Dollinger index

Securing Investors and Structuring the Deal 311

the whole project (about 59.5 percent). The net present value (NPV) of the investment

component is -$2,000,000 in Year 0. The other NPVs are calculated as follows ($000):

$400 + $400 + $100 + –$200 + –$200

NPV (tax) = (1 + .595)^1 (1 + .595)^2 (1 + .595)^3 (1 + .595)^4 (1 + .595)^5

$200 + $200 + $700 + $1, 000 + $1, 200

NPV (CF) = (1 + .595)^1 (1 + .595)^2 (1 + .595)^3 (1 + .595)^4 (1 + .595)^5

$10, 000

NPV (TV) = (1 + .595)^5

The results are:

NPV (Tax) = $383,383—19.1 percent of the returns

NPV (CF) = $647,272—32.4 percent of the returns

NPV (TV) = $968,716—which is 48.5 percent of the returns

Total = $2,000,000 (rounded off)

The example shows that most of the returns from this deal come from the terminal value

of the company. This is the riskiest figure in the example because it requires that a great

many things turn out right five years down the road. Deals like this are appropriate for

venture capital firm investments.

Other Investor Segments. But the entrepreneur would not want to go directly to a

venture capitalist for financing. First, the entrepreneur should look for an angel. If that

approach fails, the next target is a bank willing to lend money. Finally, the cash flows can

be “sold” to less risk-averse investors who will accept lower returns than the venture cap-

italists. Table 8.2 suggests how these other flows might be partitioned.

The goal, in Figure 8.2, is to raise $2 million. The investment’s tax benefits might

appeal to a wealthy investor looking for a tax write-off. People in high marginal tax

brackets can often protect their incomes or cash flows by investing in businesses that

may have high early losses. Entrepreneurs might well be able to convince a wealthy indi-

vidual with a required rate of return of 20 percent that the tax benefit cash flow projec-

tion is accurate and reliable.

Source of Flow Year 0 Year 1 Year 2

$400

200

$600

Year 3 Year 4 Year 5

TABLE 8. 1 Segmented Cash Flow Structure ($thousands)

Investment

Tax incentive

Free CF

Terminal value

Total CF

($2,000)

($2,000)

$400

200

$600

$100

700

$800

($200)

1,000

$800

($200)

1,200

10,000

$11,000

SOURCE: Adapted from J. Timmons, New Venture Creation (Homewood, IL: Irwin, 1994): 774–77.