1.

Executive summary

This is a 6 year investment proposal for a young London-based fashion software company called
DeepGears. Seed funding worth £1.55m would be exchanged for 34% of the equity (3,400 ordinary
shares) and would cost the VC a total of £1.7m. In the bad, conservative and good scenarios the
internal rate of return (IRR) could potentially achieve 40%, 53% and 97%, respectively. The target
market of online apparel industry has a long pre-existing problem of experiencing high return rates.
Whereby, retailers have simply incorporated this into their business model only for the situation to
worsen. DeepGears offers a unique and sophisticated solution that has already gathered attention
from three retailers. Adoption of online shopping across Europe is increasing and rebounding from
the impact of Covid-19 pandemic. Hence, more potential customers for DeepGears, where a patent
has been suggest in this proposal to help the company become even more competitive.

2. Company overview

DeepGears was formed in October 2020 and raised £20,000 in their first month. They are developing
a software that will allow users to visualise how 3D garments will fit on a lookalike avatar – virtual
dressing room. Whereby, their product aims to make sure customers’ expectations are met as to
how garments will fit on them. Consequently, reducing return rates and improving revenues – saving
time for both customers and online apparel retailers. Also, providing retailers with advanced
analytics to further improve their operations1.

3. Recent performance and likelihood for seed funding

DeepGear’s intends to have a commercial product finished by Q3 of 2021. Whereby, their protype
has already secured interest from 3 small independent brands to test their product in Q4 of 2021.
DeepGear’s bold ambitions of having 250+ active clients by the end of 2025 across Europe will
require substantial amount of capital. Currently, seed funding is being conducted where they have
secured £50,000 of £150,000 in exchange for 10% equity, which has risen from 9%1. Illustrating,
DeepGears are in search of funding and willing to negotiate to help grow their business rather than
retaining as much equity. Also, DeepGears will require further funding of £0.5m-£1m in Q4 of 2021
to scale up their commercial operations1. Whereby, this opportunity can be utilised by the VC to
provide current and future funding all in one go. Finally, DeepGears will have an experienced VC with
a business plan onboard who demands less equity to be exchanged for funding than currently
proposed.

4. Current ownership

Assuming £150,000 is secured before the VC steps in, DeepGear’s management shares will decrease
by 10% to 90%1, as shown by Figure 1.12.

DeepGear’s management Number of ordinary shares After 10% equity reduction

Pietro Dalpane 7,000 6,300
Giulio Capodimonti 3,000 2,700
Total: 10,000 (100%) 9,000 (90%)
Figure 1.1

1
https://www.angelinvestmentnetwork.co.uk/business-proposals/deepgears-15-1131615 (Date accessed:
23/03/21 & 26/04/21)
2
https://find-and-update.company-information.service.gov.uk/company/12982323/filing-history
 5. Investment analysis
Opportunity
a. Idea/Industry

DeepGear’s software product is intended for the apparel industry, in particular, ecommerce
platforms with the purpose of reducing online return rates and improving customer confidence in
buying the correct size and style garments.

b. Market

2020 UK annual expenditure on clothing was £54 billion and has experienced steady growth over the
last 15 years3. 2021 forecasts to the see the highest growth rate of 3.27% - rebounding from the
Covid-19 pandemic4. Figure 2.1 illustrates the UK is experiencing a sharp increase in online sales of
clothing and footwear5. Whereby, in the UK, 55% of the population shop online and consumers’
favourite item to buy online were clothes and sports goods6. Consequently, ecommerce apparel
stores are growing in numbers, because they offer a wider range of products at a lower cost. While
high street apparel stores are closing down, due to higher overhead costs, such as rent. For example,
the recent collapse of Debenhams, and the online retailer Boohoo buying the Debenhams brand and
website for £55m7. However, high street apparel retailers provide their customers with a dressing
room, which online retailers cannot. Hence, ecommerce apparel retailers experience higher return
rates.

Value of UK monthly internet clothing and

footwear retail sales, based on sales per week
index
250

200

150

100

50

0
May-13

May-14

May-15

May-16
Sep-16

May-17

May-18

May-19

May-20
Jan-13

Sep-13
Jan-14

Sep-14
Jan-15

Sep-15
Jan-16

Jan-17

Sep-17
Jan-18

Sep-18
Jan-19

Sep-19
Jan-20

Sep-20

Figure 2.1

3
https://www.statista.com/statistics/300842/annual-expenditure-on-clothing-in-the-united-kingdom-uk/
4
https://www.statista.com/forecasts/1156107/apparel-market-revenue-growth-in-the-united-kingdom
5
https://www.statista.com/statistics/286032/internet-clothing-and-footwear-retail-sales-value-monthly-
index-in-the-uk-2013/
6
https://www.statista.com/statistics/275973/types-of-goods-purchased-online-in-great-britain/
7
https://www.moneysavingexpert.com/news/2021/01/boohoo-buys-debenhams-brand-and-website-but-
stores-to-close---wh/
Figure 2.2 shows a strong increase in retail ecommerce sales as a share of retail trades across
different European countries, in particular from 2019 to 20208. This suggests a higher demand for
online shopping platforms in the future and will most likely result in more online apparel retailers.
Therefore, as the number of online apparel retailers grows, DeepGear’s potential customers grows
simultaneously.

Retail e-commerce sales as share of retail trade for different

countries, with a forecast for 2020 and 2021
30.00%

25.00%

20.00%

15.00%

10.00%

5.00%

0.00%
United Kingdom Germany France Netherlands Spain Italy

2014 2015 2016 2017 2018 2019 2020 2021

Figure 2.2

c. Positive value

DeepGears generates a positive value from already securing 3 interested apparel retailers willing to
test their commercial product1. Illustrating a strong interest and appreciation as to how
sophisticated their protype product is. Apparel retailers with ecommerce platforms have been
looking for a solution to buying incorrect sized clothes, where these high return rates have just been
incorporated into their business model9. DeepGears offers retailers an advanced, unique and easy to
use solution, that other companies cannot. Also, costs are minimal, because they don’t need to pay
storage fees for physical assets (only server costs). Thus, an increase in DeepGears customers will
improve their EBITDA exponentially. Finally, DeepGear’s management have connections to the
fashion industry and could acquire exclusive clients.

8
https://www.statista.com/statistics/281241/online-share-of-retail-trade-in-european-countries/
9
https://www.retail-week.com/supply-chain/how-can-retailers-mitigate-the-5bn-returns-
headache/7036396.article?authent=1
 d. Acceptance

The UK retail market is estimated to have items bought online and returned amounting to £5.2
billion annually9. Figure 2.3 shows clothes/shoes were the most frequently returned online item10.

Most frequently returned online product categories

Entertainment

Health & Beauty

Accessories/Jewellery

Electronics

Clothes/Shoes

0% 10% 20% 30% 40% 50% 60%

Figure 2.3

The delivery company Paazl saw that10:

• Return rates to stores are 8%.

• Online return rates are 25%.

Exposing, return rates impact online retailers considerably more. Also, KPMG reports the process of
returning an item can cost twice as much as the delivery cost9, because many firms don’t have
sufficient systems to process this reversal in logistics11. Also, returned garments run the risk of being
damaged and the retailer will have to re-sell them at a discount. Whereby, Forrster estimates half of
all returns have little to no salvage value11. Especially, as fashion comes and goes in waves, returns
are more damaging.

Therefore, DeepGear’s product could be highly accepted, because customers’ solution to not
knowing how clothes will fit and/or look on them has resulted in serial returners and Barclaycard
investigated this further to find10:

• 30% of shoppers deliberately over purchase and subsequently return unwanted items.
• 19% admitted to ordering multiple versions of the same item so they could make their mind
up when they’re delivered.

Consequently, the emphasis should be placed on the retailers than the customers themselves or the
situation will only worsen. Whereby, customers are more concerned about a company’s return
policy that the actual item – system set up to fail10:

• 68% of shoppers view return policies before making a purchase.

• 50% of shoppers abandoned a purchase – lack of return channels.
• 56% of potential customers have been deterred from shopping, due to an ecommerce site’s
return policy.

10
https://www.salecycle.com/blog/featured/ecommerce-returns-2018-stats-trends/
11
https://www.ft.com/content/5bafd9c0-235f-11ea-92da-f0c92e957a96
Thus, DeepGear’s product can be seen as a defence tactic employed by apparel retailers to reduce
return rates and make customers sure their purchasing choice is correct. Consequently, improving
revenue margins for retailers. At the start, return rates will remain high as customers will not trust
the software, but overtime customers will see how accurate the software is and return rates should
decrease. Finally, this software will provide a unique shopping experience and potentially attract
new customers. Hence, high acceptance rate, because online retailers will now match what brick and
mortar retailers can do by providing a dressing room, but sell garments at a cheaper price.

e. Competition

Figure 2.4 shows DeepGear’s potential competition.

Organisation Cost: Simple Uses Virtual Sizes Number Features

Free and smartphone clothes provided of
easy camera fitting retailers
to use sizes
provided
for
Sizer12 ✔ ✔ ✔ ✖ ✔ 4 App integrated with
some retailers.

MTailor13 ✔ ✔ ✔ ✖ ✔ 11 Generic sizes provided

– jeans, t-shirts, etc..
London ? ✖ ✔ ✔ ? ? Requires a green shirt.
College of Limited movements by
fashion avatar and clothes
(LCF)14 don’t seem realistic.
Project potentially
finished.
Figure 2.4

DeepGear’s have created high barriers to entry with their advanced yet simple product to use, which
Sizer, MTailor and LCF cannot compete with. To remain/improve competitiveness, I would suggest
implementing a patent during this investment to help DeepGears establish their brand and acquire
exclusive clients.

f. Time

The time for entry is ideal for the following reasons:

• Covid-19 pandemic increased online sales and intensified return crisis even for high street
apparel retailers who have had to extend their return window during lockdowns –
“goodwill” gestures9. Hence, potential for DeepGears to acquire both high street and online
apparel retailers as clients.
• Adoption of online shopping increasing across Europe – more clients for DeepGears.
• Only secured 1/3 of £150,000 seed funding and Q4 of 2021 additional seed funding
required1. Hence, VC seed funding can provide current and future funding.
• Strong growth potential for DeepGears when launching their commercial product in Q4 of
2021.

12
https://apps.apple.com/il/app/sizer-body-measurements-fit/id945709032
13
https://apps.apple.com/us/app/mtailor-custom-clothing/id816042916
14
https://www.bbc.co.uk/news/av/technology-49762414
 g. Speed

The 6 year investment plan can be implemented immediately upon agreement. Starting with
marketing/advertising before the product’s release in Q3 of 20211 to understand the present
demand for DeepGear’s product.

6. Uncertainties and risks

a. SWOT analysis

Strengths: Weaknesses:

• High calibre team. • No reputation – resistance from large

• Unique and innovative product – high firms, such as H&M to adopt
barriers to entry. DeepGear’s technology.
• Management – no real experience in
successfully starting and growing a
business.
• Information asymmetry of a private
firm might result in adverse selection.
Opportunities: Threats:

• Expand into niche market of plus size • Unknown competitors entering.

clothing - £9m revenue forecasted by • “Bubble” effect created from the
2022 in the UK15. Limited number of plus extension of the furlough scheme18
size clothing retailers, mostly online. and more retailers may close after
Whereby, it’s particular difficult for September 2021. In particular, micro
individuals to know their exact size and and small apparel retailers will first
have to guess, resulting in higher return close – most valuable customers,
rates. because they’re more willing to adopt
• Continuation of pandemic may be perfect DeepGears technology.
opportunity to demonstrate the benefit • Apparel retailer’s business model
of DeepGear’s product – retailers more accepts high return rates and may not
willing to adopt it. Also, social distancing be willing to use DeepGear’s
in place at least till June 2021, and can technology. Whereby, 33% of online
get brick and mortar stores on board as retailers offer free returns, but offset
fitting rooms will not be available for this cost by charging for delivery10.
customers16. Hence, higher return rates. Also, high returning customers may
• Target luxury brands – McKinsey be some of their best customers11.
forecasts ecommerce sales percentage of
total brand revenue for luxury brands will
rise from 12% to 18% worth around £60
billion annually17.

15
https://www.statista.com/statistics/829734/plus-size-clothing-market-size-united-kingdom-uk/
16
https://www.gov.uk/government/publications/covid-19-response-spring-2021/covid-19-response-spring-
2021-summary
17
https://www.mckinsey.com/industries/consumer-packaged-goods/our-insights/is-luxury-ecommerce-
nearing-its-tipping-point
18
https://www.lexology.com/library/detail.aspx?g=32475ce3-7dba-44d2-9934-
c57f2f44dde8#:~:text=UK's%20Furlough%20Scheme%20extended%20until%20the%20end%20of%20Septemb
er%202021,-
Dechert%20LLP&text=The%20Chancellor%20of%20the%20Exchequer,months%20until%2030%20September%
202021
 b. Sensitivity analysis

DeepGear’s revenues has been forecasted by estimating the number of different sized businesses
that the company will sign with, in the different scenarios, as shown by Figure 3.3, 3.5 and 3.7. Then
multiplying these individual values by the average revenue for different sized businesses (Figure
3.119) and taking a 5% commission of the sum to get DeepGears revenue1. Figure 3.2 shows all the
relevant costs associated with DeepGears (assumed to start at month 6 of 2021F), where Figure 3.4,
3.6 and 3.8 show the forecasted profit after tax (PAT) for the relevant years in the three scenarios.

Business size Micro (0-9 Small (10-49 Medium (50-249 Large (250+
employees) employees) employees) employees)
Turnover £931 £646 £694 £2,077
(billions)
Businesses (000s) 5,725 212 36 8
Revenue per £1,626 £3,047,170 £19,277,778 £259,625,000,000
business
Figure 3.1

Annual 2021F 2022F 2023F 2024F 2025F 2026F 2027F

cost
= ((No. of Micro firms*£1,626) + (No. of Small firms*£3,047,170) + (No. of
Revenue: Medium firms*£19,277,778) + (No. of Large firms*£259,625,000,000))*5%
Installation
COS (Cost and = (No. of Micro firms*£1,000) + (No. of Small firms*£1,500) + (No. of Medium
of Sales):support of firms*£2,250) + (No. of Large firms*£3,375)
DeepGears
product:
Server £2,500 £5,000 £5,000 £5,000 £5,000 £5,000 £5,000
Website £5,500 - - - - - -
built
Website - £1,000 £1,000 £1,000 £1,000 £1,000 £1,000
Overhead upkeep
costs: Marketing £10,000 £30,000 £50,000 £70,000 £80,000 £110,000 £130,000
Patent £4,500 £4,500 £4,500 £4,500 £4,500 £4,500 £4,500
Admin £75,000 £150,000 £150,000 £150,000 £150,000 £150,000 £150,000
expenses:
Figure 3.2

19
https://researchbriefings.files.parliament.uk/documents/SN06152/SN06152.pdf
Bad Outlook:

Year Micro Small Medium Large Total DeepGears

revenue revenue-
5%
2021F 0 0 0 0 £0 £0
2022F 6 0 0 0 £975,721 £48,786
2023F 18 0 0 0 £2,927,162 £146,358
2024F 30 1 0 0 £7,925,772 £396,289
2025F 42 2 0 0 £12,924,383 £646,219
2026F 54 3 1 0 £37,200,772 £1,860,039
2027F 66 4 2 0 £61,477,161 £3,073,858
Figure 3.3

2021F 2022F 2023F 2024F 2025F 2026F 2027F

Revenue £0 £48,786 £146,358 £396,289 £646,219 £1,860,03 £3,073,85
9 8
COS (£2,500) (£11,000) (£23,000) (£36,500) (£50,000) (£65,750) (£81,500)
Gross (£2,500) £37,786 £123,358 £359,789 £596,219 £1,794,28 £2,992,35
profit 9 8
Overhead (£20,000 (£35,500) (£55,500) (£75,500) (£95,500) (£115,500 (£135,500
s ) ) )
Admin (£75,000 (£150,000 (£150,000 (£150,000 (£150,000 (£150,000 (£150,000
expenses ) ) ) ) ) ) )
Profit (£97,500 (£147,714 (£82,142) £134,289 £350,719 £1,528,78 £2,706,85
before ) ) 9 8
tax
Tax on £0 £0 £0 (£26,858) (£70,144) (£305,758 (£541,372
profits ) )
(20%)
PAT (£97,500 (£147,714 (£82,142) £107,431 £280,575 £1,223,03 £2,165,48
) ) 1 6
Figure 3.4

Conservative Outlook:

Year Micro Small Medium Large Total DeepGears

revenue revenue-
5%
2021F 2 0 0 0 £325,240 £16,262
2022F 14 1 0 0 £5,323,851 £266,193
2023F 26 2 0 0 £10,322,462 £516,123
2024F 38 4 0 0 £18,368,243 £918,412
2025F 50 6 1 0 £45,691,801 £2,284,590
2026F 62 8 2 0 £73,015,359 £3,650,768
2027F 74 10 3 0 £100,338,918 £5,016,946
Figure 3.5
 2021F 2022F 2023F 2024F 2025F 2026F 2027F
Revenue £16,262 £266,193 £516,123 £918,412 £2,284,59 £3,650,76 £5,016,94
0 8 6
COS (£4,500) (£20,500) (£34,000) (£49,000) (£66,250) (£83,500) (£100,750
)
Gross £11,762 £245,693 £482,123 £869,412 £2,218,34 £3,567,26 £4,916,19
profit 0 8 6
Overhead (£20,000 (£35,500) (£55,500) (£75,500) (£95,500) (£115,500 (£135,500
s ) ) )
Admin (£75,000 (£150,000 (£150,000 (£150,000 (£150,000 (£150,000 (£150,000
expenses ) ) ) ) ) ) )
Profit (£83,238 £60,193 £276,623 £643,912 £1,972,84 £3,301,76 £4,630,69
before ) 0 8 6
tax
Tax on £0 (£12,039) (£55,325) (£128,782 (£394,568 (£660,354 (£926,139
profits ) ) ) )
(20%)
PAT (£82,238 £48,154 £221,298 £515,130 £1,578,27 £2,641,41 £3,704,55
) 2 4 7
Figure 3.6

Good Outlook:

Year Micro Small Medium Large Total DeepGears

revenue revenue-5%
2021F 3 0 0 0 £487,860 £24,393
2022F 21 2 0 0 £9,509,361 £475,468
2023F 39 5 1 0 £40,855,810 £2,042,791
2024F 57 8 2 0 £72,202,259 £3,610,113
2025F 75 11 3 0 £103,548,708 £5,177,435
2026F 93 14 4 0 £134,895,157 £6,744,758
2027F 111 17 5 1 £425,866,605 £21,293,330
Figure 3.7

2021F 2022F 2023F 2024F 2025F 2026F 2027F

Revenue £24,393 £475,468 £2,042,79 £3,610,11 £5,177,43 £6,744,758 £21,293,33
1 3 5 0
COS (£5,500) (£29,000) (£53,750) (£78,500) (£103,250 (£128,000) (£156,125)
)
Gross £18,893 £446,468 £1,989,04 £3,531,61 £5,074,18 £6,616,758 £21,137,20
profit 1 3 5 5
Overhea (£20,00 (£35,500) (£55,500) (£75,500) (£95,500) (£115,500) (£135,500)
ds 0)
Admin (£75,00 (£150,00 (£150,000 (£150,000 (£150,000 (£150,000) (£150,000)
expenses 0) 0) ) ) )
Profit (£76,10 £260,968 £1,783,54 £3,306,11 £4,828,68 £6,351,258 £20,851,70
before 7) 1 3 5 5
tax
Tax on £0 (£52,194) (£356,708 (£661,223 (£965,737 (£1,270,25 (£4,170,34
profits ) ) ) 2) 1)
(20%)
 PAT (£76,10 £208,774 £1,426,83 £2,644,89 £3,862,94 £5,081,006 £16,681,36
7) 2 0 8 4
Figure 3.8

£1,540,500 invested over the 6 year investment period.

7. Team/Management and their requirements

Name Position Experience

Pietro Dalpane CEO • BSc in Mechanical Engineering at Politecnico di Milano – 110/110
with honours.
• MSc in Mechanical Engineering at Imperial College – Pass with
Distinction.
• 4+ years at McKinsey and Company.
Philipp Henzler CTO • BSc and MSc at Ulm university.
• PhD at UCL in computer vision / Graphics and Machine Learning.
• PhD Research Intern at Facebook AI.
Giulio CBO • BSc in Management at Cass Business School.
Capodimonti • 1+ years at Coller Capital (Private Equity).
• Associate at OC&C strategy consultants.

This is a well-rounded team. Experience in consulting shows a practice in helping businesses to grow,
and Giulio’s experience in private equity will act as a good “translator” for the VC – know what the
VC requires. Also, having connections with the fashion industry will attract clients. Usama and Jin are
two extra team members that offer more than 20 years of experience in Computer Vision and AR1.
The management team requires someone who has previous experience in growing a young company
successfully, understands how to expand into the European market and the current impact of the
Brexit red tape.
 8. Strategy
a. Key areas for growth

Figure 4.1 evaluates DeepGear’s business across different areas.

DeepGears spider diagram

CEO
1
Growth 0.8 Business model

0.6
0.4
Marketing/Advertising Technology
0.2
0

Management Competition

Past investors Fund added value

IRR

Figure 4.1

• Finalise DeepGear’s product.

• Need a website and social media presence to showcase the products progress – acquire
attention/followers. Also, DeepGear’s contact information provided to help interested
parties have their questions answered (currently difficult to contact them) – potential future
clients. Also, there is little to no advertising/marketing for DeepGears.
• Research needs to be conducted with online apparel retailers to understand whether they
would adopt this technology and features they would like incorporated – potential
improvements for DeepGear’s product.
• Data/information needs to be collected that shows how DeepGear’s product reduces return
rates and improve revenues – useful feature to convince interested parties the benefits of
DeepGear’s product. Even offering 3 month free trial to get retailers to participate in the
study.

b. 100 day plan

• Assign an experienced individual to the management team to oversee the implementation
of the pre-agreed business plan. Also, understand how the current management team
operates to identify their strengths and weaknesses.
• Outsource a advertising/marketing team.
• Outsource a website builder.
• Research whether apparel retailers would be willing to use and trial the product.
 c. Value added and shareholder alignment
• Practical working knowledge and managerial experience from past involvement in the
fashion and technology industry – implementing successful growth strategy.
• Develop a aspirational and feasible business and financial plan that aligns VC’s and
DeepGear’s ambitions together – reducing conflict. Helping to keep management focused
and on track to achieving the required IRR. Essential for a young seed company.
• Outsourcing a advertising/marketing team will allow the DeepGear’s team to focus more on
perfecting the software product.
• Implementing a patent will help DeepGears remain very competitive in an ever-changing
industry.

9. Investment requirements
a. Objective of investment

Targeted IRR – 40%.

b. Price/valuation

Assumptions:

• PE ratio = 17.5520.
• London seed valuation = £1.6m21.

Method 1 – DeepGear’s valuation

DeepGears value their business at £1,500,000. Their forecasted 2025 EBITDA is

£13,000,000. Whereby, 𝐸𝑉 (𝐸𝑛𝑡𝑒𝑟𝑝𝑟𝑖𝑠𝑒 𝑣𝑎𝑙𝑢𝑒) = £13𝑚 ∗ 17.55 = £228.15𝑚.

Method 2 – Scorecard valuation22

Figure 5.1 shows DeepGear’s scorecard – ranked according to Figure 4.1:

Comparison factor Range Target company Factor

Strength of entrepreneur and 30% max 150% 0.45
team
Size of opportunity 20% max 100% 0.2
Product/Technology 30% max 200% 0.6
Competitive environment 10% max 150% 0.15
Marketing/Sales/Partnerships 10% max 10% 0.01
Total 100% 1.41
Figure 5.1

Hence, 𝐸𝑉 = £1.6𝑚 ∗ 1.41 = £2.256𝑚.

20
https://siblisresearch.com/data/ftse-100-cape-pe-
yield/#:~:text=The%20current%20Shiller%20PE%20of,P%2FE%20is%20currently%2017.55. (Date
accessed:05/05/21).
21
https://www.linkedin.com/pulse/seed-stage-valuations-london-too-high-john-spindler/
22
https://www.cbinsights.com/research/report/how-to-value-a-company/
 Method 3 – DCF (Discounted Cash Flow) method

Figure 5.2 shows the EV in the three outlooks using PAT values in Figure 3.4, 3.6 and
3.8 with the discount rate (assumed): 15%.

Outlook 2021 EV 2027 EV Total capital

invested by VC.
Bad £1,489,248 £2,165,486 ∗ 17.55 £1,540,500
= £38,004,287
Conservative £4,281,889 £3,704,557 ∗ 17.55 £1,540,500
= £65,014,970
Good £14,891,600 £16,687,069 £1,540,500
∗ 17.55
= £292,858,061
Figure 5.2

Consequently, DeepGears valuation of £1,500,000 is both fair and appropriate.

However, their 2025 EBITDA has been overestimated. £1,540,500 capital required
over the 6 year investment period.

10. Deal
a. Deal description

Debt cannot be used by DeepGears to fund this operation – no cash flows and will get rejected by
banks. Hence, VC must provide seed funding in exchange for equity. Figure 5.3 shows the total cost
of seed funding for the VC.

VC investment £1,540,500
Cost for due diligence, lawyers etc. (10%) £1,540,500 ∗ 0.1 = £154,050
Total ≈ £𝟏, 𝟕𝟎𝟎, 𝟎𝟎𝟎
Figure 5.3

Figure 5.4 shows the share split required to achieve 40% IRR in the three outlooks.

Owner of Pre-deal Post-deal

shares
Bad outlook Conservative outlook Good outlook

Share split Invested Share split IRR Invested Share split IRR Invested Share split IRR

VC 0 0% £1.7M 3,400 34% 40% £1.7M 2,000 20% 40% £1.7M 440 4.4% 40%

Management 9,000 90% £2.8M 5,600 56% 40% £5.95M 7,000 70% 40% £33M 8,560 85.6% 40%

Other 1,000 10% £0.15M 1,000 10% 152% £0.15M 1,000 10% 175% £0.15M 1,000 10% 254%

Figure 5.4
Using the bad outlook, the VC would exchange £1,540,500 for 34% (3,400 ordinary shares) of
DeepGear’s equity. Hence, £1.7M invested by the VC would achieved the required 40% IRR.
Whereby, basing the share split on the conservative or good outlook would not allocate the VC a
substantial proportion of the shares and will be a high risk investment.

b. Deal structure

A ratchet should be used if VC’s proportion of shares value doesn’t achieve the targeted 40% IRR,
then the management would make up the difference through selling their shares or taken from
DeepGear’s company profits. However, if management overachieve VC’s required IRR, then the VC
will either sell their proportion of shares and return the excess cash to management as a bonus or
return the excess proportion of the shares to management. Hence, aligning management’s and VC’s
ambitions by encouraging them to work harder. Also, the VC can sell their proportion of shares
whenever they please and can force the management team to sell their proportion.

11. Exit
a. Exit valuation and IRR

Figure 5.5 shows the 2027 estimated exit valuation and IRR in the three scenarios.

Scenario Exit valuation – VC’s proportion VC VC IRR

2027 investment multiple
Bad £2,165,486 ∗ 17.55 £38,004,287 ∗ 0.34 £1,700,000 7.60 40%
= £38,004,287 = £12,921,458
Conservative £3,704,557 ∗ 17.55 £65,014,970 ∗ 0.34 £1,700,000 13.00 53%
= £65,014,970 = £22,105,090
Good £16,681,364 £292,757,938 £1,700,000 58.56 97%
∗ 17.55 ∗ 0.34
= £292,757,938 = £99,537,699
Figure 5.5

b. Potential exit routes

Potential exit routes include trade sale, secondary buyout or IPO. The optimal would be a secondary
buyout, because it allows the VC to get out the investment quickly and cleanly – retaining more from
the sale. Also, this allows the management to retain their shares and keep on growing the business –
shareholder alignment. I would recommend keeping the IPO option open, in particular, if revenues
follow the good scenario, then widder attention of the company will form and could result in a
bidding war driving up DeepGear’s valuation. Therefore, I recommend a review to be conducted in
2024 to decide whether an IPO will be the best exit route, and begin having DeepGear’s financial
statements audited. However, this will result in selling management’s shares and rebuying the other
10% of shares. Hence, optimal exit route is secondary buyout.
 12. Appendix

6. Uncertainties and risks

b. Sensitivity analysis

The following table shows an example as to how DeepGear’s revenues have been calculated
in the bad outlook – assuming the software product can be applied across the entire range
of their client’s/business’s products :

Year Micro Small Medium Large

2027F 66 4 2 0

DeepGear’s revenue for 2027F = ((66 ∗ £1,626) + (4 ∗ £3,047,170) + (2*£19,277,778) +

(0 ∗ £259,625,000,000)) ∗ 0.05 = £3,073,858.
Assumptions made and reasoning:

• Contracts will be first signed with smaller businesses and larger businesses will be added
overtime, due to large businesses being reluctant at the start and more
information/data will need to be collected to showcase the benefits of DeepGear’s
software product in reducing return rates and improving revenues.
• 2021F – means 2021 forecasted figures, which have been started halfway through the
year – month 6.
• Estimated annual cost for server is £5,00023.
• One time cost to build a website is £5,50024 with annual upkeep approximately being
£1,00025.
• Annual salaries have been assumed to be £30,000 for 5 employees totalling £150,000.
• Marketing costs for 2021F (2021 forecasted) are assumed to be £10,000 and increase by
£20,000 thereafter.
• Assuming the 3 companies wanting to test out DeepGear’s software product in Q3 of
2021 are micro companies.
• Tax rate is assumed to be 20%.
• Annual patent cost is £4,50026 (middle of £3,000 and £6,000). Plus an additional £4,500
for upkeep and enforcement of the patent.
• Annual cost of installation and support for the clients are assumed to be £1,000 annually
for a Micro business and this increases by a factor of 1.5 for larger businesses, as shown
in the table below:

Micro Small Medium Large

Annual installation and £1,000 £1,500 £2,250 £3,375
support cost

23
https://www.manxtechgroup.com/how-much-will-a-server-cost-uk/
24
https://www.adzooma.com/blog/average-cost-uk-marketing-
agencies/#:~:text=The%20average%20prices%20for%20marketing,%C2%A32412.50%20per%20project
25
https://www.websitebuilderexpert.com/building-websites/website-maintenance-cost/
26
https://www.dehns.com/site/information/information_sheets/the_cost_of_a_patent/
• The cash flows have been forecasted for 6 years in advance as it’s assumed the VC will
aim to exit around 2027F of the investment period.
• Values may not be exact in this investment proposal, due to rounding.
• No debt assumed to be present in DeepGears.

Bad Outlook:

Assumptions made:

• Assuming DeepGears don’t manage to complete their commercial product by Q3 of

2021 and are delayed. Also, if they do complete it but none of their 3 potential
customers sign deals with them. Hence, no companies signed on (sluggish start).
Advertising campaign should kick in to attract customers.
• Number of Micro companies starts at 0, then +6 and then +12.
• Number of Small companies increases by +1 each year from 2024.
• Number of Medium companies increases by +1 from 2026.
• No large companies sign on.

Conservative Outlook:

Assumptions made:

• Assuming DeepGears complete their commercial product by Q3 of 2021 and sign

contracts with 2 of their 3 potential clients. Advertising campaign again should kick in to
attract customers.
• Number of Micro companies starts at 2 and then increasing by +12 each year.
• Number of Small companies starts at 0, then increasing by +1 from 2022 and then by +2
from 2024.
• Number of Medium companies increases by +1 from 2025.
• No large companies sign on.

Good Outlook:

Assumptions made:

• Assuming DeepGears complete their commercial product by Q3 of 2021 and sign

contracts with 3 of their 3 potential clients. Advertising campaign again should kick in to
attract customers.
• Number of Micro companies starts at 3 and then increasing by +18 each year.
• Number of Small companies starts at 0, then increasing by +2 from 2022 and then by +3
from 2023.
• Number of Medium companies increases by +1 from 2023.
• One large company signs on in 2027.

9. Investment requirements

b. Price/Valuation

The PE ratio used is the 12 month trailing PE ratio of the FTSE 100 standing at 17.55, because
it reflects the UK market, wider impact on the pandemic on the top performing companies
and the economic conditions experienced in the past 12 months.
 Method 3 – DCF (Discounted Cash Flow) method

The calculation below shows how the 2021 EV has been calculated in the bad
scenario:
£147,714 £82,142 £107,431 £280,575 £1,223,031
-£97,500 - - 2
+ 3
+ 4
+
(1 + 0.15) (1 + 0.15) (1 + 0.15) (1 + 0.15) (1 + 0.15)5
£2,165,486
+ = £1,489,248 (Rounding of PAT values)
(1 + 0.15)6

10. Deal description and structure

a. Deal description

The VC invests a total of £1.7m and their targeted IRR is 40%. To calculate the required
number of shares, for example, in the bad scenario the formula would be £1.7𝑚 ∗
(1 + 40%)6 = £38,004,287 ∗ 𝑉𝐶′𝑠 𝑝𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠. Hence, VC’s proportion of
shares = 0.3368…= 34% or 3,400 shares. DeepGear’s management shares would consist of a
56%
total of 100%-34%-10% = 56% or 5,600 shares and would have a value of £1.7𝑚 ∗ 34% =
£2.8𝑚. Also, for the other shareholders, it’s assumed their initial investment is £150,000 in
exchange for 10% of the equity and from this number their IRR is calculated.