the investor's payout is stuck at Rs 60 crore. Below Rs 20 crore the investor takes everything. Above it, the investor takes Rs 20 crore plus 20% of the rest until the total reaches 3x, Rs 60 crore. Only when 20% of the whole exit exceeds Rs 60 crore does converting pay more.
What does a capped participating preference mean in plain words?
Picture a relative who lends to your shop on the terms: my money back first, then a fifth of whatever is left, but I will never take more than three times what I put in; if a fifth of the whole shop is ever worth more, I will take that instead. The investor first takes back Rs 20 crore, then shares 20% of the remainder, until the total reaches the cap of 3x, Rs 60 crore. Above the cap, the investor can give up the preference and convert to plain common shares. Here the cap covers the total return, preference included, which is the usual reading; say so before you calculate.
The investor takes the whole exit up to Rs 20 crore, then Rs 20 crore plus 20% of the rest until the total reaches the Rs 60 crore cap at a Rs 220 crore exit, stays at Rs 60 crore until Rs 300 crore, and then converts to take 20% of the exit, Rs 80 crore at Rs 400 crore. Where exactly do the two kinks sit?
Set each piece equal to the cap. Participation reaches Rs 60 crore when 20 plus 20% of the exit less 20 equals 60, which is an exit of Rs 220 crore; converting beats Rs 60 crore when 20% of the exit exceeds it, above Rs 300 crore. At a Rs 100 crore exit the investor receives Rs 36 crore against Rs 20 crore as plain common; at Rs 400 crore it receives Rs 80 crore, exactly its 20%.
The relationshipV exit value, Rs crore 20 the 1x preference 0.2 the investor's as-converted share 60 the 3x cap on total return What it says in wordsThe first kink is where participation hits the cap; the second is where plain ownership overtakes it.Why does the flat band matter at the negotiating table?
Inside the band the investor gains nothing from a better price, while every extra rupee goes to the common holders. Between Rs 220 crore and Rs 300 crore the investor is indifferent to the price, so a quick, certain sale at the bottom of the band can suit it more than a long push for the top. A founder who knows where the band sits knows when interests diverge, and can plan the board conversation before a buyer appears.
Where candidates lose it
The common error is to find only one kink: candidates say the investor converts above Rs 300 crore and draw a smooth line up to it, missing that the cap already binds at Rs 220 crore. The flat zone is the answer to the question as asked.
The second is applying the cap to the participation alone, as if the investor could take Rs 20 crore plus another Rs 60 crore. Ask which convention the term sheet uses; the usual one caps the total.
What the interviewer asks next
- With a 2x cap instead, where do the two kinks sit?
- What does a 1x non-participating preference pay at a Rs 100 crore exit?
- Why might a founder accept a cap rather than fight participation outright?
095An investor paid Rs 100 a share for 10 lakh preferred shares. The company has 1 crore shares fully diluted. It now raises a down round, issuing 20 lakh new shares at Rs 40. How many shares does the investor convert into under full ratchet anti-dilution, and under broad-based weighted average anti-dilution?Series A to C VCMulti-stage VC
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Under broad-based weighted average, what is the investor's new conversion price?
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25 lakh shares under full ratchet and about 11.1 lakh under broad-based weighted average. Full ratchet resets the conversion price to the new Rs 40, so the Rs 10 crore converts into 10 crore / 40 = 25 lakh shares. Weighted average resets it to 100 x (100 + 8) / (100 + 20) = Rs 90, so the investor gets 10 crore / 90 = 11.1 lakh. Either way, the extra shares dilute the other holders.
What does anti-dilution protection actually change?
A shop that promises to refund the difference if the price drops within a month is protecting its customer against a later, cheaper sale. Anti-dilution keeps the investor's rupees the same and lowers the price at which they convert into common shares, so the investor ends up with more shares. The investor put in Rs 10 crore at Rs 100. If the conversion price falls to P, it converts into 10 crore / P shares. The whole question is how far P falls, and the two formulas answer differently.
After a down round at Rs 40, the investor keeps 10 lakh shares with no protection, gets 11.1 lakh under broad-based weighted average at a Rs 90 conversion price and 25 lakh under full ratchet at Rs 40, and the other holders' share falls from 75.0% to 66.7% in the full ratchet case. How does each formula set the new price?
Full ratchet is blunt: the conversion price becomes the new round's price, Rs 40, however few shares were sold there. Broad-based weighted average moves the price only in proportion to how much cheap stock was issued relative to the whole company. The Rs 8 crore raised would have bought 8 lakh shares at the old Rs 100; it actually bought 20 lakh. Against a fully diluted base of 1 crore shares, the price moves by 108 over 120, to Rs 90.
The relationshipP_1, P_2 conversion price before and after, Rs A shares fully diluted before the round, 100 lakh B shares the new money would buy at P_1, 8 lakh C shares actually issued, 20 lakh What it says in wordsLower the conversion price by the ratio of shares the money should have bought to shares it did buy, measured across the whole company.Who pays for the extra shares?
Everyone without the protection, mostly the founders and employees. With no protection the investor holds 8.3% after the round; under weighted average 9.2%; under full ratchet 18.5%. Full ratchet hands the investor 15 extra lakh shares against about 1.1 lakh under weighted average, and the other holders' 90 lakh shares fall from 75.0% to 66.7% of the company. That is why broad-based weighted average is the common market term and full ratchet a sign that a company had little negotiating power. New investors in the down round also dislike a ratchet, because it dilutes them too, and often ask for it to be waived as a condition of investing.
Where candidates lose it
The common slip is to apply the new price under both formulas, or to treat weighted average as a simple average of Rs 100 and Rs 40. Weighted average weighs the cheap shares against the whole share base, which is why it barely moves when the down round is small.
The second loss is stopping at share counts. The interviewer wants to hear who pays: every extra share the investor gets comes out of the founders' and employees' percentage, and that is the real negotiation behind the clause.
What the interviewer asks next
- Under narrow-based weighted average, counting only the 1 crore shares minus the option pool, would the price fall more or less?
- How many shares does the investor get if the down round is at Rs 80 instead?
- Why might the new down-round investor insist that existing investors waive their anti-dilution?