VC IQ Test – Have Fun!

I thought it might be interesting to pose a question and see who gets the right answer.  The facts leading up to the question are a little complex, but I think the question is an easy one.


1.  Company AB is an existing operating company that is doing well.  Company XY is also an existing operating company that is doing well.  Both AB and XY have venture investors.  AB and XY are in the same industry “Z”, but have complementary product offerings.

2.  Private equity firm LM wants to do a roll up of AB and XY to form a larger company with a broader range of product offerings in industry Z.

3.  The plan is for private equity firm LM to make an offer to buy company XY.  The structure of the offer is not irrelevant, but assume it would be a stock purchase.  LM’s offer would be made through company AB, so that it feels like LM/AB are making  the offer together with the end game being that AB’s management team would run the combined AB/XY company.

4.  To finance the offer, private equity firm LM would first make an equity cash investment in AB.  Then AB would use a big chunk of the investment cash to buy company XY.  Company XY’s stockholders would thus be cashed out (and hopefully happy).  At the end of the day, Company AB would own Company XY (they would likely do a legal merger) and the shareholders of Company AB, which now includes the private equity firm LM due to its equity investment in AB, own the combined companies.

5.  Let’s assume that private equity firm LM invested $22 million in company AB in step 4 above.  Let’s assume that $19 million of that is used to buy company XY (so $3 million of fresh cash is left in the combined company to fuel ongoing operations).

Question:  as an existing investor in company AB what is the #1 most important fact not disclosed above that I need to know to figure out whether or not I am in favor of this proposed deal?

Leave your answers in the comments.


4 thoughts on “VC IQ Test – Have Fun!

  1. Most important would be to understand the post-money cap table and key terms like control provisions so that I can understand how much my fund owns of the combined company and making sure I had protections to ensure my fund didn’t get washed out. Secondarily, I’d be concerned about whether or not $3m is enough to integrate the two companies and get it to self-sustaining growth or a logical next value creation milestone to justify raising more cash at a higher valuation.

    • Yes, the first point is the one I was thinking about. We need to know at what valuation the PE firm is making the investment into AB to be able to gauge how much of the combined AB/XY entity is owned by the original shareholders of company AB.

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