Venture capital valuations for start-up companies bear no similarity to share valuations for profitable businesses, a concept apparently misunderstood by a consortium of doctors who lost their investment in Ecolibrium Biologicals and then tried unsuccessfully to claim more than twice the value of their original investment from company directors after Ecolibrium was wound up insolvent.
Ecolibrium Biologicals Holdings Ltd was the brainchild of microbiologist Stephen Ford. Based at Bombay in South Auckland, it looked to commercialise use of biological rather than chemical pesticides.
This venture eventually failed, the death-knell being receivership initiated by Mr Ford as secured creditor.
Ecolibrium’s assets were sold in 2022 to newly incorporated Cellora Ltd, with Mr Ford as minority shareholder. Ecolibrium shareholders received nothing.
During Ecolibrium’s start-up phase, a consortium of doctors led by Mitul Jesani agreed to put in seed capital. For Dr Jesani personally, this was an initial investment in 2018 of $500,000 giving her what was then a ten per cent shareholding.
Consortium members were later required to tip in further cash, typically as short term loans; some of which were converted to equity on terms that were never specifically agreed, the High Court was told.
Evidence was given off increasing tension between Ecolibrium management and the consortium as the company burned through cash. Short term loans were advanced to meet monthly bills, primarily wages.
Consortium members were not willing to front up with a large sum as part of further capital raising, but at the same time were against dilution of their current holdings.
They were to later learn that management voted through major constitutional changes to Ecolibrium without their knowledge, ignoring their rights to vote.
Ms Jesani sued, demanding the consortium be bought out at a price of $6.21 per share, valuing the company at ten million dollars. If successful, Ms Jesani would receive $1.04 million.
She said this was the value management put on the company prior to what she claimed was oppressive behaviour subsequently driving Ecolibrium into the ground.
The figure of ten million dollars was derived from management’s draft 2020 valuation of Ecolibrium intended to support a further capital injection from venture capitalists, a capital injection being proposed at a time when Ms Jesani and the consortium were discussing possibility of having their shares bought out.
No capital injection and no share buyout eventuated.
Giving evidence in the High Court, a valuer said no value could be ascribed to the company as at 2020 using normal valuation principles: no valuation could be assessed based on future earnings (there were no immediate prospects of future earnings and Ecolibrium was currently suffering substantial negative cashflows); and an assets-based valuation was not appropriate (product development was still only work in progress with commercial viability not yet established).
Raising venture capital for a start-up company is a back-to-front process: assumptions are made as to what a business might be worth in the future to estimate a future exit value on listing or sale, then working backwards to fix a share price to achieve the venture capitalists target return rate.
Venture capital investors realise most investments will fail, written off. They spread their investments across multiple business opportunities. If only ten per cent of investments prove profitable, losses might be recovered with overall returns potentially proving handsome.
Ecolibrium management’s 2020 ten million dollar valuation was more a pie-in-the sky estimate of future value than a then current valuation of their company.
Not surprising, management did not respond to the consortium’s request to be bought out at a share price based on this ten million dollar valuation.
In the High Court, Justice Robinson ruled circumstances in which Ecolibrium management ignored the consortium’s voting rights did amount to Companies Act ‘oppressive behaviour.’
No useful remedy is available, he said.
Ecolibrium is in no position to buy them out, certainly not at $6.21 a share; it is insolvent.
Majority shareholders responsible for any ‘oppressive behaviour’ could not be required to buy their shares; valueless now that the company is in liquidation insolvent.
At best, Ecolibrium should have been put into liquidation in 2020, two years earlier than it was, he said. Whatever value could be extracted from company assets at that time could then have been distributed amongst all shareholders, including the consortium.
Jesani v. Ford – High Court (11.06.26)
26.176