Pre-Revenue SaaS Company: Option Pool and Liquidation Preference
You are valuing the common equity of a pre-revenue SaaS company immediately before a planned Series A financing. The company has $1,500,000 of cash and is burning $120,000 per month, giving about 12.5 months of runway. Founders hold 6,000,000 common shares. Seed investors hold 2,000,000 preferred shares with a 1x non-participating liquidation preference of $3,000,000. An unissued option pool of 1,500,000 shares is planned. The Series A term sheet proposes $5,000,000 for a $20,000,000 pre-money valuation. Management believes the company will either fail, be sold for $15,000,000 in three years, or reach $60,000,000 in four years, with probabilities of 50%, 30%, and 20% respectively. The preferred shares convert at the Series A price.
1. Select and justify a valuation method for the pre-Series A valuation date.
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Use a probability-weighted expected return method or an option-pricing model rather than a single DCF. The company has no revenue, negative cash flow, and a finite runway, so a conventional capitalized earnings or DCF model would depend almost entirely on speculative terminal assumptions. PWERM is appropriate because management has identified discrete outcomes with probabilities. OPM is also acceptable because the preferred shares have liquidation preferences and conversion features that create option-like payoffs for the common equity.
The VC method can be used as a cross-check: back-solve the required ownership from the expected exit value and the target return, then compare the implied pre-money value with the $20,000,000 term sheet. The analyst should test the probabilities, the exit values, and the runway. With 12.5 months of cash, the company likely needs the Series A to execute the plan, so the valuation should reflect the financing risk. The pre-money value is not the same as the post-money value; the $5,000,000 investment must be added, and the option pool must be treated as a claim on the equity.
2. Allocate a $25,000,000 post-money equity value between preferred and common, considering the option pool and liquidation preference.
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First calculate fully diluted shares, assuming the option pool is included in the pre-money capitalization: 6,000,000 founders + 2,000,000 seed preferred + 1,500,000 option pool = 9,500,000 shares. The Series A price per share is $20,000,000 ÷ 9,500,000 = $2.105. The new shares issued are $5,000,000 ÷ $2.105 = approximately 2,375,000. Post-money shares are about 11,875,000.
At a $25,000,000 equity value, the preferred shares can either take the $3,000,000 liquidation preference or convert. On conversion, the seed preferred receives 2,000,000 ÷ 11,875,000 × $25,000,000 = $4,210,526, which exceeds $3,000,000, so the preferred converts. The common class receives the residual: $25,000,000 − $4,210,526 = $20,789,474.
The $20,789,474 is shared by founders and the option pool. The option pool is not free: it represents 1,500,000 ÷ 11,875,000 × $25,000,000 = $3,157,895 of the common value, leaving $17,631,579 for existing founders before any DLOM. If the pool is created after the financing, the dilution and allocation change, so the analyst must state the assumption.
3. Explain how the option pool and burn rate affect the conclusion.
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The option pool is a claim on future equity. If it is included in the pre-money capitalization, founders bear the dilution; if it is created post-money, the Series A investors bear part of it. The analyst must model the actual term sheet. A larger pool reduces the value of existing common and can change the conversion decision for preferred shares at low exit values.
The burn rate affects both the probability of achieving the milestones and the need for future financing. At $120,000 per month, the $1,500,000 cash balance provides about 12.5 months of runway. If the Series A closes, the $5,000,000 extends the runway, but the company may still need a later round, which would create further dilution. The PWERM scenarios should include the possibility of a down round or failure. A 50% failure probability is already high; the analyst should test whether the 12.5-month runway is consistent with that probability and whether the $15,000,000 and $60,000,000 exit values are supportable. The conclusion should reconcile the PWERM value, the VC method cross-check, and the Series A price, and explain any difference.