Dollinger index

318 ENTREPRENEURSHIP

case 15 percent) rate. The fourth column in the table shows the cumulative present

value.

The actual calculation of the warrant’s value, however, requires two additional steps,

also described in Table 8.7. The first step calculates the total future payment, discount-

ed (for n periods, in this case 5) at the required rate of return (15 percent in this case)

that brings the cumulative present value (column 4: $663) to zero. In this example, the

amount is $1,333. The warrant price is the difference between this amount and the

return of principal ($1,000), in this case $333.

Pitfalls and Problems to Avoid

There is only 100 percent of anything. This is true of the equity in a new venture and

the cash flow from a start-up. Attempts to sell more than 100 percent of the equity and

cash flow will bring the entrepreneur to grief (and prison). So each time the entrepre-

neur raises money, the future is somewhat constrained by the acts of the past. Each deal

limits future options. In addition, each deal comes with covenants and legal restrictions

that further bind the entrepreneur in a net of obligations. Unless the business is self-

financing from the start, these constraints are inevitable, and the entrepreneur should

focus on the controllable factors, not the uncontrollable ones.

First, the entrepreneur should avoid choosing investors and especially investment

houses solely for their size or prestige. The choice should be made based on the needs

of the business, not the egos of the founders. Conflicts of interest between financiers,

investment houses, and entrepreneurs are inevitable. These should be resolved in favor

0 1 2 3 4 5

-$1,000

100

100

100

100

100

-$1,000

87

77

66

57

50

-$1,000

-913

-836

-770

-713

Cash Flow Interest Present Value Cumulative Present Value

Value of

Period n Payments 15% Value to Date the Warrant

TABLE 8.7 Calculating the Value of a Warrant*

*Assume: $1,000,000 subordinated debenture with a 10% coupon and warrants attached

guarantee debt holder total return of 15%

1. Calculate the future payment in period n that will provide for a positive present value equal
   to the cumulative negative present value to date. This makes the entire present value equal to
   zero at the guaranteed 15% rate.
   X
   For period 5: $663 = (1.15)^5 = $1,333


2. The warrant price is the difference between this value ($1,333) and the return of principal
   ($1,000) = $333.


3. This calculation can be made for any year, thus producing a schedule of warrant prices or
   values.

$333

-$663