Dropbox Financing

Question 1: Given their strategic goals for the business, and compared with companies in a comparable situation, how much money would you suggest Dropbox to raise in the Series B financing? What valuation range is appropriate based on comparable financing rounds at the same point in time? Provide your proposed cap table after the B round.

Dropbox has set itself the following strategic objectives:

Extend its popular consumer product to the enterprise segment

Open up a platform upon which to allow 3rd party developers to add services and applications in order to build scale

Augment consumer side through distribution partnerships

Find a way to transition itself from a web-based company to one that could service cross-platform mobile devices

Attain a robust balance sheet to compete with established industry leaders

Perform strategic hiring initiatives and key acquisitions

Reach a user-base of 1 billion

Although at the time, Dropbox was already a cashflow generative business and therefore in no immediate need of financing, they still decided to do so. In order to determine their optimal financing requirements, we utilized the venture capital method.

Using this method we decided that Dropbox would need an additional investment of 178.5 million dollars, against a 3.57 billion dollar post-money valuation to accomplish its strategic goals. We propose the following capitalization table:

Method

On the first hand, we estimated the future value of Dropbox based on its number of users in 2011, the expected growth rate of said user base and a value/user multiple derived from a comparable company.

Comparable companies in the industry are Box, Egnyte, Mozy, pCloud, Sync and Spideroak. However, we only found information on the post-money valuation of Box in 2011, as some of these companies weren’t yet operational in that year, had been acquired into a larger company with different services or information on its valuation wasn’t made public. Luckily, Box is the most comparable with Dropbox as it shares the same freemium business model and operates in the same sector, albeit with a larger emphasis on the business segment.

As there was no growth rate available for Dropbox in the case-file we took the estimated market growth (128%) for the upcoming year as a conservative estimate for this parameter, resulting in a lower post-money valuation. However, we hypothesized this would be counteracted by the fact that founders Houston and Ferdowsi were eager to obtain better terms on the negotiation, even if this meant a lower valuation for the company. Furthermore, using a conservative growth rate would result in a more realistic scenario instead of using an (over-)optimistic rate.

Dividing the post-money valuation of Box by the number of its users gave us a multiple of value/user-multiple of 97.29. Using this multiple in combination with Dropbox’s estimated future number of users, we determined its expected company value at the time of the harvest of the investment (which we assumed to be the year when the user base exceeds the 1B mark).

Company value at time t= Number of expected users at time t x Value/user multiple

We chose the harvest-point when Dropbox was expected to hit the 1B user base mark. According to our calculations Dropbox will hit these numbers in the year 2024. After calculating the company’s future value we used a hurdle rate of 30% (based on typical required return rates on investments on late stage investments by venture capitalists in the USA) to discount it to its present value.

To determine the funding requirement we assumed that Houston and Ferdowsi did not want to issue much more than 5% of extra shares, since funding was no immediate requirement and they wanted to maintain board control.

Finally, we postulated additional scenarios to determine the effect of a stronger or weaker growth than originally supposed and the range of required funding when the investors’ company ownership varies.

We can conclude that a change on the annual growth rate of the company’s user base, has a dramatic effect on the post-money valuation, and we would propose the funding be between $ 125 mio and $ 232 mio to constrain the dilution of the already existing shares.

Question 2: Sameer Gandhi remarks that the series B financing is not a “valuation optimization exercise.” What are some reasons to opt for a lower valuation?

It all depends on the trade-off between the valuation of your fundraising and the terms of the deal with the investor(s), and which side of the trade-off carries more weight for the company. In DBX’s case, they opted to substitute valuation, in order to obtain heavily company-favourable terms. Board control, the ability to direct not only the strategic initiatives of the business but also potential exit strategies, liquidation preference, and the limitation of issues that might arise from speculative secondary transactions were the most important considerations for DBX when deciding their ideal valuation.

Question 3: In general, which terms do you feel are most important in fundraising, and for Dropbox in particular? Why?

Depending on which stage a company currently finds itself, different terms become more important than others. However, there are a few that are always relevant to some degree, we will list the most important ones below, and explain them briefly.

Pre-money and post-money valuation: A valuation of a company is how much that company is worth in the eyes of investors. The difference between pre- and post-money valuation is simple, pre-money valuation is what a company is worth before proposed investments are taken into account. Post-money valuation is simply the sum of pre-money valuation and the proposed investments. This combined with how much an investor is willing to invest, gives the percentage of the company that that specific investor will own.

Convertible debt: In early stages of any company, it can be hard to make a correct estimation of what a company is worth since often times it has no real underlying assets. Convertible debt is in essence debt that later on, at a predefined