Here we look just at some basic financial maths.
Let’s take a live example:
Company GrowFast needs £5m in equity. They have a business plan ready to be financed which they believe can boost their sales and bottom line to allow them to be valued at £30m in 2 years – and a ready buyer is in the wing if they prove themselves. They believe current valuation to be anywhere between £7.5 and 15m depending on what view/ metrics you use.
1: They have an offer of Debt with (for the sake of simplicity) no current cashpay coupon and an all-encompassing 1.75X return in 2 years.
2: Or they can take preferred equity - non–participating(no double dipping) however senior on a payout to common. Valuation as of yet unccertain.
Now some maths:
To explain – Debt is giving a guaranteed return to the provider but is not sharing the upside, hence it is non-dilutive – apparently better. However, if you can raise equity (even preferred) at a high enough valuation – the dilution effect on a cash-basis is less than the cash loss effect of paying back the redemption on the debt. See the charts below – original equity holders are better taking equity, not debt as the payback on the debt is more on a cash basis than the equity dilution effect at THAT valuation (a higher exit valuation – debt would become more attractive):
- Need £5m
- Exit £30m
By John Rowland, Managing Director