MGMT 926

Allen Milewicz S01147116

On my honor, I have not received any authorized assistance in the completion of this assignment

Sarah Jenks-Daly
What is the main problem? The main problem is arriving at a value for CNXs investments in Saratoga funds. According to the terms of their contract, CNX owes Saratoga 20% of the realized and unrealized gains upon termination of the relationship. The investments have been evaluated by two different analysts, with values ranging from $21 million to $9.3 million. The initial investment was $10.6 million. CNX owes Saratoga anywhere from $0 to $ 2 million depending on the valuation. Reasoning The difficulty is that the problem requires assigning a value to variables that defy quantification. The extreme differences in values were primarily the result of the application of different valuation methodologies. Alpha/Beta employed the discounted cash flow technique, based on expected cash flows and an assessment of an appropriate discount rate. Stephen Andrews had relied much more heavily on actual transaction prices for past financings. The valuation of these investments is based on extensive calculation and precise manipulation of projected revenues, forecasted cash flows and estimated growth rates. It is extremely difficult to arrive at a precise valuation of any of these companies and to do it accurately for all eleven is even less likely. It appears that the Alpha/Beta valuation may be on the high side, with a very low discount rate, failure to include changes in the equity and VC market, and ignoring the implied value at the time of financing. It is also possible that Stephen Andrews is slightly pessimistic in his projections for future revenues. Sally Jenks-Daly seems to arrive at values between the two, but closer to Andrews' valuation. The answer to the correct valuation depends on deciding on the correct valuation method and convincing the other side of the superiority of that position. Convincing the other party of the superiority of the alternative method seems like a difficult if not impossible task. Accepting any valuation involves risk for both parties CNX may pay too much, and on the other hand, Saratoga may lose by selling too cheaply.

MGMT 926

Allen Milewicz S01147116

On my honor, I have not received any authorized assistance in the completion of this assignment

One way to settle this transaction is for CNX to give Saratoga an equity share of its investments as payment. The advantage of this approach is that it carries the risks and unknowns forward for both sides. If Andrews is correct, then CNX will have given away a small percentage of something that is not worth very much or zero. CNX would not have compounded its losses by writing another check, especially one as high as $2 million. If Alpha/Beta is correct, then CNX owns slightly less of a winner(s) but hasnt paid more money for losers. From Saratogas point of view, an equity stake is better than 20% of realized and unrealized gains to date. If Alpha/Beta is correct, there are large gains in the future, and Saratoga will own part of it. The issue now become deciding how much of an equity share is appropriate to transfer. If Alpha/Beta is correct and the portfolio is worth $20 million, CNX would owe $2 million. This would make a 10% equity share the absolute upper limit on the offer. Since CNX is offering an equity stake with a potential high up side, it should offer a significantly lower percentage. An equity stake of 3-5% of the portfolio is reasonable. Recommendations A fair compromise is to carry the risk forward. CNX should assign 3% of its holdings to Saratoga as payment. In this way the upside/downside risk is transferred. The payment for the 20% gain is converted into a 3% equity share. If a particular company does well, Saratoga realizes its profits. If a company folds, CNX has not compounded its loss with a cash payout. CNX does not have to pay out any additional cash, and Saratoga could conceivably realize more than the 20% of gains that it is currently due, if any of these companies do well. This will preserve relationships in the future for both CNX and Saratoga in the event that the new fund manager with two years of experience does not work out.