More on IPO's Video Lecture | Stocks, Bonds, Equity and Valuation : Complete Knowledge - Entrepreneurship

I think a little bit of a review
is in order now and
maybe just taking a little bit
of a step back to say well,
why does a company even
raise equity?
And why do the people who buy
the equity even do it in the
first place?
So the whole idea of what we
were doing in the last several
videos is that a company wants
to raise money to start a
website, or build a factory, or
do whatever else-- kind of
invest in the world and in its
kind of productive capacity,
so it can build the
things that the
company is meant to build.
And in every example so far--
we have the example where me
and my buddies, we have
just a business
plan, that's the asset.
And then we own all
the equity.
We're the board of directors
initially.
So that's all the equity.
So let's call this the
assets right now.
This is the equity.
And we could go to a venture
capitalist-- it could have
been an angel investor.
It could have been-- we
talked about Series A,
Series B, all of that.
And we could say OK, we need
to raise x million dollars.
What percentage of your company
do we have to give
away for that?
And it'll say OK, well we'll
value what you have right
now-- I'll do a different number
than what I did in the
past-- we'll value what you have
right now as $1 million.
And so, if you need another $2
million-- so let's say we
value what you have right
now as $1 million.
Let's say right now you have
one million shares.
So the company's pre-money
valuation is $1 million.
So you are essentially saying
that the company right now is
worth a dollar per share.
There's $1 million worth of
assets, and there's a million
shares, so a million divided by
a 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,
let me do green, I'll do
a different color, I'll do
purple-- we'll give you-- draw
the box-- we'll give you, I
don't know, $2 million.
And since we're buying it at
$1 per share, we get two
million shares for that.
And now all of this
is the equity.
This is what the founders had,
and this is all the equity.
And so now the company has
what we say was worth a
million dollars.
And 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 $2 million.
So the post-money valuation--
pre-money was $1 million--
post-money is now $2 million.
And now, we had one million
shares, now we have three
million shares.
So essentially, for giving
$2 million, 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 two out of three
million shares, or 66% of the
company for giving
the $2 million.
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 capitalist 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 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, 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 its assets.
And this is its-- let
me draw its current
equity base right there.
They should be the same size,
but you get the idea-- and
these assets, it could
be it has some cash.
It has some factories or land.
It could have a bunch
of stuff.
It could have some technology,
or we could have some
intellectual property.
Maybe it's a drug company,
or maybe it's
a technology company.
It has a bunch of patents
and stuff.
And then it has some
intangibles-- 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.
And this is its current
shareholder base, maybe some
of these are some VCs who
invested in the company when
it was private.
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 as just kind of a review of
the last video, it can do
an initial public offering.
So right now it's private.
All of these shares right now
that are owned by the VCs and
the initial founders of the
company, they are not traded
on a public exchange.
This VC can't go to the NASDAQ
and sell their shares.
They can't go to the 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 maybe these
founders-- 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 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 stipulations
around, we'll give you this
money, but if this happens, then
you have to give us this
interest rate.
And just all these
type of things.
So, what they might want
to say is, we need to
raise a lot of money.
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 a ton of money.
Let's say we want to
raise $100 million.
And that's hard to raise from
just any one individual
investor, even if they are
a big institution.
So they'll do an initial public
offering, and that
really just means and-- the IPO,
and this is review of the
last one-- is that for the first
time this company is
going to register its shares
with the SEC, and because it
does, it's going to list its
shares on an exchange.
It will get a ticker symbol,
it will maybe be company--
this'll be its ticker, T-I-C-K,
or in the last video
could be SOCKS, because it's
going to sell socks.
And then people can trade these
shares on that exchange.
It could be on the NASDAQ
or something.
And I think some of you all have
had experience doing that
where you go on your Charles
Schwab account and you say I'm
going to sell SOCK.
Well, that company that you're
selling, at some point, did an
initial public offering, and
registered with the SEC, and
got listed on an exchange.
And the way it really works
is, it's fundamentally the
same as when you raise
money from a VC.
But now, instead of raising
money from a VC, all the money
comes from, essentially,
the public.
It goes through these banks
and brokerages, but it's
coming from a bunch of
small-- I'm just
divvying it up right here.
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 do a model and
they'll say oh, this is worth--
the company beforehand
was worth $50 million.
They'll kind of go out into the
market to say well, our--
and let's say the company
right now has
five million shares.
So that this piece right
here is five million.
So if the banks value the
company at $50 million, and it
has five million shares, they'll
say OK, right now, the
pre-money valuation
is $10 a share.
And the bank will
go out there.
It'll kind of gauge interest
and say well, does it seem
like the market's 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 move
forth with the IPO.
And, hopefully, the market
actually wants to
not pay $10 per share.
The market maybe wants
to pay $20 a share.
So all of these guys, let's say
they'll pay $10 a share,
so let's say that they sell 10
million shares at $10 a share.
So the company is able to
raise $100 million.
10 times $10, $100 million.
Then they can do big ads
and all of that.
And what the bank hopes is by
selling these shares at $10 a
share-- so let's say this is
days, and this is price.
Let me change colors-- so what
the investment bank wants to
hope is that, on day one, you
sell it at $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 for too little, then the
company won't get as much
money as it deserves.
But if they sell for too much,
then the stock price goes
down, then you kind
of have a stigma
associated with the IPO.
But anyway, this begs the
question of 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, and 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.
And one is kind of the obvious
one, because they think the
shares will go up.
But to some degree, that's
speculation.
If I'm buying a share at $10,
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.
I'm just saying oh, IPOs
go up so let me buy it.
But, economically, why
was this even worth
$10 to begin with?
How do we even think about that
valuation, at a very even
high level, why is this
even worth $10 a
share to begin with?
And the idea 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, 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,
and a lot of companies
don't do it right now,
they'll actually
dividend out that cash.
So there's a couple of things
that will make this equity
have kind of an economic-- 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.
A dividend is just cash that is
given to the shareholders.
So let's say that this is a
stock certificate in SOCK.
So at some point 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,
this is an awesome technology.
It'll complement what we
already have. And maybe
they'll buy out the company.
Maybe they'll pay $300 million
for this company.
And then, essentially, they're
paying $300 million-- and
there's, what, fifteen
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 into a lot more
detail, I'll do a whole
playlist on 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'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?
Essentially, where else you
could you put your money?
When does the company dividend
out its-- 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.