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  • Welcome to part II of our "Starting a Company" video. In this video, we're going over the

  • journey of the company. From the founders getting together, to fundraising, to issuing

  • stock, to vesting agreements, and all the way to the company exit. We'll explain how

  • the process works for each one of those steps. If you haven't watched part I, go and watch

  • it. Otherwise, this won't make sense. Let's get started.

  • So after incorporating and dedicating time to the business, the company is doing great-

  • the two founders managed to build the product, launch it, and are generating revenue.

  • Let's assume that our fictitious company is a SaaS business (software as a service). It

  • has $30,000 in monthly recurring revenue: that's customer subscriptions. It's also consistently

  • growing at 10% per month, which translates to around 300% in annual growth.

  • These are good Seed Round Metrics: they want to keep growing fast and accelerate their

  • pace even more- so the founders agree to seek out a new round of funding. This time, their

  • goal is raising $500,000.

  • For this stage, they can start to reach out to Angel Investors outside their family circle.

  • They use Slidebean to create a freaking awesome pitch deck and start getting meetings.

  • We have a video on the process of finding investors, so go check that out if you have

  • questions.

  • The guys find an angel investor willing to come into this round.

  • So, what % of the company do these investors get?

  • If we used traditional methods to calculate the business valuation, for example, a 5x

  • multiplier of their annualized revenue, then we could say the business is worth about $2,000,000

  • (that's $30,000 x 12 x 5). In that case, these new investors would get a 25% chunk of the

  • company, which doesn't feel fair to the founders.

  • Knowing the potential of the product and how fast they are growing, the founders feel that

  • the company is already worth $5MM. If that were the case, the new investors would be

  • buying around 10% of the business with their $500,000 investment; however, the investor

  • believes that's too small of a percentage for the risk they are taking.

  • So what Valuation to use, $2MM or $5MM? Somewhere in the middle?

  • Neither.

  • This is where a convertible note comes into play.

  • We also have a full video on convertible notes if you want to dive deeper- but I'm going

  • to explain it in simpler terms.

  • Considering founders and investors have no way of agreeing in Valuation, they can use

  • a convertible note to hold off on the decision of how much the business is worth. With a

  • convertible note, investors can come in, the company can grow, and the conversion to stock

  • occurs later.

  • A convertible note works much like a loan, except that it's designed to be paid back

  • in stock instead of cash. How many shares of stock? That will be determined based on

  • company valuation in the future.

  • Convertible notes are also known as bridge funding because they provide quick capital

  • with the expectation of a future round.

  • So, a convertible note for this company could look like this,

  • A $500,000 investment will be made in the form of a note (Loan).

  • The company assumes that with this capital, it will be able to scale fast, getting to

  • a point where they can raise a Series A round.

  • More importantly, the money will allow them to solidify their market presence. It will

  • make it easier for future investors to define a number that's fair for the company valuation.

  • So, the capital invested in this Convertible Note ill convert into stock at a future valuation.

  • That Valuation will be defined by the investors of the Series A round, and the Seed Stage

  • investor will get the exact same terms.

  • To compensate this early-stage investor for taking a risk, they will get a discount over

  • the Valuation of the future investors. That's usually around 20%.

  • Again, check out our video on Convertible Notes if you want to understand these variables

  • with more detail.

  • For the purpose of this video, notes are issued, money is in the bank, and the company continues

  • to grow.

  • The cap table or share distribution of this company is still unchanged- this new investor

  • is not a shareholder, yet.

  • At this point, the company will want to recruit some talent. These are going to be the first

  • employees, and it's important to keep them motivated!

  • In the startup world, it's quite common to offer shares of stock to the first employees

  • in the company, this is done with a Stock Option Pool.

  • Now, the stock option pool consists of a defined amount of shares that are 'set aside', to

  • be issued to employees.

  • For an option pool, our sample company could issue 500,000 new shares of stock, bringing

  • the total number of shares to 10,500,000.

  • Once again, those 4,000,000 shares each founder started with no longer represent 40% of the

  • business. They will now represent around 38%. Our original investor also gets diluted: their

  • 2,000,000 shares no longer represent 20% of the company, they are now approximately 19%.

  • The shares on the stock option pool are not given to employees, again, because of tax

  • purposes.

  • If the company just gave, say 100,000 shares to a new key employee, they would effectively

  • be receiving an asset that has a value. Remember how the company valuation was $250,000 after

  • the first round of investment?

  • Well, that means that each share is worth around $0.023. 100,000 shares represent about

  • $2,380, which would be considered a taxable income.

  • At a small valuation, this doesn't represent much money. Still, as the company scales more,

  • this could bring serious tax implications. So, instead of giving the shares to employees,

  • the stock option pool is made up of . The company is offering the employee

  • the option to purchase shares at a defined, fixed price.

  • In this case, that price could be $0.023, because it's the last 'official' Valuation

  • the company had: this is called the strike price.

  • If the company increases in value, and the price per share increases, the employee still

  • has the option to purchase shares at the original strike price, which lets them turn a profit!

  • For the purpose of this scenario, we're going to assume two key employees were hired, each

  • one getting 250,000 stock options.

  • As our theoretical company grows, we'll look into some scenarios on what happens with these

  • stock options.

Welcome to part II of our "Starting a Company" video. In this video, we're going over the

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B1 US company valuation stock convertible option investor

Startup Funding Explained - Seed Round and Stock Option Pool (Part II)

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