Speaker 1: The lecture year about to here comes from afro Tech
Speaker 1: seventeen which was held in San Francisco, California. Marlon Nichols,
Speaker 1: a VC with MAC venture capitalists on the main stage,
Speaker 1: helping us understand start of funding rounds and the impact
Speaker 1: on the CAB table, which is a spreadsheet or table
Speaker 1: that shows the equity capitalization for a company. Cap tables
Speaker 1: include all the equity in the company like common and
Speaker 1: preferred shares and more. It's s who owns what. Basically,
Speaker 1: Marlon is the person to give this talk. He's a
Speaker 1: C stage venture capitalists that invest in visionary founders, build
Speaker 1: in the future that the world wants to see. Some
Speaker 1: of his current in previous portfolio companies include Bravity which
Speaker 1: ons afro Tech, gimblet Media Listener, Maven, Mango, dB, Play Versus,
Speaker 1: and more. But I remember so much about this talk
Speaker 1: from afro Tech seven team is how full of knowledge
Speaker 1: it was things that were critical to the founders with
Speaker 1: central outcome. Like in the music business, artists get so
Speaker 1: excited about getting a record deal that they don't read
Speaker 1: their contracts, therefore don't understand the economics of selling a record,
Speaker 1: touring or merchandise. In the world of startups. Too many
Speaker 1: founders get a big surprise when they go to sell
Speaker 1: and find out they're not gonna get as much of
Speaker 1: the pie, and say want to start because they're so diluted.
Speaker 1: So founders listening, it's the holiday season and I'm preparing
Speaker 1: some more fire interviews for you guys that bring in
Speaker 1: the new year. But for now, enjoy this throwback. So
Speaker 1: we're gonna get into into cap tables. So basically, uh,
Speaker 1: where's our runner, I'm gonna I'm gonna start. I'll make
Speaker 1: this real interactive, right all right? Cool? Who can tell
Speaker 1: me what the cap table is? Anybody? Damn, it's on
Speaker 1: the screen. Basically, it's your it's your it's your ledger, right,
Speaker 1: it's your it's your record for ownership within your company.
Speaker 1: And it covers two types of stock. Primarily there's common
Speaker 1: stock and preferred stock. UM. Again, everyone knows what the
Speaker 1: difference between those two are. Huh No, man, y'all do
Speaker 1: your homework. I sent it out now. Um So, common
Speaker 1: stock is generally what UM founders get, and preferred stock
Speaker 1: is what investors purchase or um or trade, and the
Speaker 1: differences that preferred stock gets get some more UM, I
Speaker 1: guess privileges then common stock does. For instance, when you
Speaker 1: when you start thinking about change of control UM or
Speaker 1: wanting to raise more capital or anything like that, UM,
Speaker 1: the preferred stock owners are gonna have to approve that
Speaker 1: in order for it to get done. So I guess
Speaker 1: the biggest the biggest thing you can take away from
Speaker 1: from me today is that once you raise capital from
Speaker 1: venture capitalists or any investors, you start to give up
Speaker 1: some control of your company. Right, all right, so cool.
Speaker 1: So what I did was put together this exercise, UM,
Speaker 1: where we're gonna pretend that, UM, we're an entrepreneur and uh,
Speaker 1: we're raising we're creating our company, and we're raising a
Speaker 1: couple of rounds of funding, and the first round of
Speaker 1: funding is going to be a convertible note. Um, does
Speaker 1: anyone know what a convertible note is? We got one
Speaker 1: right there? Essentially, I think, if if I haven't right,
Speaker 1: it's a debt product that on your next round of
Speaker 1: capital converts into equity at a discount for your investors.
Speaker 1: That's perfect. And so the reason why UM, yeah, So
Speaker 1: the reason why UM, a startup would raise a convertible
Speaker 1: note as opposed to do on a price round or
Speaker 1: a straight equity round. Initially, Um, there are there are
Speaker 1: a few reasons, but the primary reason is you don't
Speaker 1: want to you don't want to price it. So you
Speaker 1: don't want to put a price tag on your company
Speaker 1: before you started, because that that's gonna act as a
Speaker 1: trigger for further pricing down down the road. So if
Speaker 1: you're really if you're really early, and you don't want
Speaker 1: to say, oh, my company is only worth you know,
Speaker 1: two million dollars, you can do something that is a
Speaker 1: convertible note. And um, you have this thing on it
Speaker 1: called a cap. I'll talk about it in a little bit,
Speaker 1: but um, that's uh implied valuation as opposed to a
Speaker 1: hard valuation. So you're leaving the door open to be
Speaker 1: able to either price your company up or down. Um
Speaker 1: later on makes sense. Question right here, can you do
Speaker 1: a convertible note if you have an LLC or is
Speaker 1: that also somewhere what arry ship earlier where you have
Speaker 1: to get a C corps if you're taking a lawyer
Speaker 1: can answer that? Okay, Uh, the the answer The answer
Speaker 1: is yes, Um, you can't. Actually, it can't convert into
Speaker 1: equity until it's a corporation though. Yeah, And and if
Speaker 1: the I'm not giving legal advice here. I'm not a
Speaker 1: not a lawyer, but if you're gonna start a company
Speaker 1: and you intend to take on capital, then you should
Speaker 1: just start with a corporation, all right. So UM any
Speaker 1: other questions before UM? What are your opinion? What is
Speaker 1: your opinion on a safe versus a convertible note? As
Speaker 1: an investor, I don't like safe, so UM if everybody
Speaker 1: else as safe as a it's kind of a derivative
Speaker 1: of a convertible note. UM. It was created by by
Speaker 1: the folks at y Combinator, and it's meant to be
Speaker 1: UM equally investor and and founder friendly. But really it's
Speaker 1: it's founder friendly. UM. So there there there there's some
Speaker 1: issues that I have with it. UM One, there's usually
Speaker 1: not a maturity date on it, so this note can
Speaker 1: just live in perpect you as an investor, I'm I'm investing.
Speaker 1: I'm doing this note. I'm investing in your company because
Speaker 1: I want that to turn into equity. There's also a
Speaker 1: lot of times it's UM. It's very um coy about
Speaker 1: what happens. UM once this think converts, do I convert
Speaker 1: on par with whatever? Around UM whatever financing that's happening,
Speaker 1: and my junior to that and my senior to it.
Speaker 1: There's just a lot of issues, um for an investor.
Speaker 1: So we've never done a straight um safe. We've always
Speaker 1: made those changes to it, so might as well just
Speaker 1: start with a convertible note. And I think, um, there's
Speaker 1: been some some reports from founders where they're also finding
Speaker 1: issues with the with the safe down the road. But
Speaker 1: it was meant to be, um, you know it was.
Speaker 1: It was a nice try, all right, yeah, M thank you.
Speaker 1: Which side of the table usually sides, whether it's going
Speaker 1: to be a valued round or a convertible note, It
Speaker 1: depends really, Um. Most of the time it's the it's
Speaker 1: the founder. Um. But I'll give you one. I'll give
Speaker 1: you experience that I had where I had a founder
Speaker 1: that was coming out of Y combinator. Um h Lee
Speaker 1: Andrew had a hinge too, and he his intention was
Speaker 1: to raise a note, um, but he had he had
Speaker 1: done enough where it made sense to to to basically
Speaker 1: price it. And UM. You know the thing that investors
Speaker 1: think about when it's when you're doing a note is
Speaker 1: there's some there's some there's some variables that you can't
Speaker 1: control there, right, You can't control what the valuation of
Speaker 1: the price round is going to be, so I prefer
Speaker 1: to know what that is and set that if I can. UM.
Speaker 1: But if again, like I said before, if a UM,
Speaker 1: if an entrepreneur is really early and you know they're
Speaker 1: the data is not there to properly said, then they
Speaker 1: may prefer to go with go with a note. But
Speaker 1: it's it's a conversation. Sometimes it depends on who has
Speaker 1: the power. If it's a really hot start up and
Speaker 1: this is what they want to do and you want
Speaker 1: to end and that's what you're gonna do. All right, Okay,
Speaker 1: so uh let's move in everybody who did their homework. Dah. Okay,
Speaker 1: it's gonna be harder. Um, alright, So the first exercise, right,
Speaker 1: so we're starting this company. Um, we have m there
Speaker 1: we go. We have ten million authorized shares in the
Speaker 1: company and two founders between the two of them are
Speaker 1: taking of that. So they're taking two point five million
Speaker 1: shares each, right, and um, this is their first round
Speaker 1: round of investment. And again it's a note. Um, it's
Speaker 1: a note. And uh they're taking in five k from
Speaker 1: from dope VC. That's me right, Um, there's a there's
Speaker 1: a cap on the note, which again is a is
Speaker 1: an implied valuation. And so a little bit more about that.
Speaker 1: What what what this means is when UM when either
Speaker 1: when the note mature's right, so let's say we have
Speaker 1: a we have a UM A twenty four month term
Speaker 1: on this note, it then turns into equity at that point,
Speaker 1: this UM, this five million cap becomes the valuation right now,
Speaker 1: if there is a price round before that maturity date,
Speaker 1: then the valuation is at whatever UM price is set
Speaker 1: by that the investor that's leading that round, right. So
Speaker 1: if ah, here's here's the upside or the good thing
Speaker 1: about UM notes. Potentially good thing about notes for investors
Speaker 1: is that if I have a five million cap and
Speaker 1: the valuation is set at ten million, then I pay
Speaker 1: as I pay a price of five million for those
Speaker 1: shares as opposed to ten million. So I'm kind of winning,
Speaker 1: right UM. But it's it's a pre visit I get
Speaker 1: for for taking the risk early. UM. And then you
Speaker 1: and then the other thing is the I'll get to
Speaker 1: you a second. The other thing is, um, you have
Speaker 1: a discount. So it's either or it's whichever is lower.
Speaker 1: So if the you know, if it is a ten
Speaker 1: million dollar valuation. That's set um, and it's it's you
Speaker 1: know I have I can either choose between uh, taking
Speaker 1: seventy five price at seven s that or I can
Speaker 1: take the five million. Obviously five is lower than seven
Speaker 1: point five, so I'm gonna take five, right, Um. And
Speaker 1: then uh, there's it's a note, it's a it's a
Speaker 1: debt instrument. So there's interest that's accumulated every year. Um.
Speaker 1: You had a question right here. I'm sorry give him
Speaker 1: my I was saying, initially, the value of your company
Speaker 1: is based on what in the smith you've got, or
Speaker 1: so how does that work? See your question is how
Speaker 1: how is the valuation set? Right? Um? It's kind of ambiguous. Actually,
Speaker 1: um it it can be. You know, an entrepreneur feels
Speaker 1: that their their company is worth this amount um from
Speaker 1: an investor's perspective, if they are tangible things like revenue, right,
Speaker 1: I'll look at that um and then apply a multiple
Speaker 1: towards that that revenue. So let's say other companies in
Speaker 1: the space are let's call it trading at a four
Speaker 1: rex multiple. I would apply that four rex to to
Speaker 1: that revenue number, and that's how I get my my valuation.
Speaker 1: But then there are other things you got to consider too, like,
Speaker 1: you know, is this a return founder? UM? Has she
Speaker 1: sold a company before for a lot of money? Has
Speaker 1: she taken a company public before? Is it's the same team?
Speaker 1: You give them some credit for that sort of valuation?
Speaker 1: Starts to inch up? Right? Is it a UM? Is
Speaker 1: it a really new and hot space? Is this deal
Speaker 1: really competitive? Is UM? You know Ryan over k poor
Speaker 1: capital trying to steal the deal from me and I
Speaker 1: gotta and I gotta outpriced him or something like that, Right, So, UM,
Speaker 1: A lot of things go into it, but generally try
Speaker 1: to find markers and and uh industry markets to help
Speaker 1: you figure it out. All right, So jumping into the model,
Speaker 1: I mean, if you can do division, you can create
Speaker 1: a cap table. Right. That's that. That's all it is.
Speaker 1: So I'm just gonna try to walk you guys through this.
Speaker 1: Hopefully it's not too clumsy. Right. So we said that
Speaker 1: UM there were ten million authorized shares and the found
Speaker 1: each of the founders, the founder one and founder too.
Speaker 1: Can you see, Oh you guys gotta put that back up, Okay? UM? Sorry?
Speaker 1: So founder one, Founder two UM both have two point
Speaker 1: five million shares each, right, totally down here five million shares.
Speaker 1: The valuation cap for the note was five million, So
Speaker 1: that's that's here. The the importance of the valuation cap
Speaker 1: is it determines what I'm going to pay per share
Speaker 1: um of stock. Right. So for instance, so basically, and
Speaker 1: what I'm gonna look at is the number of shares
Speaker 1: that have been allocated, right, and I'm gonna divide that. Um,
Speaker 1: I'm gonna divide the valuation by the number of shares
Speaker 1: that have been allocated, and that's how I get my
Speaker 1: price valuation per share, right, So it's just the vision.
Speaker 1: So that's how I got to to one dollar here. Um,
Speaker 1: Now that's just the So that's the the comment I
Speaker 1: got in an investor actually two investors that put in
Speaker 1: five each dope VC and investor one right, totaling one million. Right.
Speaker 1: So so now there's been one million dollars invested into
Speaker 1: the company in the form of a convertible note. And uh,
Speaker 1: the only other thing on on this on this exercise
Speaker 1: that um it's really important to point out is remember
Speaker 1: we talked about the purpose of having a cap table
Speaker 1: is to understand your ownership, Right, how much of my
Speaker 1: company do I now own? So as the founders with
Speaker 1: just that one million dollar investment combine, they own eighty
Speaker 1: three three of the company, right, which is a great
Speaker 1: place to um to be when you're when you're starting
Speaker 1: a company. I think I have some trigger questions. Yeah,
Speaker 1: so we talked about the cap in the discount. So
Speaker 1: let's let's move forward to exercise two. Exercise two bills
Speaker 1: on exercise one. So you know, a year has passed
Speaker 1: and UM, my company has done well, and uh someone
Speaker 1: or your company has done well. I'm the investor. Your
Speaker 1: company has done well, and so you're raising another round
Speaker 1: of funding to help you with growth. Right, So what's
Speaker 1: gonna happen here? Your seed notes are going to convert.
Speaker 1: They're gonna either convert at um the five million cap
Speaker 1: or or of the of the valuation. The the the investor,
Speaker 1: the new investor. They're gonna price this thing. So they're
Speaker 1: gonna set a pre money valuation of thirteen million. Anybody
Speaker 1: know the difference between the pre money and post money
Speaker 1: pre money, Yeah, she she got it. Pre money is
Speaker 1: um the price of the company or what the company
Speaker 1: is valued at prior to the investment, and then the
Speaker 1: post money is um. It's an addition of the valuation
Speaker 1: of the pre and the dollars that came in UM
Speaker 1: after right, and so when you're when you're talking about
Speaker 1: before the round is done, you talk about valuation in
Speaker 1: terms of pre money, and then once the round is
Speaker 1: um has concluded, then you speak about it in terms
Speaker 1: of post money. It's uh so there there, there wasn't right,
Speaker 1: because it's not an equity round. It's basically debt. At
Speaker 1: that point, the question was was the five million um
Speaker 1: cat considered a post or or pre and it's um,
Speaker 1: it's neither actually because it's a convertible note. It's a
Speaker 1: instrument at that point, and while you're holding a note,
Speaker 1: you're not actually holding equity and so there and so
Speaker 1: there isn't a true valuation at that at that point, Yeah,
Speaker 1: I already know the answer, but for some of them
Speaker 1: entrepreneurs here, so what is a the average interest rate
Speaker 1: when giving out a convertible note? Who sets that? The
Speaker 1: investor or the founder of the company. Like everything involving
Speaker 1: a deal is everything is negotiable, right, So UM and independents,
Speaker 1: who has who has more power in the deal. But
Speaker 1: typically you'll have a lawyer and that law firm would
Speaker 1: have seen some number of deals similar to this, and
Speaker 1: they'll SAYY, the the average or the or the median
Speaker 1: interest rate is this, and so that's what they'll they'll say,
Speaker 1: let's go with right. And as an investor, you know,
Speaker 1: I'm thinking about it from a you know, a risk
Speaker 1: reward standpoint, UM, and I may go up and I
Speaker 1: may go down, and it's basically just another negotiation, another
Speaker 1: level for lever for a negotiation. UM. Typically if you're
Speaker 1: really bullish on the deal, the interest rate doesn't doesn't
Speaker 1: matter so much to you, right, UM, there are other
Speaker 1: factors that are that are more important. So if the
Speaker 1: you know, if the entrepreneur wants to lower interest rate,
Speaker 1: you're probably gonna do that, all right. And you know,
Speaker 1: if if things go as they should, the UM, the
Speaker 1: interest that you're gonna get over a year or a
Speaker 1: two year period is not going to really be material
Speaker 1: in terms of your your ownership. UM. So can you
Speaker 1: hear me? Can you hear me? So? What has been
Speaker 1: your experience with buy sell agreements and how do they
Speaker 1: what role do they play in this discussion about ownership evaluation?
Speaker 1: All right, we gotta read the questions in and keep
Speaker 1: them about about UM, about this I can. I can
Speaker 1: catch up with you about that afterwards. UM. Okay, So
Speaker 1: it's a thirty million pre money UM. It's a two
Speaker 1: million dollar round. There are two new investors UM. One
Speaker 1: is going to invest a million, the other one's gonna
Speaker 1: invest half a million. I'm going to follow on and
Speaker 1: do UM do half a million in this round. And
Speaker 1: we're gonna we're gonna ask for a twenty option pool
Speaker 1: and we're gonna do it pre investment. So does anyone
Speaker 1: know what an option pool is? Ahead? Yeah, So it's
Speaker 1: a it's a percentage of the of the UM common
Speaker 1: stock in the company that's that you're holding UM to
Speaker 1: either reward employees for for doing well or use it
Speaker 1: as a recruiting vehicle to hire. I don't know your
Speaker 1: CTO right because one of the one of the carrots
Speaker 1: or the main things about the main attractive things about
Speaker 1: UM joining a startup is a fact that it's you know,
Speaker 1: it's gonna grow and you'll have ownership within that startup.
Speaker 1: So this option pool UM allows you to to basically
Speaker 1: award and UM reward your employees and soon to be
Speaker 1: employees with stock in the company UM. And so at
Speaker 1: the at the early stages. At the early stages, Um,
Speaker 1: you want a pretty hefty um option pool so that
Speaker 1: you don't have to to kind of create an option
Speaker 1: pool again and again and again, because as you create,
Speaker 1: as you increase that option pool, you you become deluded.
Speaker 1: Right because remember it's price over um over shares, right,
Speaker 1: So once you start adding more shares, you lose, you
Speaker 1: lose ownership. I'm sorry back there, So you actually just
Speaker 1: mentioned the word delution. How do you think through from
Speaker 1: a term sheet perspective? Uh, you know sort of who
Speaker 1: gets deluded? When you know? Is it founders? Is it
Speaker 1: subsequent investors? How do you how do you think through that? Yeah?
Speaker 1: So one of the things, one of the key things
Speaker 1: here is this pre pre investment, right, So I want
Speaker 1: that option pool to be created before I put my
Speaker 1: money into this round. And the reason I'm doing that
Speaker 1: is because once that option pool is created, at whatever
Speaker 1: time that option pool is created, whoever owns stock in
Speaker 1: that company, they're going to own less, right. So I
Speaker 1: want that to happen before I invest, and entrepreneurs might
Speaker 1: want that to happen after I invest. So again it's
Speaker 1: another it's another point where we start to negotiate. She
Speaker 1: had a question here he's bringing mic being sorry the
Speaker 1: option pool being hefty? What do you mean by that
Speaker 1: with like a T or like what is oh it?
Speaker 1: It's it's gonna vary. I think UM anywhere from ten
Speaker 1: to For a really early company, it's fair. Um. Most
Speaker 1: of the times you'll probably get to fifteen or or
Speaker 1: or ten percent at at this stage. Series A companies
Speaker 1: UM probably have an option pool around ten percent because
Speaker 1: at a Series A you probably have your most of
Speaker 1: your key executives in place, which are the ones that
Speaker 1: are gonna be awarded most of that option pool. UM.
Speaker 1: So you know, you can have a little bit a
Speaker 1: little bit less. But in this case we're asking for
Speaker 1: for twenty and so in this spreadsheet, basically what we're
Speaker 1: what we're doing is we need to say, all, right,
Speaker 1: of that of those ten million authorized shares that we
Speaker 1: UM that we have, we need that to be in
Speaker 1: the option pool. So for those of you spreadsheet jockeys
Speaker 1: out there, basically just run a goal seek um and
Speaker 1: uh you know so that you set this cell here
Speaker 1: to to equal um basically by changing the number here, right,
Speaker 1: So what happens is this number UM gets bigger and
Speaker 1: you can see that my price per share gets smaller.
Speaker 1: So that's the that's what that's what we mean by
Speaker 1: by delution. Now in this UM series A. Right, so
Speaker 1: we're putting in half a million. These two UM investors
Speaker 1: are putting in one point five million total, which is
Speaker 1: a two million. The pre money valuation is thirteen million,
Speaker 1: and the price per share is basically calculated by the
Speaker 1: pre money valuation divided by the sum of the common
Speaker 1: stock plus the stock that was purchased in that note
Speaker 1: that's now converting into the equity. Everybody got that, all right?
Speaker 1: Now you can ask questions if you don't, but I'm
Speaker 1: assuming you got it. Sure, I'll repeat it. So the
Speaker 1: the price per share is calculated by taking the value
Speaker 1: the pre money valuation, which we said at thirteen million,
Speaker 1: and we're gonna divide that by the sum of the
Speaker 1: total stock that has been issued in the company. Right,
Speaker 1: So um, the common stock plus the stock that was
Speaker 1: purchased as a part of the convertible note, because remember
Speaker 1: the convertible note is converting into equity at the first
Speaker 1: price round and that's where we are right now, I
Speaker 1: got it already, A right? Cool? Um? All right? So
Speaker 1: now now we actually have preferred stock in the company.
Speaker 1: I'll get you in a second. Now we actually have
Speaker 1: preferred stock in the company, right, because we're investing in
Speaker 1: a price round series A. So now I have you
Speaker 1: know I had before, I only had fully fully deluded ownership.
Speaker 1: Right now I have preferred ownership and I have UM
Speaker 1: total ownership. Anyone knows why this is important? Bode care
Speaker 1: it comes It all comes back to control. It all
Speaker 1: comes back to control. Right. So remember I said the
Speaker 1: difference between common stock and preferred stock is that preferred
Speaker 1: stock has more privileges, right and UM and they get
Speaker 1: to make certain decisions. Right. Can you sell your company
Speaker 1: for a dollar? If I'm an investor and I and
Speaker 1: I bought in for two dollars, I'm gonna say no, right,
Speaker 1: and the other investors are gonna say that too. There's
Speaker 1: a concept of UM voting thresholds for for the preferred
Speaker 1: UM stock stockholders, right, so I could say maybe it's majority.
Speaker 1: So if we want a decision to go forward of
Speaker 1: the preferred or fifty point one or fifty point zero
Speaker 1: zero zero zero zero zero one percent of the preferred
Speaker 1: need to agree to move forward UM with whatever that
Speaker 1: measure is. So as you're thinking about your investors and
Speaker 1: who you're taking money from. This becomes really important because
Speaker 1: there're gonna be some investors that you you really align with,
Speaker 1: that you think are are really good for your company,
Speaker 1: and they're gonna be other investors that you're like, right,
Speaker 1: it's they're okay, but um, but we need the money,
Speaker 1: so we let them in. And you just want to
Speaker 1: make sure that no one investor can make decisions about
Speaker 1: your company all by themselves, right. So in this case,
Speaker 1: the VC almost thirty eight of the preferred ownership right,
Speaker 1: which means that I would then need you know, I
Speaker 1: would need Let's see, so I would need it. In
Speaker 1: most cases, I would lead to need at least two
Speaker 1: investors to agree with me or at least one other
Speaker 1: investor to agree with me in order to move that
Speaker 1: measure forward. And as a as an entrepreneur, that's something
Speaker 1: that you that you want to make sure. Now you
Speaker 1: note that none of the founder the founders don't have
Speaker 1: any preferred stock right, And again that's because founders get
Speaker 1: common stock and investors get preferred stock. But what's still
Speaker 1: important here, it's how much of the company the founders
Speaker 1: founders owned. They got deluded now now they own combine
Speaker 1: fifty four of the company. So something else you've got
Speaker 1: to think about as you move closer and closer to
Speaker 1: exiting this company. Right, and you've got to think about
Speaker 1: how much you're doing this for a reason? Right, You're
Speaker 1: doing this because at the end of the day, I mean,
Speaker 1: you may be doing this too for a social good,
Speaker 1: which is great. But at the end of the day,
Speaker 1: I think, I think we build companies to to generate wealth,
Speaker 1: and so your ownership is really important and unders standing
Speaker 1: you know, what you could get at the end of
Speaker 1: the road is really really important. You have a question,
Speaker 1: can you can you talk a little bit about the
Speaker 1: impact of forfeitures or the explorations of option agreements to
Speaker 1: your cap table, you know how forfeit amounts are redistributed.
Speaker 1: That's a little beyond the scope of this exercise, UM,
Speaker 1: but I can talk to you about it offline afterwards.
Speaker 1: I feel like we'll get everybody lost. I missed how
Speaker 1: the note shares convert, like the actual five three five
Speaker 1: converts into seven shares. But general answer to your question, UM,
Speaker 1: if let's say, let's say, UM, you awarded some number
Speaker 1: of shares to an employee and they have a vesting period.
Speaker 1: So that's another concept. So there's a vest investing period
Speaker 1: just means that you don't get all that stock at once, right,
Speaker 1: which is really really important because you want to incentivize
Speaker 1: your employees to stay and do and do a good
Speaker 1: job over a period of times, usually a four year period.
Speaker 1: So let's say this employee leaves at the two year mark,
Speaker 1: so of UM, you know, of the stock that they've
Speaker 1: been awarded essentially would have bested, so they owned that
Speaker 1: there were the other fifty percent would go back into
Speaker 1: the pool, which is the gist of your question. But
Speaker 1: I know you want to get deeper, so we can
Speaker 1: talk about later. And I'm sorry. Oh right, So the
Speaker 1: the note and how it how it converted Basically, I'll
Speaker 1: let you see the formula. So remember we had a
Speaker 1: seven percent We had seven percent interest on a note, right,
Speaker 1: so based and it's a year later, so um our
Speaker 1: initial investment amount which was UM half a million, just
Speaker 1: multiplying that by one point zero seven and that turns
Speaker 1: into uh, you know this many shares. And and again
Speaker 1: the way that we're calculating those shares is we're taking
Speaker 1: the We're either going to take the price for share
Speaker 1: or the or the disc or the price for share
Speaker 1: based on the discount, right, Um, which one of these
Speaker 1: are we're gonna take as a investor the price of share, right,
Speaker 1: because it's we're paying less for it. Um. And the
Speaker 1: way that this is calculated is basically you're taking the
Speaker 1: common stock, which is all that existed in the in
Speaker 1: the company. Um, you know when when we put our
Speaker 1: when we did the note, and UM, you're putting that
Speaker 1: into the the the cap right, which was UM five millions,
Speaker 1: got it? Okay, Yeah, I'm not sure if you're actually
Speaker 1: gonna cover it in the next section, but can you
Speaker 1: talk about the difference between cumulative preferred stock and non
Speaker 1: cumulative preferred stock and how UM that basically breaks down
Speaker 1: as far as like um, you know, invest their ownership
Speaker 1: in which one they prefer. Yeah, we'll we'll get to it.
Speaker 1: Um towards the tourds inn um. All right, So uh
Speaker 1: three three in UM and four. I think we're running
Speaker 1: short on time. So UM, I think right, UM, the
Speaker 1: three and four will will trying to put together. UM.
Speaker 1: So exercise three basically we're gonna do the next round
Speaker 1: of funding. It's a year later, Series B twenty million,
Speaker 1: pre money. That's the that's the evaluation UM's ten million
Speaker 1: dollar round. You've got two new investors each putting in
Speaker 1: five million two point um two point two million, and
Speaker 1: then um, all of the Series A investors are doing
Speaker 1: their parada um and for paradis means basically it's your
Speaker 1: ownership in the company before this round, and you're just
Speaker 1: basically multiplying that percentage. I can't hear you zoom in?
Speaker 1: Can you zoom in? Oh zoom in? Oh h sure,
Speaker 1: the help I can? UM? I forgot where it was?
Speaker 1: Oh parata right, So basically you're multiplying your percentage ownership
Speaker 1: by whatever however much is coming into the company. Right,
Speaker 1: So if I own UM, well, i'll just show you
Speaker 1: in the in the model. So here we go. So
Speaker 1: Series B basically, UM, I can how's that all? Right?
Speaker 1: So UM, basically my Series B amount, I'm going to
Speaker 1: calculate it by taking my fully deluded ownership in the company,
Speaker 1: UM times the amount that's being raised in the round. Right.
Speaker 1: So one of the terms in in the term sheet
Speaker 1: or in the UM the the investment documents is you
Speaker 1: might have a right to invest at your pro rata, right,
Speaker 1: So that that what that does is it makes sure
Speaker 1: that I can maintain the same level of ownership in
Speaker 1: the next round of funding, which as an investor is
Speaker 1: really important to me because I don't I don't like delution, right,
Speaker 1: and I'm thinking about the the carrot at the end
Speaker 1: of the trail, right, how much am I going to
Speaker 1: get out of this thing when it's all set and done?
Speaker 1: All right, So all the other things are the same
Speaker 1: mechanics as before. Let's let's talk about UM exits, right.
Speaker 1: So at exit UM we're saying that the company is
Speaker 1: now doing two million UM in revenue, and this is
Speaker 1: two years after the Series B. The reason why the
Speaker 1: time matters is because UM we inventure capital and investing UM.
Speaker 1: The measure of UM of successes is I r R,
Speaker 1: which is a time based metric. So it's not just
Speaker 1: the dollar amount, but it's how quickly did I return
Speaker 1: that dollar amount to to my investors. So the fact
Speaker 1: that it's not UM one year later UM is is
Speaker 1: really important. But so it's two years later UM after
Speaker 1: the Series B. There were no investments after the Series B,
Speaker 1: which is also really important. UM. The reason why that's
Speaker 1: that's important is because if I did not participate I
Speaker 1: did invest in the Series B, then there's going to
Speaker 1: be some level of delution because there was no UM
Speaker 1: round and I didn't. There was no round for me
Speaker 1: to invest in. There's no delusion for me to worry about. Yeah,
Speaker 1: for those pro rata rights, do you have to put
Speaker 1: more money in as one of the original founders, um,
Speaker 1: when the money is raised in the Series B founders
Speaker 1: don't have progrado rights, not founders, I'm sorry, the original investors. Yeah,
Speaker 1: So that that's that's what I was saying. If UM,
Speaker 1: if you if you have that privilege, if you have
Speaker 1: that right, then in order to maintain it, you have
Speaker 1: to invest whatever that number is in this round. If
Speaker 1: you don't, you lose it. Generally speaking, UM, five minutes okay, UM,
Speaker 1: So just to wrap this up, and we're applying to
Speaker 1: exit multiple of five. So exit multiple is basically created
Speaker 1: in the same you get it basic basically looking at
Speaker 1: public companies and other private companies in the space, and
Speaker 1: you and you determine, UM, whatever that is. Maybe take
Speaker 1: the median of a bunch of public companies of their UM,
Speaker 1: their trailing trailing twelve month revenue, and you and you
Speaker 1: apply it. UM. So what we did here really quickly,
Speaker 1: uh two million UM revenue in revenue at the time,
Speaker 1: and it's an exit multiple of five. So the exit
Speaker 1: valuation is basically a billion. And then um our our
Speaker 1: take of that is whatever our fully deluded ownership was
Speaker 1: at that time times that billion, which gives us basically
Speaker 1: a hundred and nine million. And then to calculate I
Speaker 1: R R you can create it to you guys have
Speaker 1: the table, but um, you basically create a table similar
Speaker 1: to this which basically here captures your your outflow. So
Speaker 1: what I invested as negative numbers and then ultimately what
Speaker 1: I'm going to get back. And the formula here is
Speaker 1: basically just an X I R R on the on
Speaker 1: the eggs, the the the exit number, and and that's
Speaker 1: how you get to the to the end. Only other
Speaker 1: thing that um, you guys should I want to consider
Speaker 1: here is a concept of liquidation preference, UM. And so
Speaker 1: liquidation preference comes into account at the at the at
Speaker 1: the very end, right, the standard these days is one
Speaker 1: x liquidation preference. So what that means is, UM, Remember
Speaker 1: I said that preferred has certain privileges that common doesn't.
Speaker 1: One of those privileges is that we get paid before you,
Speaker 1: the entrepreneur that's doing all the work, gets paid because
Speaker 1: we put up the money. It's fair UM. And so
Speaker 1: one x means that as soon as we um we
Speaker 1: get our ownership, whatever our ownership, whatever our percentage is
Speaker 1: of that return, then the common holders start to get
Speaker 1: their returns right now. If you do something like a
Speaker 1: too x liquidation UM preference, now you're getting into a
Speaker 1: place where the investors UH is getting a little bit
Speaker 1: more than UM, maybe what some say, maybe more than
Speaker 1: what they deserve, but it depends on the situation when
Speaker 1: the deal was done. So now once we get to
Speaker 1: one x, right now everyone starts participating and including us.
Speaker 1: So we're continuing to so right alongside you, I'm taking
Speaker 1: I'm taking more cash and more cash in until I
Speaker 1: get to two times my my UM my ownership in
Speaker 1: the company. So pretty A lot of people think this
Speaker 1: is unfair to entrepreneurs, a little um founder unfriendly. So
Speaker 1: typically it's one x UM, but really important for you
Speaker 1: for you to note in something critical for you to
Speaker 1: think about as you're thinking through and negotiating terms. And
Speaker 1: I think we are out of time, but i'd probably
Speaker 1: take one question, one or two questions gentlemen. A gentleman
Speaker 1: behind me wanted to know if the slides were available somewhere,
Speaker 1: or do you have a course you teach. Yes, so
Speaker 1: in the number in in a few places so UM
Speaker 1: hbc uvc UM they they it's one of our interns.
Speaker 1: UM they have an online course and UH I provided
Speaker 1: some of the content for that, so you can find
Speaker 1: it there. Also the specific UM specific PowerPoint presentation and
Speaker 1: the Excel document I think had been sent to everyone
Speaker 1: UM through through BT and afro tech. They didn't send
Speaker 1: along with the answers, but I'm sure they'll they'll do
Speaker 1: that right after the session, all right, thank you. Black
Speaker 1: Tag Green Money is a production of Blavity afro Tech
Speaker 1: on the Black Effect podcast Network and i Heeart Media.
Speaker 1: Is produced by Morgan Dabon and me Well Lucas, with
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Speaker 1: Special thank you to Michael Davis, Sadam sims Ins a
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