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Getting a seed round from a VC

Series A funding from a seed venture capitalist. Created by Sal Khan.

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  • piceratops seed style avatar for user kleinebre
    -- Why would an angel investor spend 5M on an idea that's considered to be worth 1M?
    (30 votes)
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    • blobby green style avatar for user Henry
      The angel investor is not purchasing the idea for $5 million. He is investing in their idea by purchasing other assets (such as computers, labor, buildings,etc..) for the company (and idea) to use. Those assets are worth $5 million. So now the total value of the company is worth 6 million (5 million of the assets he bought and the 1 million dollar "idea") and he owns 5/6 of the company. He still has intact the $5 million he initially invested, but the $5 million isn't money any more, it's assets.
      (81 votes)
  • blobby green style avatar for user KnoMoreBabel
    So how does one determine pre-money valuation?

    It can't be completely arbitrary, but it seems like it's not explicitly bound to factors like actual dollars invested on the books, or material equity like printing equipment.

    Thank you.
    (6 votes)
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    • blobby green style avatar for user Henry Sohn
      Actually, it is pretty much arbitrary. Ultimately, it is all a negotiation. How do you determine the value of anything? It's supply and demand. A Picasso will be highly valued because there is quite limited supply (one of each work), and considerable demand (lots of collectors who want a Picasso and who have money). A startup could try to point to other companies that are in a similar space/competitive position and argue that they should be valued comparatively. But if there are no easy comparisons, then it's a function of how many other investors you are able to connect with and get excited about your company (create demand), and how much you are willing or capable of holding out for a higher pre-money valuation. If the company doesn't immediately need the cash, and/or the employees are able to continue working with limited or no pay, then you could simply wait until someone agrees to a higher valuation. That's why you shouldn't wait too long before starting to raise money. You don't want to be squeezed into accepting a lower valuation if you can help it.
      (24 votes)
  • old spice man green style avatar for user Cato
    This has sort of been touched on already in the existing questions, but no-one's asked outright: Why is it better to print more shares for the new investor and not just hand over some of the existing shares?

    So in the first example, Sal and his buddies would start with 200,000 shares apiece and then hand over 100,000 each to the angel investor who doubles the company assets. There's no reason why this wouldn't still work (more or less) in the situation where the investor puts in $5m and the idea is deemed to be worth only $1m. Both hinge on the fact that the value of a share is pretty flexible -- it's just representing some fraction of the equity.

    The only problem I see is if there aren't enough shares to start with, a single share could become worth more than anyone would be willing to trade (e.g. if Google had only 100 shares it would be a disaster!). But if you start out with a billion shares, say, then you won't run into this problem unless you're really successful.
    (6 votes)
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    • blobby green style avatar for user harryschiff
      There is a huge difference between buying shares from a Company and buying shares from an Owner of that Company.

      If I have 100 Shares and give you 50, then you have bought those 50 shares FROM ME, and the money that you gave for them is MINE. I now owe the government tax on the profit I made on selling these shares.

      That's not what the investor wants - they want the money in the Company. So they buy Shares FROM THE COMPANY, i.e. the Company issues new Shares to them, and gets the money.
      (7 votes)
  • leaf green style avatar for user Rob Wilinski
    Is there a good source you can recommend for developing a business plan, or a KA video that covers that topic?
    (6 votes)
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  • starky ultimate style avatar for user Andrew
    I'm wondering how the company is still valued at 10mil after the start up, since, presumably, once the guys and their employees all have salaries they go and start spending it. Doesn't this deplete the 5mil portion given by the angel investor?
    (4 votes)
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    • starky ultimate style avatar for user Andrew
      That makes sense, say in the case of a website, which becomes an asset of the company's. But what about employee salary? That money goes to paying a mortgage, or breakfast at Denny's, or Christmas presents--in other words it no longer belongs to the company. What about that portion of the initial worth? It it translated into the purported worth of the employees themselves?
      (3 votes)
  • leaf red style avatar for user Beverly
    how do you "double the share count"?
    (4 votes)
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  • female robot grace style avatar for user Liane C Troutt
    What does Sal mean at by pre-money valuation?
    (2 votes)
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  • blobby green style avatar for user ian.krasnow
    So a business founder can value his idea at 5m in shares, then get an investor to buy 5m of shares, thus valuing the company as 10m. What would happen if the founder then sold off all his shares. Wouldn't that allow him to steal all of the angel investor's money?
    (1 vote)
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    • male robot hal style avatar for user Andrew M
      Usually the terms of the investment do not permit the founder to sell his shares until the investors have received some sort of payout or opportunity to sell their shares.

      Plus, who's going to want to buy the founder's shares under those conditions, with the founder leaving the company. As soon as the founder decides he's exiting, his shares are basically worthless.
      (5 votes)
  • purple pi purple style avatar for user Arcbound Ravager
    So companies can manipulate shareholders by just making more shares whenever. Also, could the company gain extra volition of its company decisions by printing more shares and pre-arranging to sell them to a friend?
    (2 votes)
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    • piceratops seedling style avatar for user Travis Bagley
      Issuing more shares depends on a lot of things. Generally those who run the company hold large amounts of shares in said company. Usually they do what is in the best interest of the company and therefore what is best to increase their own share price. Voting must also be factored in. A company cannot just issue new shares and give them away. If they are doing a secondary offering they are acquiring more capital so as long as that capital isn't wasted shareholder's shares still have the same monetary value.

      When companies issue more shares there are certain terms that come into play. Most often in order to prevent controlling interest being bought out from under the current leadership of the company, current holders of shares get first dibs. Usually a company's management will have the first shot to buy shares.

      A company's stock price includes shareholder's feelings about the company. If a company misuses capital shareholders will lose faith in the company and demand for the stock will fall. With a fall in demand comes a fall in price. Management doesn't want to destroy the value of the shares.

      A company can buy its own shares and give them to employees as long as voting allows it. Many CEO's receive bonuses of company stock. Many companies also offer their employees ways to buy shares of the company at a discounted rate.

      I think the confusion here is if there is someway to gain more control by limiting who can buy the new shares. You can't just give the friend first dibs. This is all something that has to be agreed upon by management and shareholders. Anyone with money can buy a piece of a public company. If I want to own the entire Coca Cola company and I have unlimited funds I can sit there and just keep buying and buying shares until no one will sell to me. If no one will sell I have to either up the price I will pay or wait. Generally anyone will sell you something for the right price.
      (2 votes)
  • male robot hal style avatar for user e3.kumar
    How would management work if the investor gets 5/6th of the company. Wouldn't the investor now be the sole decision maker of the company?
    (3 votes)
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    • male robot hal style avatar for user e3.kumar
      How does that work legally? From other videos, I was under the impression that the equity holders had the power. Or is it that its more like a democratic state where the equity holders have some voting power but its management that holds all the decision making power?
      (2 votes)

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.