Defense counsel for a start-up firm retained Cornerstone Research and David Smith of the University of Virginia to analyze the potential implications of forced changes to the firm’s capital structure.
The firm funded its operations and product development through external venture capital financing. After several rounds of convertible preferred stock financing, the firm faced the risk that some of the rounds would be invalidated. It would have to return the invested funds with interest, and likely face bankruptcy proceedings.
Professor Smith performed a contingent claims analysis of the firm’s value using Monte Carlo simulations in the scenario where the firm’s capital structure was affirmed by the court. This analysis was based on the price and contractual terms of the most recent round of financing and the firm’s overall capital structure, which included various series of convertible preferred stock with different investor rights.
Professor Smith also analyzed how the firm’s value would be distributed among the various claimants in the event of a bankruptcy. Lastly, Professor Smith analyzed how a bankruptcy might impact the value of the firm.