Start-up Valuation

Okay, So, for one, I failed CFA level I, two, I am having trouble working out some start-up logic:

if I have a stock pool set aside for owners and employees of, say, 30%, and the rest up-for-sale to investors, then how do I value my stock? how do I sell the initial shares? At the diluted value? or the normal value?

The normal stock price at initiation would be:

initial Investment / (# of shares of CommStock - # of stock in option pool) = intial stock price at initiation

Initial Investment / # of shares of CommStock = Diluted Share Price at initiation

because there is, hypothetically, very little competition for these stocks (and thusly their returns) the stock *at initiation* is theoretically only worth the initial investment no??

How do I sell stock at the regular price, to get the capital I need to start, when the diluted price is going to be lower? Do investors just accept this? As long as there is a 4 year hold clause for employees options?

okay I’ve cleared this up… Issued at par w/ the options holds

typically the venture capital investors would get convertible preferred stock where they retain the equity upside if you make it big and also have downside protection through some liquidation preference which is equal at minimum to their initial investment, possibly compounded with some rate of return

wait, so they want to either get their complete investment back with interest, or make it big if I make it big?

That makes no sense. I can see them initially wanting the stock priced similar to the initial capital on day one, but after day one, how can they expect to get their initial investment back? I’ll have spent it by then, and the office being rented is not coming back. I understand as preferred shareholders they’ll have claim to assets, but they can’t expect to get their money back with interest upon failure…can they?

^ not sure if you’re joking or not. Assuming you’re serious, the liquidation preference certainly doesn’t guarantee them that they will get their money back if you go bust, but they will be first in line. If you’re marginally successful, they will be guaranteed their money back plus some interest. If you hit it big, they will hit it big too by converting to common.

Convertible preferred stock/convertible preferred debt is basically debt + a bunch of call options on the equity. So, basically what higgmond said. Since it is structured like debt, there is an expectation to pay you back (unless they are bankrupt/insolvent), and you have exposure to the upside.

Haha, thats just the tip of the iceberg bro. The venure investors would also likely have anti-dilution clauses that will limit the amount you can give to yourself and employees through stock options. They will add a right-of-first-refusal clause which will allow them to participate in future financing rounds and possibly increase their pro-rata ownership share of the company. They may add a redemption clause in case you sit around not making progress for too long, where they can call the whole thing off and try to get paid by liquidating your assets. Venture funding has been extremely tight in 2012, very little liquidity for the riskiest enteprises across the board. For a garage startup you’re better off with angel investors - call your rich uncle or explore some crowdfunding site…

Higgmond is 100% right. I’ve sat in one or two VC meetings in college.

Oh, i know they get dibs on assets first, I see how they’d get their investment and interest back, but i thought this was like an implicit agreement, not just a assumed expectation.

is there a difference between anti-dilution and non-dilution?

If you are honestly looking for venture money, you need to be on the lookout for more than just redemption clauses. VC’s will try everything they can think of to get the largest share of your company for the least amount of money possible. They will also want veto rights on just about every corporate decision including how often you are allowed to take a piss. You also have to remember that for the most part the value you have determined for the company is meaningless. They will put their own value on the company and make their investment accordingly. I don’t say these things wilth malice BTW. VC’s provide a very valuable service and the really good ones bring far more than money to the table.

So, read any agreement very, very, very, very, very carefully and be sure you understand every single sentence. Some sentences will literally be 15-20 lines long with parentheses and brackets all over the place. I probably read 20 - 30 preferred stock purchase agreements per year and some of them can take days to fully understand.

Thank you higg.