Venture Capital puzzles, solved step by step

A post-money of Rs 60 crore, and a Rs 12 crore cheque needs 20% of the company. Rs 1,000 crore divided by 10 is Rs 100 crore, but later rounds leave you with only 60% of your stake, so the price falls to Rs 60 crore. Rs 12 crore buys 20% at that price, which dilutes to 12% by the exit and is worth Rs 120 crore, exactly 10x.

Why work backwards from the exit?

A shop owner who knows a sari will sell for Rs 10,000 and needs to double her money can pay the weaver at most Rs 5,000. She starts at the selling price and divides. A venture investor does the same: start at the exit value, divide by the multiple you need, and what is left is the most the company can be worth when you buy in. Here that is Rs 1,000 crore over 10, Rs 100 crore, before you account for what later rounds do to your stake. This is often called the venture capital method.

Where does the dilution go in the chain?

Later rounds do not change the exit value; they shrink the share of it you own. If you hold 20% today and keep 60% of it, you own 12% at the exit. Because you only collect 60% of the stake you buy, the company must be priced at 60% of the undiluted figure for the maths to work, Rs 60 crore post-money rather than Rs 100 crore. Rs 12 crore at Rs 60 crore post is 20%, and the pre-money is Rs 48 crore.

What do you add to show judgement?

Translate the multiple into a yearly rate and question the inputs. 10x over six years is about 47% a year, and the whole answer leans on a single exit value that is far from certain. If only one company in three reaches that exit, the honest calculation uses an expected exit, and the price you can pay falls by the same factor. Saying that sentence turns a formula into an investment view.

The net margin is 20% and the EBITDA margin is about 31.7%. With no debt or cash, enterprise and equity value are the same, so 8x revenue equals 40x earnings and earnings are 8/40 of revenue. Grossing up 20% for 25% tax gives a pre-tax and EBIT margin of 26.7%, and adding back 5% of depreciation gives 31.7%.

How can two multiples give a margin?

If a flat sells for 25 times its yearly rent and 5 times the owner's yearly income from all sources, rent must be one fifth of that income, without knowing the price. When two multiples price the same value, dividing one by the other gives the ratio of their denominators. Here 8x revenue and 40x earnings price the same equity, because a company with no debt and no cash has enterprise value equal to equity value. So earnings over revenue is 8 over 40, a 20% net margin.

How do you climb from net profit back to EBITDA?

Undo each deduction in reverse order. Tax is 25% of pre-tax profit, so net profit is 75% of it, and pre-tax profit is 20% divided by 0.75, about 26.7% of revenue. With no interest, pre-tax profit equals EBIT. Adding back depreciation of 5% gives EBITDA of 31.7% of revenue. A common slip is grossing up by 1.25 instead of dividing by 0.75, which gives 25% instead of 26.7%.

Does the answer make sense for a company priced like this?

Check with a third multiple. The EV/EBITDA is 8 divided by 0.317, about 25.3x. A 20% net margin with a 40x earnings multiple describes a profitable business that the market expects to keep growing quickly, which is the profile of a mature software company rather than an early startup. Say the assumption that made the trick work, no debt and no cash; with net debt, EV and equity value differ and you need the balance sheet to link them.

The price implies a free cash flow margin of about -7%, and the line gives Rs 312.5 crore at the actual minus 30%. Rs 600 crore over Rs 50 crore is 12x ARR; divided by 0.25 that is a score of 48; less 55 points of growth leaves -7%. At minus 30% the score is 25, the multiple 6.25x and the EV Rs 312.5 crore, so the price assumes a 23-point margin gain worth Rs 287.5 crore.

How do you run a peer line backwards?

If you know that flats in a building sell for Rs 10,000 a square foot and one sold for Rs 1.2 crore, you can tell its size without measuring it: 1,200 square feet. A peer line works the same way. When the market prices software companies at a fixed multiple of their Rule of 40A score for software companies: revenue growth rate plus free cash flow margin, both in per cent. Forty or more is the conventional bar for a healthy balance of growth and cash generation. score, any observed price tells you the score the market is assuming. Rs 600 crore over Rs 50 crore is 12x ARR, and 12x over 0.25 is a score of 48.

What is the price paying for that the company does not yet earn?

Run the line forwards with the actual numbers. Growth of 55 plus a margin of minus 30 is a score of 25, worth 6.25x ARR, or Rs 312.5 crore. The gap of Rs 287.5 crore is what the market pays today for the company moving its margin from minus 30% to -7%, a 23-point improvement, without giving up growth. An investor buying at Rs 600 crore should ask how plausible that improvement is and how soon it must arrive.

How far can you trust the line?

A ten-company scatter fitted with one slope is a rough guide. The line explains the middle of the peer set well and the edges badly, so a company at either extreme of growth or margin will often sit far from it for reasons the score does not capture. The score also weights a point of growth the same as a point of margin, which markets do not always do. Treat the implied margin as a question to put to management rather than a fact about the company.

20% if Rs 200 crore is the pre-money, 25% if it is the post-money. Pre-money is the value before the cheque, so post-money is 200 plus 50, Rs 250 crore, and 50 over 250 is 20%. If Rs 200 crore already includes the cheque, investors own 50 over 200, which is 25%, and the pre-money was only Rs 150 crore. One unstated word moves five points of the company.

What do pre-money and post-money actually mean?

Two friends own a food stall worth Rs 2,00,000. A third friend puts in Rs 50,000 for a new oven. The stall is now worth Rs 2,50,000 and the new friend owns a fifth of it, because the Rs 50,000 is inside the new total. Pre-money is the value before the new money arrives, post-money is pre-money plus the new money, and the investor's share is always the cheque divided by post-money. The only question is which of the two numbers the founder quoted.

Why does the post-money reading cost the founder more?

If Rs 200 crore is post-money, the pre-money is only Rs 150 crore: the founder sold Rs 50 crore of shares against a company valued Rs 50 crore lower. 25% against 20% is a quarter more of the company for the same cheque, and that extra slice is diluted alongside everything else in every later round. Check both readings the same way: 20% of 250 is 50, and 25% of 200 is 50. Both pass, which is exactly why the sentence alone cannot settle it.

Headlines tend to quote whichever number sounds bigger, and a term sheet settles it by stating the pre-money and the fully diluted share count. Some convertible instruments quote a post-money cap instead, so the habit of asking which one carries straight into later work.

2.25x your money, about 31% a year over three years. ARR grew 3 x 2 x 1.5, nine times. The multiple fell from 40x to 10x, a quarter of where it started. Value is ARR times the multiple, so it grew 9 x 0.25 = 2.25 times. The company did nine times better as a business, and the price of that business fell by three quarters along the way.

Why do revenue growth and the multiple multiply?

A shopkeeper who sells three times as many mangoes at half the price takes in one and a half times the money, not three. Valuation is ARR times the multiple, so the change in value is the growth in ARR times the change in the multiple. Entry: ARR of 1 at 40x is a value of 40. Exit: ARR of 9 at 10x is 90. Ninety over forty is 2.25x. Compound the growth rates first: 3 x 2 x 1.5 is 9, not 3 + 2 + 1.5.

Is 2.25x in three years a good outcome?

It is about 31% a year, respectable, but look at where it came from. Nine times the business produced barely two and a quarter times the money, because the entry price assumed growth that the exit price no longer rewarded. The break-even exit multiple is 40 / 9, about 4.4x ARR: below that, a company that grew nine times would still lose money. That is the risk of paying a high multiple, and it is why growth investors ask what multiple they need at exit before they ask how fast the company will grow.

What did the puzzle leave out on purpose?

Dilution: any round in those three years shrinks the stake, so the real multiple is lower. Preferences: in a weak exit a preferred holder may be paid ahead of common, which can lift the investor's multiple above the common one. The path of the multiple: the figure draws an even decline, but only the two ends are given, and the multiple of money depends only on them. State these and the answer becomes an investor's view rather than an arithmetic result.

Applied to every share, the offer implies Rs 720 crore, but it prices common shares, not the company. The Rs 1,200 crore figure was a price for preferred shares, which are paid back first in a sale and carry protections. Common is paid last, is illiquid and usually needs company consent to sell. A buyer discounts for all of that. Neither Rs 1,200 crore nor Rs 720 crore is the company's value.

Why do the two prices differ for the same company?

A first-class and a general ticket on the same train cost different amounts, but the fare gap says nothing about the train's speed. Preferred and common are different securities in the same company: preferred is paid back before common in a sale, so a rupee of preferred is worth more than a rupee of common whenever a weak exit is possible. Multiplying the preferred price by every share gives the headline Rs 1,200 crore; multiplying the common offer, 60% of that price, by every share gives Rs 720 crore. Both are prices of a security scaled up, not a measure of what the business is worth.

Where does the discount come from?

Take an illustration: preferred holders own 40% and are owed Rs 400 crore first in any sale. In a Rs 400 crore sale they take everything and common gets nothing; only above Rs 1,000 crore, where 40% of the sale beats Rs 400 crore, do the two classes share pro rata. Common holds the first loss in the bad outcomes. On top of that come illiquidity, the company's right to block or match a sale, and the lack of information rights. Each adds to the discount, and none says the company is worth less than at the last round.

When would a secondary price be a real markdown signal?

When the discount is to the same security, or much larger than the structure explains. A buyer offering a deep discount for preferred shares from the latest round is a stronger signal, because the security is identical to the one that set the headline. Ask which class is being sold, how big the preference stack is relative to the likely exit range, and how much stock is on offer; a small, forced sale tells you about the seller's need for cash as much as the company.