More on IPOs

I think a little bit of a review is in order now and maybe just taking a little bit of step back to say well why does a company even raise equity and what are the people who buy the equity even do it in the first place so the whole idea of what we're doing in the last several videos is that a company wants to raise money it wants to raise money to you know start a website or build a factory or do whatever else kind of invest in the world and its kind of productive capacity so it can build the things that the company is meant to build and in every example so far you know we have the example where you know meet my buddies we have just a business plan that's the asset and then we own all of the equity where the board of the directors initially so that's all the equity so let's call this the let me call this the assets right now this is the equity and we could go to a venture capitalist it could have an angel investor could have been you know we did we talked about Series A Series B all of that and we could say okay you know we need to raise X million dollars what percentage of your company are we have to give away for that and we'll say okay well we'll value what you have right now I'll do a different number than when I did in the past we'll value what you have right now is one million dollars and so if you need another two million dollars so let's say there's we value what you have right now is one million dollars let's say right now you have one million shares right so the company's pre-money valuation is a million so they're essentially saying that the company right now is worth $1 per share there's a million dollars worth of assets and there's a million shares so a million divided by million is $1 per share so they're valuing it at $1 per share and essentially they're saying that we're willing to give you or we're willing to buy more shares from you at $1 so if we give you let me see me do green I'll do a different color I'll do purple will give you the box will give you I don't know two million dollars will give you two million dollars and since we're buying it at $1 per share we get two million shares for that two million chairs for that so this two million shares and now all of this is the equity right this is what the founders had this is all the equity and so now there's the company has the what we say it was worth a million dollars this is kind of an arbitrary thing and we'll talk more about how you can actually value these intangible assets and things but now they had that and now they have another two million dollars so the post-money valuation pre-money was 1 million post-money is now 2 million and now we had 1 million chairs now we have 3 million shares so essentially for giving two million dollars these venture capitalists or whoever so these shares go to some VC or angel investor they have now 2/3 of the company they have 2 out of 3 million shares or 66% of the company for giving the two million dollars so that was kind of a private raise of capital and so you've probably heard the words private company and public company a private company is one whose shares are not traded on a public exchange so if this company wants to raise money by selling equity the only place it can do it is to venture capitalists or to private equity firms and we'll talk a little bit more about kind of the difference a venture capitalists really is a private equity firm because it's buying private equity but private equity tends to invest in more established business when people just talk about private equity by itself but we'll go we'll do several videos on that so this is essentially this company is a private company raising private equity now the example we did in the last video is you know let's say this company grows to a certain size let me just do another company so it's clean let's say I have another company these are all rights assets and this is its let me draw its current equity base right there they should be the same size but I think you get the idea hey you know these assets it could be you know have some cash it has some factories or land could have a bunch of stuff it could have some technology or because have some intellectual property you know maybe it's a drug company or maybe it's a technology company has a bunch of patents and stuff and then it has some intangibles you know a brand who knows what it has these are the assets of the firm this is the equity of the firm so this company right now has no debt and we'll talk about that in a second what it means to have debt right and this is current shareholder base maybe some of these are you know some VCS who invest in the company when it was private there's you know maybe the founder has these shares but this is the equity base right here and let's say this company wants to raise a lot of money and then this kind of a review of the last video it can do an initial public offering so right now it's private right all of the all of these shares right now that are owned by the VCS and there's the and the the initial founders of the company they're not traded on a public exchange this VC can't go to the Nasdaq and sell their shares they can't you know go to their broker and say hey sell my million shares I have in company X they have to just sit on them maybe they can find another private equity investor to buy their shares or you know and you know maybe these founders there's there's no liquidity here there's no other person they can sell the shares to and also if this company wants to raise money right now it has to kind of go to a VC and do a very kind of you know do the whole process where you negotiate what this value is what the pre money value is and they have to come up with all these legal documents and all of these all of these stipulations around you know we'll give you this money but if this happens and you have to give us this interest rate and if you know all these types of things so what they might only say we need to raise a lot of money we want all of these guys want a way for them to be able to sell their shares easily if they need to and this company says well we need to raise you know a ton of money let's say we want to raise 100 million dollars and we can't that's hard to raise from just any one individual investor even if they are big institution so they'll do an initial public offering and that really just means and you know the IPO and this is a review of the last one is that for the first time this company's going to register its shares its going to register its shares with the SEC and it's going to because it does that's going to and it's going to list its shares on an exchange it'll get a ticker symbol you know maybe be company you know this will be its ticker symbol TI ck or in the last K and the last video could be Sox because it's going to sell Sox and then people can trade these shares on that exchange you know it could be on the on the Nasdaq or something and I think some of you all have had experience doing that where you know you go on your Charles Schwab account and you you say I'm going to sell sock well that that company that you're selling is at some point in initial public offering and got and registered with the SEC and got listed on exchange and the the way it really works is it's it's fundamentally the same as when you Ray money from a VC but now instead of let's say instead of raising money from a VC all of the money comes from essentially the public right it goes through these banks and brokerages but it's coming from a bunch of you know small I'm just divvying it up right here you know it could be coming from millions and millions of people but the same process kind of holds in order to see what price these shares are bought at someone has to say well what is the company worth before it gets the money what is the company worth before it gets this money kind of a pre-money valuation that still has to happen and that's what the investment bank does the investment bank will essentially fit into a model in the sale you know this is worth the company beforehand was worth 50 million dollars and it's kind of a you know they'll kind of go out into the market and say well you know our and let's say the company right now has I don't let's say the company already has I'll make a number 5 million shares right so that this piece right here is 5 million so if they if the bank's value the company at 15 million it has 5 million shares they'll say okay right now the pre-money valuation is $10 a share and the bank will go out there and they'll kind of gauge interest and say well you know it does it seem like the market is willing to pay $10 a share for a company like this or give this company a 50 million pre-money valuation and if so they'll don't move forth with the value with the with the IPO and hopefully they'll they actually hopefully the market actually wants to not pay $10 per share that market maybe wants to pay $20 a share so all of these guys essentially let's say they'll pay $10 here so let's say that they raise they sell 10 million shares at $10 a share so the company is able to raise a hundred million dollars right ten times ten hundred million dollars then it can do to make you know big ads and all of that and what what the bank hopes is by selling the shares at $10 a share so let's say this is the this is days and this is price we change colors so with the investment bank wants to hope is it on day one you sell it $10 a share and then the price moves up that the demand was actually to sell it for much more and there's a bit of a balancing act because if they sell it for too little then the company won't get as much money as it deserves but if they sell it for too much in the stock price goes down then you kind of have a stigma associated with the IPO but anyway this begs the question of you know sure I understand why the company is selling shares it needs money it needs to operate it needs to build factories or put out advertising all that but why are people buying shares to begin with why do people buy shares in the stock market and frankly there's two answers you know and one is kind of the obvious one because they think the shares will go up but to some degree that's you know that's speculation if I'm buying a share at ten dollars just because I'm hoping that there's some other dude out there who maybe a few weeks later is going to pay $15 I'm just speculating if you know I'm just saying Oh IPOs go up so let me buy it but but economically why was why was this even worth $10 to begin with you know how do we even think about that valuation yet at a very even high level why is this even worth $10 a share to begin with and the idea is is that these assets assets are nothing but claims on future benefits right a house is an asset because you get the future benefit of getting to live in it right or the future benefit of not having to pay rent so the future benefit of these is this they'll hopefully at some point in the future generate an income stream and even more they'll generate cash and at some point in the future no companies don't do it right now they'll actually dividend out that cash so there's some there's a couple of things that might like that that will make this equity have kind of an economic it'll-it'll ground it economically and it could be these assets starting to pump out cash and then each of the shareholders will get a dividend write a dividend is just cash that's given to the shareholder so let's say that this is a stock certificate in sauk so at some point when this when this when the assets of this company start generating cash each of the shareholders might be getting a dividend or maybe a large company at some future date says wow you know this is an awesome technology it will complement what we already have and maybe they'll buy out the company maybe they'll pay maybe they'll pay 300 million dollars for this for this company and then you know they're essentially they're paying 300 million dollars it was it and there's 15 million shares so they're paying $20 a share so those are the economic kind of grounding points that why these shares even have a value and I'll go a lot into a lot more detail make a whole playlist on how you how do you even think about whether this is worth 50 million or is it worth 5 million or is it worth 500 million and it's kind of an art more than a science because you can make you're going to make tons of assumptions in terms of how fast the company grows what's the risk free rate of return that you could get on other assets you know essentially where else you could you put your money when does a company dividend out it's much you know there's so many assumptions so it's more of an art so it's really kind of you try to get a handle on things but there's no real right answer the real right answer is kind of what someone's willing to pay for it but anyway I'll see you in the next video