WEBVTT - Understanding Equity Cap Tables w/ Marlon Nichols 0:00:01.160 --> 0:00:03.680 The lecture year about to here comes from afro Tech 0:00:04.120 --> 0:00:09.280 seventeen which was held in San Francisco, California. Marlon Nichols, 0:00:09.320 --> 0:00:12.039 a VC with MAC venture capitalists on the main stage, 0:00:12.039 --> 0:00:15.680 helping us understand start of funding rounds and the impact 0:00:15.760 --> 0:00:18.759 on the CAB table, which is a spreadsheet or table 0:00:19.079 --> 0:00:23.680 that shows the equity capitalization for a company. Cap tables 0:00:23.680 --> 0:00:26.360 include all the equity in the company like common and 0:00:26.480 --> 0:00:30.400 preferred shares and more. It's s who owns what. Basically, 0:00:31.920 --> 0:00:34.519 Marlon is the person to give this talk. He's a 0:00:34.600 --> 0:00:37.880 C stage venture capitalists that invest in visionary founders, build 0:00:37.880 --> 0:00:40.479 in the future that the world wants to see. Some 0:00:40.600 --> 0:00:43.840 of his current in previous portfolio companies include Bravity which 0:00:43.880 --> 0:00:48.520 ons afro Tech, gimblet Media Listener, Maven, Mango, dB, Play Versus, 0:00:48.520 --> 0:00:51.840 and more. But I remember so much about this talk 0:00:51.880 --> 0:00:54.480 from afro Tech seven team is how full of knowledge 0:00:54.480 --> 0:00:57.560 it was things that were critical to the founders with 0:00:57.680 --> 0:01:00.920 central outcome. Like in the music business, artists get so 0:01:01.000 --> 0:01:03.320 excited about getting a record deal that they don't read 0:01:03.360 --> 0:01:07.479 their contracts, therefore don't understand the economics of selling a record, 0:01:07.760 --> 0:01:12.000 touring or merchandise. In the world of startups. Too many 0:01:12.040 --> 0:01:14.319 founders get a big surprise when they go to sell 0:01:14.560 --> 0:01:16.200 and find out they're not gonna get as much of 0:01:16.280 --> 0:01:19.360 the pie, and say want to start because they're so diluted. 0:01:20.480 --> 0:01:24.680 So founders listening, it's the holiday season and I'm preparing 0:01:24.720 --> 0:01:26.840 some more fire interviews for you guys that bring in 0:01:26.840 --> 0:01:30.959 the new year. But for now, enjoy this throwback. So 0:01:31.000 --> 0:01:37.600 we're gonna get into into cap tables. So basically, uh, 0:01:37.920 --> 0:01:39.880 where's our runner, I'm gonna I'm gonna start. I'll make 0:01:39.920 --> 0:01:43.039 this real interactive, right all right? Cool? Who can tell 0:01:43.080 --> 0:01:49.920 me what the cap table is? Anybody? Damn, it's on 0:01:49.960 --> 0:01:56.920 the screen. Basically, it's your it's your it's your ledger, right, 0:01:56.960 --> 0:02:00.280 it's your it's your record for ownership within your company. 0:02:00.440 --> 0:02:03.800 And it covers two types of stock. Primarily there's common 0:02:03.840 --> 0:02:08.480 stock and preferred stock. UM. Again, everyone knows what the 0:02:08.480 --> 0:02:14.560 difference between those two are. Huh No, man, y'all do 0:02:14.560 --> 0:02:18.120 your homework. I sent it out now. Um So, common 0:02:18.120 --> 0:02:21.959 stock is generally what UM founders get, and preferred stock 0:02:22.080 --> 0:02:26.360 is what investors purchase or um or trade, and the 0:02:26.360 --> 0:02:31.120 differences that preferred stock gets get some more UM, I 0:02:31.160 --> 0:02:35.120 guess privileges then common stock does. For instance, when you 0:02:35.200 --> 0:02:38.120 when you start thinking about change of control UM or 0:02:38.240 --> 0:02:41.520 wanting to raise more capital or anything like that, UM, 0:02:41.600 --> 0:02:44.720 the preferred stock owners are gonna have to approve that 0:02:44.800 --> 0:02:47.520 in order for it to get done. So I guess 0:02:47.520 --> 0:02:50.120 the biggest the biggest thing you can take away from 0:02:50.400 --> 0:02:53.440 from me today is that once you raise capital from 0:02:53.720 --> 0:02:56.600 venture capitalists or any investors, you start to give up 0:02:56.639 --> 0:03:01.840 some control of your company. Right, all right, so cool. 0:03:01.880 --> 0:03:05.399 So what I did was put together this exercise, UM, 0:03:05.400 --> 0:03:09.840 where we're gonna pretend that, UM, we're an entrepreneur and uh, 0:03:09.919 --> 0:03:12.960 we're raising we're creating our company, and we're raising a 0:03:13.000 --> 0:03:15.920 couple of rounds of funding, and the first round of 0:03:15.919 --> 0:03:19.040 funding is going to be a convertible note. Um, does 0:03:19.040 --> 0:03:23.720 anyone know what a convertible note is? We got one 0:03:23.840 --> 0:03:33.079 right there? Essentially, I think, if if I haven't right, 0:03:33.120 --> 0:03:36.320 it's a debt product that on your next round of 0:03:36.400 --> 0:03:39.840 capital converts into equity at a discount for your investors. 0:03:40.240 --> 0:03:47.520 That's perfect. And so the reason why UM, yeah, So 0:03:47.560 --> 0:03:51.680 the reason why UM, a startup would raise a convertible 0:03:51.760 --> 0:03:53.840 note as opposed to do on a price round or 0:03:53.840 --> 0:03:56.840 a straight equity round. Initially, Um, there are there are 0:03:56.840 --> 0:03:59.280 a few reasons, but the primary reason is you don't 0:03:59.320 --> 0:04:00.840 want to you don't want to price it. So you 0:04:00.840 --> 0:04:02.640 don't want to put a price tag on your company 0:04:02.720 --> 0:04:06.040 before you started, because that that's gonna act as a 0:04:06.080 --> 0:04:09.480 trigger for further pricing down down the road. So if 0:04:09.480 --> 0:04:12.160 you're really if you're really early, and you don't want 0:04:12.200 --> 0:04:14.480 to say, oh, my company is only worth you know, 0:04:14.880 --> 0:04:17.560 two million dollars, you can do something that is a 0:04:17.600 --> 0:04:20.720 convertible note. And um, you have this thing on it 0:04:20.839 --> 0:04:23.760 called a cap. I'll talk about it in a little bit, 0:04:24.040 --> 0:04:27.839 but um, that's uh implied valuation as opposed to a 0:04:27.880 --> 0:04:30.880 hard valuation. So you're leaving the door open to be 0:04:30.920 --> 0:04:34.120 able to either price your company up or down. Um 0:04:34.240 --> 0:04:42.080 later on makes sense. Question right here, can you do 0:04:42.120 --> 0:04:44.400 a convertible note if you have an LLC or is 0:04:44.440 --> 0:04:47.039 that also somewhere what arry ship earlier where you have 0:04:47.080 --> 0:04:49.320 to get a C corps if you're taking a lawyer 0:04:49.320 --> 0:04:56.560 can answer that? Okay, Uh, the the answer The answer 0:04:56.640 --> 0:05:01.279 is yes, Um, you can't. Actually, it can't convert into 0:05:01.320 --> 0:05:05.640 equity until it's a corporation though. Yeah, And and if 0:05:05.680 --> 0:05:09.040 the I'm not giving legal advice here. I'm not a 0:05:09.240 --> 0:05:12.240 not a lawyer, but if you're gonna start a company 0:05:12.560 --> 0:05:16.080 and you intend to take on capital, then you should 0:05:16.080 --> 0:05:20.520 just start with a corporation, all right. So UM any 0:05:20.520 --> 0:05:25.440 other questions before UM? What are your opinion? What is 0:05:25.480 --> 0:05:29.520 your opinion on a safe versus a convertible note? As 0:05:29.560 --> 0:05:32.800 an investor, I don't like safe, so UM if everybody 0:05:32.839 --> 0:05:36.640 else as safe as a it's kind of a derivative 0:05:36.760 --> 0:05:40.360 of a convertible note. UM. It was created by by 0:05:40.880 --> 0:05:43.360 the folks at y Combinator, and it's meant to be 0:05:43.720 --> 0:05:47.920 UM equally investor and and founder friendly. But really it's 0:05:48.080 --> 0:05:51.400 it's founder friendly. UM. So there there there there's some 0:05:51.480 --> 0:05:54.840 issues that I have with it. UM One, there's usually 0:05:54.880 --> 0:05:58.640 not a maturity date on it, so this note can 0:05:58.720 --> 0:06:03.080 just live in perpect you as an investor, I'm I'm investing. 0:06:03.080 --> 0:06:05.680 I'm doing this note. I'm investing in your company because 0:06:05.720 --> 0:06:08.560 I want that to turn into equity. There's also a 0:06:08.600 --> 0:06:13.480 lot of times it's UM. It's very um coy about 0:06:13.560 --> 0:06:17.560 what happens. UM once this think converts, do I convert 0:06:18.160 --> 0:06:22.239 on par with whatever? Around UM whatever financing that's happening, 0:06:22.560 --> 0:06:24.840 and my junior to that and my senior to it. 0:06:25.480 --> 0:06:28.360 There's just a lot of issues, um for an investor. 0:06:28.760 --> 0:06:33.840 So we've never done a straight um safe. We've always 0:06:33.880 --> 0:06:36.520 made those changes to it, so might as well just 0:06:36.560 --> 0:06:39.280 start with a convertible note. And I think, um, there's 0:06:39.320 --> 0:06:44.000 been some some reports from founders where they're also finding 0:06:44.120 --> 0:06:47.440 issues with the with the safe down the road. But 0:06:47.600 --> 0:06:49.680 it was meant to be, um, you know it was. 0:06:49.720 --> 0:06:56.800 It was a nice try, all right, yeah, M thank you. 0:06:58.240 --> 0:07:02.160 Which side of the table usually sides, whether it's going 0:07:02.200 --> 0:07:05.479 to be a valued round or a convertible note, It 0:07:05.560 --> 0:07:09.320 depends really, Um. Most of the time it's the it's 0:07:09.360 --> 0:07:13.200 the founder. Um. But I'll give you one. I'll give 0:07:13.200 --> 0:07:15.720 you experience that I had where I had a founder 0:07:15.760 --> 0:07:19.080 that was coming out of Y combinator. Um h Lee 0:07:19.120 --> 0:07:22.520 Andrew had a hinge too, and he his intention was 0:07:22.560 --> 0:07:25.080 to raise a note, um, but he had he had 0:07:25.080 --> 0:07:28.320 done enough where it made sense to to to basically 0:07:28.320 --> 0:07:33.440 price it. And UM. You know the thing that investors 0:07:33.480 --> 0:07:36.280 think about when it's when you're doing a note is 0:07:37.600 --> 0:07:40.440 there's some there's some there's some variables that you can't 0:07:40.440 --> 0:07:44.400 control there, right, You can't control what the valuation of 0:07:44.440 --> 0:07:47.440 the price round is going to be, so I prefer 0:07:47.960 --> 0:07:51.720 to know what that is and set that if I can. UM. 0:07:51.760 --> 0:07:54.880 But if again, like I said before, if a UM, 0:07:54.920 --> 0:07:57.720 if an entrepreneur is really early and you know they're 0:07:57.800 --> 0:08:00.840 the data is not there to properly said, then they 0:08:00.880 --> 0:08:03.240 may prefer to go with go with a note. But 0:08:03.320 --> 0:08:06.680 it's it's a conversation. Sometimes it depends on who has 0:08:06.680 --> 0:08:08.640 the power. If it's a really hot start up and 0:08:08.640 --> 0:08:10.320 this is what they want to do and you want 0:08:10.320 --> 0:08:14.600 to end and that's what you're gonna do. All right, Okay, 0:08:14.640 --> 0:08:22.600 so uh let's move in everybody who did their homework. Dah. Okay, 0:08:22.920 --> 0:08:27.360 it's gonna be harder. Um, alright, So the first exercise, right, 0:08:27.400 --> 0:08:32.040 so we're starting this company. Um, we have m there 0:08:32.080 --> 0:08:34.960 we go. We have ten million authorized shares in the 0:08:35.000 --> 0:08:39.360 company and two founders between the two of them are 0:08:39.400 --> 0:08:44.120 taking of that. So they're taking two point five million 0:08:44.480 --> 0:08:48.400 shares each, right, and um, this is their first round 0:08:48.520 --> 0:08:52.439 round of investment. And again it's a note. Um, it's 0:08:52.440 --> 0:08:57.000 a note. And uh they're taking in five k from 0:08:57.160 --> 0:09:02.240 from dope VC. That's me right, Um, there's a there's 0:09:02.240 --> 0:09:04.360 a cap on the note, which again is a is 0:09:04.400 --> 0:09:07.360 an implied valuation. And so a little bit more about that. 0:09:07.400 --> 0:09:11.640 What what what this means is when UM when either 0:09:11.720 --> 0:09:14.760 when the note mature's right, so let's say we have 0:09:14.840 --> 0:09:17.520 a we have a UM A twenty four month term 0:09:17.600 --> 0:09:21.960 on this note, it then turns into equity at that point, 0:09:22.400 --> 0:09:27.640 this UM, this five million cap becomes the valuation right now, 0:09:27.720 --> 0:09:30.920 if there is a price round before that maturity date, 0:09:31.400 --> 0:09:35.559 then the valuation is at whatever UM price is set 0:09:35.640 --> 0:09:38.760 by that the investor that's leading that round, right. So 0:09:39.280 --> 0:09:42.640 if ah, here's here's the upside or the good thing 0:09:42.640 --> 0:09:45.959 about UM notes. Potentially good thing about notes for investors 0:09:46.040 --> 0:09:48.880 is that if I have a five million cap and 0:09:49.120 --> 0:09:52.800 the valuation is set at ten million, then I pay 0:09:53.000 --> 0:09:55.520 as I pay a price of five million for those 0:09:55.520 --> 0:09:57.880 shares as opposed to ten million. So I'm kind of winning, 0:09:58.360 --> 0:10:00.680 right UM. But it's it's a pre visit I get 0:10:00.720 --> 0:10:04.040 for for taking the risk early. UM. And then you 0:10:04.320 --> 0:10:06.000 and then the other thing is the I'll get to 0:10:06.040 --> 0:10:07.680 you a second. The other thing is, um, you have 0:10:07.720 --> 0:10:12.040 a discount. So it's either or it's whichever is lower. 0:10:12.440 --> 0:10:14.360 So if the you know, if it is a ten 0:10:14.360 --> 0:10:17.880 million dollar valuation. That's set um, and it's it's you 0:10:17.920 --> 0:10:20.959 know I have I can either choose between uh, taking 0:10:21.120 --> 0:10:24.760 seventy five price at seven s that or I can 0:10:24.800 --> 0:10:30.240 take the five million. Obviously five is lower than seven 0:10:30.280 --> 0:10:35.320 point five, so I'm gonna take five, right, Um. And 0:10:35.360 --> 0:10:37.800 then uh, there's it's a note, it's a it's a 0:10:37.920 --> 0:10:43.640 debt instrument. So there's interest that's accumulated every year. Um. 0:10:43.679 --> 0:10:53.280 You had a question right here. I'm sorry give him 0:10:53.320 --> 0:10:57.600 my I was saying, initially, the value of your company 0:10:57.640 --> 0:11:01.200 is based on what in the smith you've got, or 0:11:02.240 --> 0:11:04.480 so how does that work? See your question is how 0:11:04.640 --> 0:11:09.640 how is the valuation set? Right? Um? It's kind of ambiguous. Actually, 0:11:10.240 --> 0:11:13.680 um it it can be. You know, an entrepreneur feels 0:11:13.679 --> 0:11:17.280 that their their company is worth this amount um from 0:11:17.320 --> 0:11:21.520 an investor's perspective, if they are tangible things like revenue, right, 0:11:21.800 --> 0:11:25.280 I'll look at that um and then apply a multiple 0:11:25.320 --> 0:11:28.760 towards that that revenue. So let's say other companies in 0:11:28.800 --> 0:11:32.040 the space are let's call it trading at a four 0:11:32.080 --> 0:11:34.880 rex multiple. I would apply that four rex to to 0:11:35.000 --> 0:11:38.040 that revenue number, and that's how I get my my valuation. 0:11:38.320 --> 0:11:40.719 But then there are other things you got to consider too, like, 0:11:40.960 --> 0:11:43.920 you know, is this a return founder? UM? Has she 0:11:44.400 --> 0:11:46.520 sold a company before for a lot of money? Has 0:11:46.520 --> 0:11:49.000 she taken a company public before? Is it's the same team? 0:11:49.200 --> 0:11:51.000 You give them some credit for that sort of valuation? 0:11:51.040 --> 0:11:53.840 Starts to inch up? Right? Is it a UM? Is 0:11:53.880 --> 0:11:56.560 it a really new and hot space? Is this deal 0:11:56.640 --> 0:12:00.400 really competitive? Is UM? You know Ryan over k poor 0:12:00.480 --> 0:12:02.840 capital trying to steal the deal from me and I 0:12:02.880 --> 0:12:06.679 gotta and I gotta outpriced him or something like that, Right, So, UM, 0:12:06.920 --> 0:12:09.480 A lot of things go into it, but generally try 0:12:09.520 --> 0:12:14.360 to find markers and and uh industry markets to help 0:12:14.400 --> 0:12:19.680 you figure it out. All right, So jumping into the model, 0:12:19.720 --> 0:12:22.080 I mean, if you can do division, you can create 0:12:22.120 --> 0:12:25.000 a cap table. Right. That's that. That's all it is. 0:12:25.400 --> 0:12:28.720 So I'm just gonna try to walk you guys through this. 0:12:28.760 --> 0:12:32.240 Hopefully it's not too clumsy. Right. So we said that 0:12:32.480 --> 0:12:35.920 UM there were ten million authorized shares and the found 0:12:36.000 --> 0:12:39.400 each of the founders, the founder one and founder too. 0:12:39.679 --> 0:12:59.000 Can you see, Oh you guys gotta put that back up, Okay? UM? Sorry? 0:12:59.040 --> 0:13:03.600 So founder one, Founder two UM both have two point 0:13:03.679 --> 0:13:08.960 five million shares each, right, totally down here five million shares. 0:13:10.840 --> 0:13:14.680 The valuation cap for the note was five million, So 0:13:14.760 --> 0:13:20.720 that's that's here. The the importance of the valuation cap 0:13:20.880 --> 0:13:23.920 is it determines what I'm going to pay per share 0:13:24.360 --> 0:13:29.920 um of stock. Right. So for instance, so basically, and 0:13:29.920 --> 0:13:32.440 what I'm gonna look at is the number of shares 0:13:32.480 --> 0:13:39.840 that have been allocated, right, and I'm gonna divide that. Um, 0:13:39.880 --> 0:13:42.840 I'm gonna divide the valuation by the number of shares 0:13:42.880 --> 0:13:44.560 that have been allocated, and that's how I get my 0:13:44.840 --> 0:13:49.880 price valuation per share, right, So it's just the vision. 0:13:50.040 --> 0:13:54.920 So that's how I got to to one dollar here. Um, 0:13:54.960 --> 0:13:59.280 Now that's just the So that's the the comment I 0:13:59.360 --> 0:14:02.960 got in an investor actually two investors that put in 0:14:03.000 --> 0:14:11.320 five each dope VC and investor one right, totaling one million. Right. 0:14:11.880 --> 0:14:16.880 So so now there's been one million dollars invested into 0:14:16.960 --> 0:14:22.440 the company in the form of a convertible note. And uh, 0:14:22.840 --> 0:14:25.640 the only other thing on on this on this exercise 0:14:25.680 --> 0:14:29.440 that um it's really important to point out is remember 0:14:29.520 --> 0:14:31.960 we talked about the purpose of having a cap table 0:14:32.280 --> 0:14:35.240 is to understand your ownership, Right, how much of my 0:14:35.440 --> 0:14:39.880 company do I now own? So as the founders with 0:14:40.080 --> 0:14:44.240 just that one million dollar investment combine, they own eighty 0:14:44.320 --> 0:14:47.720 three three of the company, right, which is a great 0:14:47.720 --> 0:14:49.960 place to um to be when you're when you're starting 0:14:50.000 --> 0:14:55.480 a company. I think I have some trigger questions. Yeah, 0:14:55.480 --> 0:14:57.840 so we talked about the cap in the discount. So 0:14:57.920 --> 0:15:03.240 let's let's move forward to exercise two. Exercise two bills 0:15:03.280 --> 0:15:07.400 on exercise one. So you know, a year has passed 0:15:07.960 --> 0:15:11.880 and UM, my company has done well, and uh someone 0:15:12.000 --> 0:15:13.840 or your company has done well. I'm the investor. Your 0:15:13.840 --> 0:15:17.360 company has done well, and so you're raising another round 0:15:17.360 --> 0:15:20.680 of funding to help you with growth. Right, So what's 0:15:20.720 --> 0:15:23.880 gonna happen here? Your seed notes are going to convert. 0:15:24.400 --> 0:15:27.080 They're gonna either convert at um the five million cap 0:15:27.520 --> 0:15:36.680 or or of the of the valuation. The the the investor, 0:15:36.760 --> 0:15:39.680 the new investor. They're gonna price this thing. So they're 0:15:39.720 --> 0:15:43.440 gonna set a pre money valuation of thirteen million. Anybody 0:15:43.480 --> 0:15:59.920 know the difference between the pre money and post money 0:16:00.280 --> 0:16:03.880 pre money, Yeah, she she got it. Pre money is 0:16:04.120 --> 0:16:06.960 um the price of the company or what the company 0:16:07.040 --> 0:16:09.960 is valued at prior to the investment, and then the 0:16:10.040 --> 0:16:14.000 post money is um. It's an addition of the valuation 0:16:14.040 --> 0:16:17.880 of the pre and the dollars that came in UM 0:16:17.920 --> 0:16:21.680 after right, and so when you're when you're talking about 0:16:22.520 --> 0:16:25.400 before the round is done, you talk about valuation in 0:16:25.480 --> 0:16:27.800 terms of pre money, and then once the round is 0:16:27.920 --> 0:16:30.960 um has concluded, then you speak about it in terms 0:16:31.040 --> 0:16:45.960 of post money. It's uh so there there, there wasn't right, 0:16:46.000 --> 0:16:49.000 because it's not an equity round. It's basically debt. At 0:16:49.000 --> 0:16:52.400 that point, the question was was the five million um 0:16:52.520 --> 0:16:56.560 cat considered a post or or pre and it's um, 0:16:56.600 --> 0:16:59.800 it's neither actually because it's a convertible note. It's a 0:17:00.160 --> 0:17:03.160 instrument at that point, and while you're holding a note, 0:17:03.440 --> 0:17:06.359 you're not actually holding equity and so there and so 0:17:06.440 --> 0:17:12.080 there isn't a true valuation at that at that point, Yeah, 0:17:12.440 --> 0:17:15.160 I already know the answer, but for some of them 0:17:16.200 --> 0:17:20.240 entrepreneurs here, so what is a the average interest rate 0:17:20.359 --> 0:17:23.600 when giving out a convertible note? Who sets that? The 0:17:23.680 --> 0:17:30.800 investor or the founder of the company. Like everything involving 0:17:30.840 --> 0:17:34.800 a deal is everything is negotiable, right, So UM and independents, 0:17:34.840 --> 0:17:37.199 who has who has more power in the deal. But 0:17:37.400 --> 0:17:41.800 typically you'll have a lawyer and that law firm would 0:17:41.800 --> 0:17:45.280 have seen some number of deals similar to this, and 0:17:45.320 --> 0:17:48.479 they'll SAYY, the the average or the or the median 0:17:49.000 --> 0:17:52.040 interest rate is this, and so that's what they'll they'll say, 0:17:52.119 --> 0:17:55.040 let's go with right. And as an investor, you know, 0:17:55.080 --> 0:17:57.440 I'm thinking about it from a you know, a risk 0:17:57.480 --> 0:18:01.000 reward standpoint, UM, and I may go up and I 0:18:01.040 --> 0:18:04.520 may go down, and it's basically just another negotiation, another 0:18:04.600 --> 0:18:08.520 level for lever for a negotiation. UM. Typically if you're 0:18:08.560 --> 0:18:11.680 really bullish on the deal, the interest rate doesn't doesn't 0:18:11.720 --> 0:18:14.760 matter so much to you, right, UM, there are other 0:18:14.760 --> 0:18:17.000 factors that are that are more important. So if the 0:18:17.640 --> 0:18:20.119 you know, if the entrepreneur wants to lower interest rate, 0:18:20.359 --> 0:18:23.520 you're probably gonna do that, all right. And you know, 0:18:23.560 --> 0:18:26.959 if if things go as they should, the UM, the 0:18:27.000 --> 0:18:29.560 interest that you're gonna get over a year or a 0:18:29.560 --> 0:18:32.160 two year period is not going to really be material 0:18:32.200 --> 0:18:39.000 in terms of your your ownership. UM. So can you 0:18:39.000 --> 0:18:43.200 hear me? Can you hear me? So? What has been 0:18:43.320 --> 0:18:48.520 your experience with buy sell agreements and how do they 0:18:48.760 --> 0:18:52.360 what role do they play in this discussion about ownership evaluation? 0:18:52.720 --> 0:18:55.120 All right, we gotta read the questions in and keep 0:18:55.119 --> 0:18:58.360 them about about UM, about this I can. I can 0:18:58.400 --> 0:19:02.760 catch up with you about that afterwards. UM. Okay, So 0:19:03.320 --> 0:19:06.200 it's a thirty million pre money UM. It's a two 0:19:06.200 --> 0:19:09.040 million dollar round. There are two new investors UM. One 0:19:09.080 --> 0:19:10.640 is going to invest a million, the other one's gonna 0:19:10.640 --> 0:19:14.280 invest half a million. I'm going to follow on and 0:19:14.320 --> 0:19:17.480 do UM do half a million in this round. And 0:19:17.720 --> 0:19:21.840 we're gonna we're gonna ask for a twenty option pool 0:19:22.359 --> 0:19:25.679 and we're gonna do it pre investment. So does anyone 0:19:25.720 --> 0:19:35.840 know what an option pool is? Ahead? Yeah, So it's 0:19:35.920 --> 0:19:39.359 a it's a percentage of the of the UM common 0:19:39.400 --> 0:19:43.199 stock in the company that's that you're holding UM to 0:19:43.640 --> 0:19:47.280 either reward employees for for doing well or use it 0:19:47.320 --> 0:19:50.000 as a recruiting vehicle to hire. I don't know your 0:19:50.040 --> 0:19:54.040 CTO right because one of the one of the carrots 0:19:54.240 --> 0:19:57.919 or the main things about the main attractive things about 0:19:58.080 --> 0:20:00.800 UM joining a startup is a fact that it's you know, 0:20:00.840 --> 0:20:03.760 it's gonna grow and you'll have ownership within that startup. 0:20:04.040 --> 0:20:07.840 So this option pool UM allows you to to basically 0:20:08.000 --> 0:20:12.800 award and UM reward your employees and soon to be 0:20:12.840 --> 0:20:16.320 employees with stock in the company UM. And so at 0:20:16.359 --> 0:20:20.400 the at the early stages. At the early stages, Um, 0:20:20.520 --> 0:20:24.399 you want a pretty hefty um option pool so that 0:20:24.440 --> 0:20:26.679 you don't have to to kind of create an option 0:20:26.720 --> 0:20:29.919 pool again and again and again, because as you create, 0:20:30.040 --> 0:20:33.360 as you increase that option pool, you you become deluded. 0:20:33.520 --> 0:20:37.880 Right because remember it's price over um over shares, right, 0:20:37.920 --> 0:20:42.639 So once you start adding more shares, you lose, you 0:20:42.720 --> 0:20:51.000 lose ownership. I'm sorry back there, So you actually just 0:20:51.119 --> 0:20:54.440 mentioned the word delution. How do you think through from 0:20:54.440 --> 0:20:57.879 a term sheet perspective? Uh, you know sort of who 0:20:57.960 --> 0:21:01.040 gets deluded? When you know? Is it founders? Is it 0:21:01.160 --> 0:21:04.760 subsequent investors? How do you how do you think through that? Yeah? 0:21:04.840 --> 0:21:07.160 So one of the things, one of the key things 0:21:07.200 --> 0:21:12.040 here is this pre pre investment, right, So I want 0:21:12.040 --> 0:21:14.760 that option pool to be created before I put my 0:21:14.840 --> 0:21:17.479 money into this round. And the reason I'm doing that 0:21:17.640 --> 0:21:20.679 is because once that option pool is created, at whatever 0:21:20.720 --> 0:21:23.320 time that option pool is created, whoever owns stock in 0:21:23.359 --> 0:21:27.159 that company, they're going to own less, right. So I 0:21:27.200 --> 0:21:31.640 want that to happen before I invest, and entrepreneurs might 0:21:31.680 --> 0:21:35.040 want that to happen after I invest. So again it's 0:21:35.080 --> 0:21:40.439 another it's another point where we start to negotiate. She 0:21:40.480 --> 0:21:46.240 had a question here he's bringing mic being sorry the 0:21:46.280 --> 0:21:48.399 option pool being hefty? What do you mean by that 0:21:48.560 --> 0:21:53.000 with like a T or like what is oh it? 0:21:53.320 --> 0:21:56.840 It's it's gonna vary. I think UM anywhere from ten 0:21:57.000 --> 0:22:01.920 to For a really early company, it's fair. Um. Most 0:22:01.960 --> 0:22:04.680 of the times you'll probably get to fifteen or or 0:22:04.880 --> 0:22:08.040 or ten percent at at this stage. Series A companies 0:22:08.560 --> 0:22:11.680 UM probably have an option pool around ten percent because 0:22:11.720 --> 0:22:15.760 at a Series A you probably have your most of 0:22:15.800 --> 0:22:18.080 your key executives in place, which are the ones that 0:22:18.119 --> 0:22:21.960 are gonna be awarded most of that option pool. UM. 0:22:22.080 --> 0:22:24.080 So you know, you can have a little bit a 0:22:24.119 --> 0:22:26.520 little bit less. But in this case we're asking for 0:22:26.960 --> 0:22:33.280 for twenty and so in this spreadsheet, basically what we're 0:22:33.359 --> 0:22:35.680 what we're doing is we need to say, all, right, 0:22:35.800 --> 0:22:40.200 of that of those ten million authorized shares that we 0:22:40.440 --> 0:22:45.920 UM that we have, we need that to be in 0:22:46.040 --> 0:22:50.199 the option pool. So for those of you spreadsheet jockeys 0:22:50.240 --> 0:22:54.399 out there, basically just run a goal seek um and 0:22:54.720 --> 0:22:57.240 uh you know so that you set this cell here 0:22:57.400 --> 0:23:02.320 to to equal um basically by changing the number here, right, 0:23:02.760 --> 0:23:07.800 So what happens is this number UM gets bigger and 0:23:07.920 --> 0:23:11.160 you can see that my price per share gets smaller. 0:23:12.040 --> 0:23:14.199 So that's the that's what that's what we mean by 0:23:14.400 --> 0:23:19.040 by delution. Now in this UM series A. Right, so 0:23:19.359 --> 0:23:22.760 we're putting in half a million. These two UM investors 0:23:22.800 --> 0:23:25.480 are putting in one point five million total, which is 0:23:25.520 --> 0:23:29.399 a two million. The pre money valuation is thirteen million, 0:23:30.160 --> 0:23:34.200 and the price per share is basically calculated by the 0:23:34.320 --> 0:23:38.000 pre money valuation divided by the sum of the common 0:23:38.119 --> 0:23:43.399 stock plus the stock that was purchased in that note 0:23:43.800 --> 0:23:52.600 that's now converting into the equity. Everybody got that, all right? 0:23:53.040 --> 0:23:55.120 Now you can ask questions if you don't, but I'm 0:23:55.119 --> 0:24:00.800 assuming you got it. Sure, I'll repeat it. So the 0:24:01.880 --> 0:24:06.560 the price per share is calculated by taking the value 0:24:06.600 --> 0:24:09.399 the pre money valuation, which we said at thirteen million, 0:24:10.320 --> 0:24:13.760 and we're gonna divide that by the sum of the 0:24:14.160 --> 0:24:17.200 total stock that has been issued in the company. Right, 0:24:17.280 --> 0:24:22.159 So um, the common stock plus the stock that was 0:24:22.280 --> 0:24:25.280 purchased as a part of the convertible note, because remember 0:24:25.320 --> 0:24:28.800 the convertible note is converting into equity at the first 0:24:28.840 --> 0:24:34.200 price round and that's where we are right now, I 0:24:34.280 --> 0:24:38.680 got it already, A right? Cool? Um? All right? So 0:24:39.560 --> 0:24:43.919 now now we actually have preferred stock in the company. 0:24:44.000 --> 0:24:45.760 I'll get you in a second. Now we actually have 0:24:45.840 --> 0:24:48.760 preferred stock in the company, right, because we're investing in 0:24:48.840 --> 0:24:53.080 a price round series A. So now I have you 0:24:53.160 --> 0:24:57.040 know I had before, I only had fully fully deluded ownership. 0:24:57.240 --> 0:25:00.919 Right now I have preferred ownership and I have UM 0:25:01.240 --> 0:25:07.560 total ownership. Anyone knows why this is important? Bode care 0:25:09.960 --> 0:25:12.439 it comes It all comes back to control. It all 0:25:12.480 --> 0:25:15.119 comes back to control. Right. So remember I said the 0:25:15.160 --> 0:25:19.119 difference between common stock and preferred stock is that preferred 0:25:19.160 --> 0:25:23.160 stock has more privileges, right and UM and they get 0:25:23.200 --> 0:25:26.240 to make certain decisions. Right. Can you sell your company 0:25:26.320 --> 0:25:28.159 for a dollar? If I'm an investor and I and 0:25:28.280 --> 0:25:31.600 I bought in for two dollars, I'm gonna say no, right, 0:25:31.880 --> 0:25:34.200 and the other investors are gonna say that too. There's 0:25:34.240 --> 0:25:38.640 a concept of UM voting thresholds for for the preferred 0:25:39.359 --> 0:25:43.720 UM stock stockholders, right, so I could say maybe it's majority. 0:25:44.200 --> 0:25:48.359 So if we want a decision to go forward of 0:25:48.480 --> 0:25:52.280 the preferred or fifty point one or fifty point zero 0:25:52.359 --> 0:25:55.200 zero zero zero zero zero one percent of the preferred 0:25:55.680 --> 0:25:59.080 need to agree to move forward UM with whatever that 0:25:59.200 --> 0:26:03.840 measure is. So as you're thinking about your investors and 0:26:03.920 --> 0:26:08.320 who you're taking money from. This becomes really important because 0:26:08.359 --> 0:26:11.800 there're gonna be some investors that you you really align with, 0:26:12.119 --> 0:26:14.320 that you think are are really good for your company, 0:26:14.960 --> 0:26:18.800