Following from the last post, there was a range of fairly attractive outcomes where the capped participation had an impact: let’s review the results from the grey zone.
Grey zone: In the (C) grey zone, we have a moderately good result, but one where the capped participation has a mixed impact. Regardless of the exit amount in this range, our choices are:
- (Scenario 1) With no participation, we make the same decision as the green zone – we have decide whether to take our 1x liquidation preference ($2M) OR convert into common and take our 25% of the $33M or more ($8.25M). Obviously, we take the higher number, so convert.
- (Scenario 2) With full participation, again there no choice to make: we get our $2M liquidation preference AND 25% of the remaining $22M.
- (Scenario 3) With capped participation, we still have to decide whether to take our capped participation (the participating preference up 4x * $2M = $8M) OR convert to take 25% of the exit value. The decision is the same across all this range: we take the capped participation, as that is always higher than converting and taking 25% of the proceeds.
But look what happened there in columns E and H:
- In Column E, our capped participation is juicing our returns nicely, increasing us from $2.5M in the non-participating scenario to $4M in the capped participating. That’s why we included this term, to help improve our outcome in scenarios where the entrepreneur didn’t really deliver on the plan.
- In Column H, though, we are getting maxed out at $8M of proceeds in that “window” of exits between $26M and $32M. In column H, the cap cost us $1.25M compared to the fully participating; but it’s also $0.25M better than had we taken a non-participating liquidation preference. This is giving the entrepreneur some “catch up” for delivering pretty well on the plan.
Make sense? Please make your own copy and play around.
Hopefully between the prose and the spreadsheet, we have illuminated the cost of the compromise for founders and investors finding this middle ground of a “capping participation.”
If not, at least you hopefully come away knowing that VentureSouth would never willingly cap the total potential upside of our investments!