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Going 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.

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  • blobby green style avatar for user ThomasMcGrath007
    Sorry to seem dumb, but i'm wondering: "Does creating new shares cost money?"
    please help i'm a little confused
    (12 votes)
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    • blobby green style avatar for user Bill B
      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)
  • leaf green style avatar for user jak
    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)
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  • male robot hal style avatar for user Aditya Joshi
    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)
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    • old spice man green style avatar for user TerryMHogan
      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)
  • female robot ada style avatar for user bubakerthefirst
    At Sal 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?
    (4 votes)
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  • blobby green style avatar for user ThomasMcGrath007
    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)
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    • blobby green style avatar for user yasare
      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)
  • leaf green style avatar for user Bing
    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)
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  • blobby green style avatar for user admin
    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)
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    • leaf yellow style avatar for user Mike Koss
      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)
  • blobby green style avatar for user rothenberg.matthew
    Don't you individually have $300K worth of value by the end of Series A?
    (2 votes)
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  • blobby green style avatar for user Nitya Das P
    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)
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  • blobby green style avatar for user paul.dicesare
    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)
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    • leaf blue style avatar for user Alexandro Colorado
      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.