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Video transcript
- [Voiceover] Where I had left off in the last video, we had talked about the scenario where my buddies and I we came up with this idea to sell socks online. We went to a rich investor we call an Angel investor who's usually kind of a rich uncle type of figure who gets excited by young guys innovating in the world. We say "Hey, we need $5 million." He says sure enough, I think the idea you have by itself or maybe some kind of prototype you might have made or something. That's worth $5 million. I'll give you another $5 million of cash to get started, rent some space, hire some people and for that since what you had was $5 million, that's what you're bringing to the table. I'm bringing $5 million cash to the table, I essentially get half the company and the way that works is it's not like we each gave him half of our shares instead since we are the board of the company, we issue another million shares. We doubled the share count and we give it to him. This pre-money valuation's really, really important because if we had agreed, if we said this wasn't five million, if we said that this is, I don't know. Let's say if he is a hard negotiator, he says "No, that's only worth a $1 million," and I'm going to give $5 million. Let me ask you, how many shares would we have to issue? Think about it. If he was a hard negotiator, let me draw it down here so I don't want to mess up the issue. Because our idea I mean really is a hard thing to estimate what an idea is worth. He negotiates hard, at the end of the day we're desperate, financial markets have collapsed so we'll take money from whoever's willing to give it to us and we really want to quit our jobs. He says that what we have right now, our idea is only worth a $1 million. He's going to give us $5 million. How many shares do we have to give him? This right here, this is a million shares. That's what we started off with so when he says that what we have right now is worth a $1 million, he's essentially saying that's it's worth a dollar per share, a dollar per share so my 200,000 shares are worth $200,000 according to his valuation. Up here we said that what we had before is worth $5 million in the previous video. If what we had before is worth $5 million and there were a million shares initially. This was the million shares then the pre-money valuation or actually it's the valuation either pre or post money would be $5 per share. In the $5 per share world, what we did was we issued another million shares and sold them for $5 million or we sell them for $5 per share to get the $5 million and so we ended up with a 50, 50 split of the company. This is the Angel investor and this is all of us down here. All of this is equity. No debt, no liabilities just yet. Now in this reality if he's valuing what we have right now at essentially $1 per share. His is worth a $1 million, you have a million shares. It's $1 per share. In order for him to give $5 million, he's essentially going to buy $5 million worth of stock at $1 per share. He's essentially going to need five million shares, five million shares. Notice in this situation up here before when I have 200,000 shares, well when I had 1/5 of $5 million, that was five million. When I had 1/5 of $5 million, the value of my shares was $1 million. Then when I have 1/10 of two million shares, I still have 1/10 of $10 million of total asset because now he threw in his $5 million. My share is still worth $1 million of it. I have a tenth of 10 million as oppose to a fifth of five million. In this situation, I used to have a fifth of one million which would be $200,000. Now I have 200,000 over, how many total shares are there now? There are now six million shares. Now I have 1/60, is that right? I have 200,000 and I have 200,000 over six million, that's 6,000,000 so that cancels out. I now own 1/30 of the company, before I had 1/5 and were valuing it at six million because I have a million here and five million here times six million. What's 1/30 of six million? 1/6 over 30 is equal to 1/5 of a million, so this is still $200,000. No matter what I do, between the pre-money and the post-money valuation, my per share value doesn't change any and I want to show you that but this matters a lot because based on what this pre-money valuation is, it tells us how many shares or what percentage of the company our Angel investor gets for investing his $5 million. In this case he gets 5/6 of the company. What is that? Five times, that's like 80% of the company. I think roughly and we are left with the other no 1/6 is, right. 1/6 no, it's more than 80. It's like 84% and we're left with like 16% of the company. It's a very different scenario depending on what our pre-money valuation is and of course the pre-money valuation is just you just take the pre-money valuation plus the amount of cash they're given and that's the post-money valuation. The amount of money you get, pre-money and then post-money, you have the money in and that's you get the $6 million valuation. Fair enough, I think I've beaten this horse dead now. I think you have a good sense of it and let's say that we end up lucky. The guy wasn't a hard negotiator and we ended up with that first situation. Let me redraw it. Now, if I were to draw the assets of this corporation, the assets of this corporation at least at the time of that guy's investment where it's a very intangible asset. We call it the idea, it now has a value $5 million and we have some cash, we have five million in cash and then if we do the shares, so we do that in another box. There you go, there are the shares and of that share we'll have two million shares outstanding, two million shares. I have one million to the Angel investor, he has 50% of the shares and just because I like to keep track of my slice. There's 200,000 shares that go to Sal. Fair enough. Now I mean obviously the whole point of this wasn't just a negotiate and raise money and quit our jobs. The whole point of this was to start a business. Let's say we take this $5 million, we start hiring people and really our first step is to build out our website and just have a working site going. Let's say we burn through $4 million of that and we build a site. Let's say, we only have a $1 million left. This is maybe six months in the future we all quit our jobs, we got some fancy loft like office space. We got a foosball table and we also built a website, we hired some graphic designers and things. We've burned through most of our cash and were starting to get a little bit worried because we haven't made a profit yet but we have a neat website, we have a neat website. When we went to the Angel investors, we just had an idea, a business plan and we just have, hopefully we had our charisma and we were able to sell the guy on the idea, he thought we're going to be the next dominant sock player in the world but now we actually built something. We took his money and as promised, we built a nice website and now we need to raise more money one, because we've hired 50 people and this $1 million isn't going to last us too long and that would be a shame to run out of cash just when we're getting off the ground. We now actually have a real website and offices and all of that and we want to raise some money because we want to put up some AdWords on Google so people know about our site. We want to spend a couple million dollars for Super Bowl ads so people know that they can get socks online now. We have to raise more money and now at this stage, we would go back to the venture capital community but we wouldn't go to the Angels. The Angels are the guys who like the big picture who want just to throw some money into an early idea. It's usually a relatively small amount, actually $5 million would be a large amount for an Angel. We want to go to real professional VCs now and what we would do is we would go to a seed VC. Seed VCs are kind of the first round and each round is every time you have to go back to the till to raise money, that's kind of a round of financing but Seed Investors, so there's a lot of words for it but seed investors are usually VC investors who are actual professionals at what they do. They're actually managing other people's money and we'll do another video on how they raise that money and it's very related to how private equity confirms and hedge funds also raise their money. They are usually managing other people's money while an Angel investor is usually, he's just sitting on top of a big pile of money and likes to play with it. They're managing other people's money and they intend to have some fancy NBAs that they just hired who'll make models and do projections and negotiate a little bit harder with you when you're actually trying to get a value on your business but we have to go to these guys. They have some value, I mean they all connect us with other dudes and they have experience starting businesses. They can introduce us to other people who've done similar things and all the rest help us network and help us manage the business. We go to a venture capitalist and we get the door closed a lot of times but that's what one venture capitalist, one seed venture capitalist finally comes to us. The terminology can be a little ambiguous here but we'll call it our Series A financing, Series A. Sometimes it will be called your seed financing but we'll call it Series A because we want to formalize it. Just so you know, the A is because it's our first real formal round of financing. In our second round which I'll do probably in the next video, it would be Series B and then Series C and then Series D. Every time we run out of cash, we want to go back to the till. We've already done the Series A, now we want to do a Series B and a Series C and so forth and so on and eventually we'll hopefully get to some type of an IPO which I'll talk about in the next video because I just realized I'm out of time again.