Raising 1st round of funding for your Startup Video Lecture | Stocks, Bonds, Equity and Valuation : Complete Knowledge - Entrepreneurship

Let's say I'm hanging out with
my buddies one night and we
realize that there's a
huge opportunity in
selling socks online.
And so we decide to
start a company.
So the first thing we
would do is we would
write a business plan.
And say, you know what?
In this business plan writing
process, this is all we've all
contributed to it
individually.
So we'll all be equal
shareholders.
Let's say there's five
of us friends.
So the first thing we want to
do is we want to start a--
well you know, you could do in
different orders, you could
just write up a business plan,
or you can start the
corporation.
But we'll just assume we
start a corporation.
And I'm going to indicate the
corporation by creating a
balance sheet right
from the get-go.
So, what are the assets of the
corporation, and what are the
debt-- and what are the
liabilities-- and we could
talk a little bit about what
a corporation even is.
So it's asset to begin with.
It's essentially just an idea.
I mean, you could say it takes
physical form to some degree
in the business plan, but it's
just an idea first. And then,
there are no immediate
liabilities, it doesn't owe
anybody any money.
And we learned in the balance
sheet videos-- and you might
want to watch the balance sheet
videos as a prerequisite
to this one-- but in general,
assets are equal to
liabilities plus equity.
So this is assets.
The only asset we have right
now is our idea.
Maybe you want to add the
potential talent that we have,
maybe unique skills.
They are very intangible
at this point.
These are the assets that our
five buddies have together.
And we have no liabilities.
It doesn't sound like we
borrowed money or anything.
So everything we have-- so the
assets are equal to our
equity-- and I'll do that in a
brown color-- so there's no
liabilities and we
just have equity.
And equity is essentially what
the owners of the company have
the rights to.
For example, if-- I haven't
assigned any numbers here and
I did that for a reason-- but if
the assets were $10 million
and liability was $5 million,
if we had owed $5 million to
someone else, then you
would have $5 million
left for the equity.
And that's what the owners of
the company would have.
Me and my five buddies, or I
guess my four buddies, we
decide we're the owners of the
company, so we'll be equal
shareholders.
So we would split the equity
between us five ways.
So we just pick an
arbitrary number.
Let's say to begin with we have
a million shares, so each
of us have 200,000 shares
in the company.
And that's a bit of an
arbitrary notion.
And you normally do assign some
value to those shares
initially, it's some pennies
per share, but I won't get
into the technicalities
of that.
Just fair enough to say that we
each have 200,000 shares in
this company.
And some of them go to me and
then the rest of them go to
buddy one, buddy two, buddy
three, and buddy four.
This is the equity right here.
And there's a total of one
million shares outstanding.
Good enough.
Well, just an idea and some
paper and some well
intentioned individuals
alone isn't
enough to start a company.
We're going to have to create
some type of an online
presence, and do some
programming, and maybe have a
warehouse, and do
some marketing.
So we're going to have to-- and
really we're going to have
to quit our jobs so that we can
work on this full time.
So we're going to have
to raise some money.
Money to hire some engineers, so
that we can quit our jobs.
To hire some marketing people,
et cetera, et cetera.
So where do we get
our money from?
So this is where the whole
venture capital world comes
into the picture.
You've heard the word before.
I think you have some
sense of what it is.
And the venture capital world,
it's kind of separated into
different people who invest
in different stages.
So you'll have people, they're
called angel investors.
And sometimes these people won't
even call themselves
venture-- angel investors.
And these are the guys that
are kind of these, I don't
want to stereotype it, but
they'll be kind of like the
old guys who made it big in
the `80s and now they're
sitting on billions
of dollars.
And they want to participate
in the neat, fun ideas that
young guys like me and
my friends think of.
And so they're kind of like your
rich uncle who says, oh
that's a great idea, I'll throw
some money behind that.
They usually invest at
a very early stage.
So those are probably
the people
we would go to initially.
And then we'll talk to the
people after that, the other
types of venture capitalists.
But in general, venture
capital can
meet a lot of things.
But it means someone who's
going to give you money.
They're going to take a stake in
your company and hope that
your-- they give you enough
money to kind of get your
venture going.
To kind of start
your business.
So let's say we go to an angel
investor, and we say hey,
angel investor, don't you think
this is a great idea?
We're going to sell
socks online.
You know, socks are something
people run out of every week,
we can even do subscriptions
for socks.
You get 10 pairs of month,
et cetera, et cetera.
You can give them as gifts.
All of these lovely things.
And the first nine guys slam
their doors on our face.
They think our business
is stupid.
But the tenth guy says, hey you
know, that's interesting.
So we enter into negotiations.
And he's like, you know what?
I'm going to invest. But we have
to figure out what I'm
going to get in exchange for
investing in your company.
How much of your company
I'm going to get.
And so this leads to a
process of valuation.
So let's say we say need $5
million from the angel
investor to get started.
We need $5 million-- let me
write that down-- that's what
we say we need.
And that's what the angel
investor says that he's
willing to give us,
because he agrees.
$5 million, that's enough for us
to quit our jobs, and then
we could all take salaries
for some time.
We could hire a bunch
of people.
We can rent office spaces.
Do everything you need to
do to start a company.
And $5 million will support
that for, I don't
know, a year or two.
I don't know, depending on how
many expenses we have.
But the question is, what does
he get for that $5 million.
So in order to come to that
conclusion, you have to
determine what is what we had
before he came to the picture
worth, right?
Notice, when I did this balance
sheet I didn't even
write what these assets
are worth.
What is this worth?
And this value, this is called
a-- well in general, whenever
you're valuing anything, it's
called a valuation.
And since we want to know what
this is worth-- this is before
we got any kind of money from
investors-- this would be
called a pre-money valuation.
And I'll show you why that
matters in a second.
Because, if us and this angel
investor agree that this-- our
assets before we go to them--
are worth $5 million.
So if we agree that they're
worth $5 million-- let me draw
that so, what color was
I doing that in?
It was in yellow-- so if we
agree-- let me draw it a
little bit smaller-- essentially
it's just an idea,
and then we have the shares,
a million shares.
Of that million,
I have 200,000.
The other 800,000 are
with my friends.
These are one million shares
total, or shares outstanding.
So if this idea-- we agree with
the angel investor-- if
we agree this is worth
$5 million.
So everything we have today
is worth $5 million.
Then when he gives us
another $5 million,
that's an asset, right?
We'll have $5 million in cash.
So he'll give us another
$5 million.
He'll essentially get
50% of the company.
He'll get all of these
shares up here.
Now how does that work out?
Well if you think about it,
this is the post-money
company, right?
So let's think about
it a couple ways.
This is $5 million.
That's the idea.
What is the $5 million worth?
That's not a trick question.
That's worth $5 million,
right?
It's worth $5 million.
So what is the post-money
valuation?
When we talk about valuation
we're talking about the value
of the assets, especially
because we're not dealing with
any debt right now.
Everything on the right-hand
side is equity,
so this is all equity.
Let me write that, no
liabilities yet.
And in general, when you're
doing a startup company, if I
want to start socksonline.com,
and I go into my local bank
and say, hey give me a
loan, they're just
going to turn me away.
Because if you have a venture
that really doesn't exist yet
and has no cash flow, they know
that you're not going to
pay the interest on the debt, so
you're not going to even be
able to raise debt until you
are a more mature company.
Or until you-- maybe you could
post some collateral.
And I'll talk more about that.
Maybe you could say hey,
I'll use my house.
If I don't pay the debt, you
can take my house, or
something like that.
But for the most part we
don't want to do that.
So the only way to raise money
at this early stage is by
issuing equity.
So going back to what we were
talking about, what is the
post-money valuation?
We said before any of this stuff
on the top existed, the
pre-money valuation of just
our idea was $5 million.
Now, the angel investor, if we
value this at $5 million,
he'll give us $5 million more.
What is the total value of
all of the assets now?
Well if we said this was $5
million, that's just something
we agreed with.
This is worth $5 million.
So the combined assets, if you
believe that this is worth $5
million, is now $10
million, right?
And this would be the post-money
valuation.
And if you think about it, if
you think about the company in
this form right now, we-- me
and my buddies-- we've
contributed half of the
value of the company.
And this rich guy, he's
contributed the other half of
the company.
So it makes sense that he
has 50% of the company.
So how is that going to work?
Well, I don't give away any of
my shares, and neither are any
of my friends.
They're all going to
keep their shares.
So we had five chunks of
$200,000 that went-- 200,000
shares that went
to each of us.
All right, that was buddy
one, two, three, four.
So what we'll do is, we'll
actually issue another million
shares and give it to
this rich dude.
So this is another one
million shares.
So as the company board, you
can actually authorize to
create shares.
And that's what we did, and we
essentially sold those shares
for $5 million.
So now instead of having one
million shares, you have two
million shares.
So something interesting here,
and some people often talk
about the notion of
dilution, right?
Because before, I had 200,000
out of a million shares.
So before, I had 20%
of the company.
And now what do I have?
Well we've essentially doubled
the share count, so now I only
have 10% of the company.
So some people say, oh you know
what, my share of the
company got diluted.
But it really isn't the case,
because the company has gotten
all this cash.
I now own 10% of something
that's twice as valuable, as
opposed to 20% of something
that's half as valuable.
If you really believe
that, then this
was no change, right?
I now own 10% of ten million,
which in theory should be
worth a million dollars.
Before I owned 20% of five
million, which was also worth
a million dollars.
So if you believe these
valuations, I
probably-- I'm neutral.
And we're going to put this
$5 million to work.
And actually let me take a
step-- actually no, I just
realized I'm out of time.
Let me continue this
in the next video.