If you're seeing this message, it means we're having trouble loading external resources on our website.

If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked.

Main content
Current time:0:00Total duration:11:04

Video transcript

so whether I left off in the last video we had we had kind of 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 a rich uncle type of figure who gets excited by young guys innovating in the world and we say hey we need five million dollars 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 five million dollars so I'll give you another five million dollars of cash to kind of get started rent some space hire some people and for that since what you had was five million that's what you're bringing to the table I'm bringing five million dollars cash the table I essentially get half the company and the way that works is it's not like we gave we each gave him half of our shares instead since we are the board of the company we issue another million shares so we double the share count and we give it to him and this pre-money valuation is really really important because if we 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 we if you know he is a hard negotiator he says no that's only worth a million dollars right and I'm going to give five million dollars right so let me ask you how many shares would we have to issue so think about it he's if he was a hard negotiate down here so I don't want to mess up the issue if he because our idea I mean it really is a hard thing to estimate what an idea is worth so he negotiates hard in the end of day were 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 so he says that's that that what we have right now our idea is only worth a million dollars right and he's going to give us five million dollars so how many shares do we have to give him this right here this is a million shares right that's what we started off with so when he says that what we have right now is worth a million dollars he's essentially saying that it's worth $1 per share $1 per share so my 200,000 shares are worth $200,000 according to his valuation up here we said that what we had before was with Phi million dollars in the previous video right if what we had before is worth five million dollars and there were a million shares initially right this was the million shares then the pre-money valuation I have actually the valuation either pre or post money would be five dollars per share five dollars per share and in the five dollar per share world what we did is we issued another million shares and sold them for five million dollars or we sell them for $5 per share right to get the five million dollars and so if we ended up with a 50/50 split of the company right this is the angel investor angel and this is all of us down here and this is all of this is equity no no debt no liabilities just yet now in this reality if he's valuing what we have right now is essentially $1 per share he says worth a million dollars you have a million shares it's $1 per share in order for him to give five million dollars he's essentially going to buy five million dollars worth of stock at $1 per share so he's essentially going to need five million shares five million shares and notice in the situation up here before when I have when I have two hundred thousand shares well when I had 1/5 of a million of five million dollars that was five million when I had one fifth of five million dollars the value of my shares was 1 million dollars right and then when I have tenth when I have one tenth of two million shares oh I still have one tenth of ten million dollars of total asset value because now he threw in this his five million dollars and so my share is still worth 1 million dollars Evan I have a tenth of 10 million as opposed to a fifth of 5 million in this situation I used to have a fifth of to of 1 million which would be $200,000 and now I have 200,000 over how many total shares are there now there now 6 million shares right so now I have one 60th right is that right I have 200,000 and now have 200,000 over six six million right that's six thousand thousands that cancels out I now own one thirtieth of the company right before I had one fifth and we're valuing it at six million right because I have a million here and five million here times six million and so what's one thirtieth of six million one six over 30 is equal to one fifth of a million so this is still two hundred thousand dollars so no matter what I do my the 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 right because based on what this pre-money valuation is it tells us how many how many shares what percentage of the company our angel investor gets for investing in his five million dollars in this case he gets five sixths of the company five said what is that five times that's like 80 percent of the company I think roughly and we are left with the other know one-sixth is right one six notice more than eighty is like eighty four percent and we're left with like sixteen percent of the company so 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 right the amount of money you get you know pre pre money and then post money you add the money in and that's you get the six million dollar valuation fair enough I think I've I've beaten this horse dead now I think you have a good sense of it let's say let's say that we end up lucky the guy that wasn't a hard negotiator and we ended up with that first that first situation so let me redraw it so now if we 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 we're it's a very intangible asset we call it the idea it now has a value five million dollars and we have some cash we have five million in cash five million in cash and then if we do the shares let me do that another box oh there you go there the shares and all of that chair we'll have two million shares outstanding two million shares I have 1 million to the angel investor angel so 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 sell fair enough now I mean obviously the whole point of this wasn't just to negotiate and raise money and quit our jobs the whole point of this was to start a business so let's say we take this 5 million dollars we start hiring people and really our first step is to build out our website and just kind of have a a working site going so let's say we we burn through 4 million dollars of that and we build a site so let's say we only have a million dollars left this is you know 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 and so we've burned through most of our cash and we're 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 right something that you know when we went to the angel investors we just had a we just had an idea a business plan and we just have you know we just hopefully we had our charisma and we were able to sell the guy on the idea he thought it was you know we're going to be the next the next dominant soccer 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 money more money one because we've hired 50 people and this million dollars is going to last us too long and that would be a shame to 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 we want to put up some AdWords on Google so people know about our site we want to spend you know a couple million dollars for a Superbowl ad so people know that they can get Sox online now so we have to raise more money and now at this stage we 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 you know just to kind of throw some money into an early idea and they it's usually a relatively small amount actually five million dollars would be a large amount for an angel we want to go to kind of real professional VCS now and what we would do is we would go to a seed VC sow seed VCS are kind of the the first round and each round is kind of 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 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 firms and and hedge funds also raise their money but they are usually managing other people's money well while a angel investors usually you know he's just sitting on top of a big pile of money and likes to play with it so they're managing other people's money and they tend to you know have some fancy MBAs that they just hired will make models and do projections and and negotiate a little bit harder with you when you're when you're actually trying to get a value on your business but we have to go to these guys now they have some value I mean they'll connect us with other dudes and they'll you know 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 so we go to a venture capitalist and we get the door closed a lot of times on this but one venture capitalist one seed venture capitalist finally comes to us and the terminology can be a little bit big use here but we'll call it our series a financing series a sometimes it'll be called your seed financing but we'll call it series a because we want to formalize it and 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'll 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 a Series A now we want to do a series B in a Serie C and so forth and so on and eventually we will 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