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Finance and capital markets
Unit 6: Lesson 5
Life of a company--from birth to deathGoing back to the till: Series B
More on the series A financing. Going back for another round with a series B financing. Created by Sal Khan.
Want to join the conversation?
- Sorry to seem dumb, but i'm wondering: "Does creating new shares cost money?"
please help i'm a little confused(12 votes)- There are administrative/legal costs associated with issuing and registering the shares but the shares themselves don't cost money per se. The issued shares do however represent ownership of a fraction of the company so they have value. Say you had a company with only five shares and five shareholders. Each would hold 1 of the 5 total shares. If you issued 5 new shares and gave one to each of the existing shareholders they would each have 2 out of the 10 total shares. That would mean that they each still held 1/5 of the total shares and consequently each still own 1/5th of the company. If however you gave those new shares to 5 new shareholders then the original 5 shareholders would each only own 1/10th of the shares (1 of 10). In this case the "cost" of issuing new shares is primarily that the percent of the company that the original shareholders owned would be diminished by the creation of new shares. This is called dilution, because the ownership percent of the original shareholders is diluted by bringing in additional shareholders. Whether it is worth it depends on what the original shareholders got in exchange for the new shares they created. Most of the time what they get is cash they need to pay expenses, so it's worth it. New shares can be given in exchange for other things too, such as patent rights, legal services, or even just as bonuses for executives. As far as the administrative/legal costs, A company I follow recently issued 1.2 million new shares and it cost them a bit over $50,000 in administrative fees. I hope that helps.(25 votes)
- Is there a law or something that prevents the entrepreneurs from just taking the venture capitalists' money and letting the business fail yet keeping the money?(6 votes)
- For the business to genuinely fail, they'd have to lose the money. Keeping it would be equivalent to fraud, as it doesn't belong to them, it belongs to the company.
So yes, there are laws to stop this from happening.(12 votes)
- How exactly does the Angel value our idea? Wouldn't he want it to be valued as low as possible? So that he can get more equity in the company?(5 votes)
- Yes, that's part of the bargaining. The angel wants the value as low as possible, and the entrepreneur wants it as high as possible. They have to come to an agreement, this is why he says "You go around and some people just close their doors to you." Because if you're asking for $10 million for a website that sells pet supplies, investors might scoff (unless it was the late 90's)(5 votes)
- AtSal was talking about how VC mentality revolves around the idea that they run the risk of loosing on 10 of the investments they make but make a return on one. I was wondering if there is a specific theory that goes with this and do they diversify their portfolio in order to try to mitigate their losses? 2:50(4 votes)
- They diversify just by not making their bets too large a portion of their total portfolio.(4 votes)
- Khan, I have a question.
when you get investors, how do you communicate/get them do you jus find (say for the sock example) do you call up the for example, Old Navy store and ask to see the head honcho? Or do you have to go to wall street. Sorry i'm still in middle school and am just getting interested.(3 votes)- From what I know about the VC world, finding investors typically comes as a result of searching and networking. So in certain cities (most prominently San Francisco/Bay Area), there is going to be a community of angel investors and venture capitalists from which you can solicit funds. I imagine that with the angel investors it a "who you know" situation where you have a friend who has a friend who is an angel investor. With the venture capitalists (and VC firms) you can directly solicit or apply to receive money.(2 votes)
- If it is to the advantages of the VC’s to lower the pre-money valuation (so that their investment worth more), why wouldn't they do that (what factors would make the VCs want to have higher pre-money valuation)?(3 votes)
- Hey Sal,
I was wondering when raising capital, is it a must to issue more share (dilute shares), or can the stock holders just give share but the remaining shares will be equal to the share before
Example A
100 shares, 1 share equals $1
they have two share holders each having 50 share
but a venture capitalist gives another $100.
This brings the companies value up 200 dollars.
now instead of issuing 100 more shares cant the share holder just give 50 shares to the venture capital and the rest 50(1 vote)- The problem with this is that the money for the shareholder shares would go to the Shareholders, not the company. If the purpose is to raise funds for the company, then the company has to issue the shares and receive the money for the new shares.
If the company does not need new funds, a new investor can purchase the shares of the existing shareholders to gain a share of the company and give the existing shareholders some liquidity/cash.(3 votes)
- Don't you individually have $300K worth of value by the end of Series A?(2 votes)
- No. You own a lesser percentage of the company at a higher value per share. So in effect, you end up with the same overall worth. In this case, $200k. Agreed?(1 vote)
- If the same VC doesn't fund the company in Series B, does it mean that the valuation of the company has gone down or that the company is not profitable? How does the company justify not getting the amount from the same VC?(1 vote)
- It only means that the series B VC is willing to give the company a better deal than the series A VC.(2 votes)
- Sal- Would you go back to the same VC's for different rounds of financing? What are the pros/cons of this approach?(1 vote)
- Just to answer Paul question. Yes there might even be VCs that have different department specialized in each of the levels of a company. So you might have different level of funding depending on what the company maturity is at. However you might want to keep your options open since negotiation might be different.(1 vote)
Video transcript
Where I left off in the last
video, my buddies and I, we had a business plan. We had a great idea to
sell socks online. We went to an angel investor. He had originally given
us $5 million. He valued what we already had
at $5 million dollars. So, since he was giving us $5
million and we had $5 million, he got 50% of the company. And we have the other 50%. We have two million
total shares. And we took four of that
million, let's say six months have passed. We hired 50 people, and we
finally built a working version of our website. But we now are about
to run out of cash. We still haven't started selling
things, and we'll actually have to start selling a
lot of things before we have enough money to support
ourselves. So we need to go start
raising money again. And we also want to spend money
marketing and all the rest. So we go to some
professional investors. We'll go to seed venture
capitalists, and we're going to do our Series A
round of funding. Which just means our first kind
of professional venture capital round of funding. We finally-- some guy finds
a team that, they like us. And we start getting
to the negotiation. They say, you know what? You guys say you need
$10 million. We believe you. We know that that's what it
takes and we think you have a good business. So, let's see, let me say that
we need to raise $10 million. Just so I make that clear. We need it for ongoing
expenses. And of course we'll have a big
business plan and everything that further fleshes this out. And we also have need-- we're
going to do some marketing, et cetera, et cetera. So they say, you know, we have
$10 million and we think this is a hot space, because we know
those other VC's across the street also invested in an
online undergarment play. And we know that that's the
hot thing right now. So we're also going to do it. So the question now is,
what do they get for their $10 million. So once again we get into
this what is the company worth right now? So once again, they're going to
do a pre-money valuation. So what is this whole thing
worth right now? So they'll say, the
idea's good. They won't break down. They won't say oh, the idea
is worth $5 million. But the general idea is,
hopefully, from that stage where the post-money valuation
was $10 million, right? Back here it was $10 million. Then we did a bunch of work. We used some of this
$5 million. We did a bunch of work. Hopefully we added value. If we added value, our value of
this stuff now, this-- we turned this cash into other
types of assets like a website and other things, and knowledge
in our firm, and expertise, and all that stuff. Hopefully now, what we have here
is worth more than $10 million, right? Otherwise we kind of
destroyed wealth. And all of this is
very intangible. It's very hard for someone to
really place a value on things at this point. A lot of VC's, they kind of
swing for the fences. They're like, you know what,
these guys have a 10% chance of being worth a billion
dollars, and a 90% of being worth 0. If I make 10 of these bets, at
least one of them is going to pay off and make
my whole fund. And so that's how they
kind of think. So at this level, they'll do
some hard negotiating. But it often times is going to--
not at this level, this is where we are right now-- it's
kind of what other people got for this stage
of a company. They say oh, you know,
you have a pretty good built-up website. Those other guys who had a
pretty good built-up website at this point, those guys across
the street, they had to pay-- they had to give a $20
million pre-money valuation. But you know, you guys are a
little bit-- your market isn't quite as big as the broader
undergarments market. You're just socks. So the opportunity
isn't as big. So we'll give you a $15 million
pre-money valuation. So they're saying that what
we have right now is worth $15 million. And that's pretty good. If that were reality, if it
really is worth $15 million, then what are our shares
worth right now? Notice, they haven't
given us any money. This is the pre-money
valuation. So $15 million divided by two
million shares, right? That's how many we
have right now. So what is the value
per share? 15 million divided by 2
is $7.50 per share. That's pretty good. Because back here-- remember,
this is kind of a scenario that didn't happen, that was
kind of a negative scenario-- but back here when the pre-money
was $5 million for a million shares, it
was $5 per share. Then it became $10 million
for two million shares, still $5 per share. But before and after this round,
that angel said oh, your shares are worth
about $5 per share. Now this VC, who is a
professional investor and has teams of MBA's making
spreadsheets for him, says that actually, what we
have right here is worth $7.50 a share. So just over those six months
we actually got a 50% return on our shares, if you
believe that. And the angel investor's
happy. He feels good about it. This was vindication
for his bet on us. So we feel good. We feel like we've given
him, at least in the short term, a return. So anyway, we get a $15 million
pre-money valuation. And I'll let you think
about this one. What's the post-money
valuation? What happens when you layer on
the $10 million from this venture firm? Actually, just to make the math
simple, let's say that we're raising 7.5 million. Let's say that we wanted 10
million, but we were hoping for 20 million pre-money
valuation, because that's what the other guys got. And since they're only giving us
a $15 million pre-money, we just don't want to take as many
shares from them, because we don't want to give as much
of the company away. So we're just going to take $7.5
million, because we think that's just enough that
we need to keep going. So we do that. We take $7.5 million from this
seed venture capitalist. And he essentially valued our old
shares at $7.50 per share. So, for $7.5 million at $7.50
per share, he should get another million shares. So what we're going to do--
this angel investor is probably sitting on our board
now because he owns so many of the shares. The board of directors of a firm
is essentially elected by the shareholders. So if you have 50% of the
shares, you can put yourself on the board. You could probably put some
other people on the board of directors as well. So, we had two million. These guys get a million. How many shares do
we have now? We now will have three
million shares. So we had to issue another
million shares. And what is our post-money
valuation? Pre-money was 15. We have $7.5 million now. Our post-money valuation
is $22.5 million. And now, what percentage
do each of us own? So the angel investor owns one
million, not out of two million shares like
he used to. He now owns one million out
of three million shares. So now he owns 30%. The seed VC, he has a million
out of three million, so he owns-- well this is 33
and 1/3%-- the seed VC owns 33 and 1/3%. And then me and my buddies, we
collectively own 33 and 1/3%, and I have 1/5 of that, so
I have a little over 5%. So the founders, that's us, we
still have about a third of the company. And now we have the $7.5 million
we just raised, plus we have the million dollars
in cash we had before. We have $8.5 million to keep
on going with our business. Fair enough. So let's say another
six months go by. So our old balance sheet-- let
me draw all of the shares-- I want to do a couple of more
rounds of financing before I take the company public. So this is my slice down
here, $200,000. This is the angel investor. This is the seed VC. And then, of course, let's say
after, I don't know, another six months we burn
through the cash. We've marketed the website, we
have only $1 million left. And that's usually our trigger
point for when we want to raise more money. In fact we probably would have
to do it at $2 million because we've raised more employees, and
we're burning more cash. Your cash burn is essentially
how much cash is going out of the door every month, because
your business still isn't making money. And of course you have all of
the assets of the firm, which essentially, it's a website,
and offices, and the knowledge, some of
it intangible. So, website, and everything
that comes with it. Your brand now, you probably
have, because you've marketed. So people recognize
socksonline.com. I don't know if that already
exists so forgive me if I'm actually somehow insulting a
real business out there. But you have a brand now. And so you're almost ready. You're actually generating
revenue. But you're still kind of
cash flow negative. You're burning less money
because people are actually going to your site. They're buying stuff. But you just need a little bit
more money, you think, to get profitable, right? Once you get this amount of
money, you're ready to go. So you go to another VC. Once again, a lot of
them turn you away. But one guy finally says OK,
I'll give you some money. And you say, you know
I need $5 million. He says, fair enough. I'm going to value your business
at-- let's say we're in an optimistic world, so
we're doing up rounds. Up rounds are when your
pre-money valuation of this round is more than the
post-money valuation of the last round. So the value is going up. You are creating value. It would be a down round-- like
here, they valued us at $15 million. While the post-money of our last
round was $10 million. So that was an up round. If these guys said no way,
the world has changed. We're only going to value all
of this stuff at $8 million, then that would be a down round,
and no one's happy about that. We'll talk about the
repercussions of that in the future, why down rounds
aren't good. So often times, you actually
don't want to get too good of a valuation. Because if you get too good of a
valuation, in the next round it might be hard to get people
who are going to give you a better valuation. You might be forced to take
a down round, which has negative aspects. But just quick and dirty, you're
a prominent brand now. It's a little easier for
you to raise money. You go to some VC who
specializes in kind of helping people get to that profitability
stage. And what you do is you
raise your Series B. And just to put it simply,
it's an up round. Your post-money from your last
round was $22.5 million, right? $22.5 million. You've generated some value. So now they say,
you know what? Your business is worth
$30 million. And you need another
$10 million to really pump up the marketing. How many shares do they get? Well the pre-money was $30
million, we had three million shares, so they're assigning us
a value of essentially $10 a share, which is great. Remember the first round, the
angel gave us $5 per share? Second round we got
$7.50 per share. And now we're getting
$10 per share. So if we're selling him shares
at $10 per share, we just have to issue another million shares
to get $10 million. It's another million shares,
and this goes to VC2, the second VC. And that's our Series B. We raised $10 million. Fair enough. So we've done one round
of angel investing. And then we've got
our Series A that gave us the $7.5 million. Then we did our Series B that
gave us $10 million. And we could keep doing this,
Series C, Series D, and so on and so forth. And I'll continue this
in the next video.