So, where I’d left off in the last video, we had kind of talked about the scenario where my buddies and I came up with this idea to sell socks online. We went to a rich investor we call an angel investor who is usually kind of a rich uncle type of figure who gets excited by young guys innovating in the world. And we say, “Hey! We need $5 million.” He says sure enough. I think the idea you have by itself or maybe some kind of prototype you might have made or something, that’s worth $5 million. So, I’ll give you another $5 million of cash to kind of get started, rent some space, hire some people and for that, what you had was $5 million, that’s what you’re bringing to the table. I am bringing $5 million cash to table. I essentially get half the company. And the way that works is it’s not like we each gave him half of our shares; instead, since we are the board of the company, we issue another $1 million share. So, we double the share count and we give it to him.

This pre-money valuation is really, really important because if we had agreed, if we said this wasn’t $5 million, if we said that this is, let’s say he is a hard negotiator and he says, “No, that’s only worth a $1 million.” And I am going to give $5 million. So, let me ask you, how many shares would we have to issue? So, think about it because our idea, I mean it really is a hard thing to estimate what an idea is worth. So, he negotiates hard. At the end of the day, we’re desperate. Financial markets have collapsed so, we’ll take money from whoever is willing to give it to us and we really want to quit our jobs. So, he says that what we have right now, our idea is only worth $1 million and he is going to give us $5 million. So, how many shares do we have to give him? This right here, this is $1 million shares. That’s what we started off with. So, when he says that what we have right now is worth $1 million, he’s essentially saying that it’s worth $1.00 per share. So, my $200,000.00 shares are worth $200,000.00 according to his valuation.

Up here, we said that what we had before was worth $5 million in the previous video. If what we had before is worth $5 million and there were $1 million shares initially, then the valuation of either pre-money and post-money would be $5.00 per share. In the $5.00 per share world, what we did is we issued another $1 million shares and sold them for $5 million, then we sell them for $5.00 per share to get the $5 million. And so, we ended up with a 50/50 split of the company. This is the angel investor, this is all of us down here and all of these are equity. No debt, no liabilities just yet.

Now in this reality, if he is valuing what we have right now at essentially $1.00 per share, he says it’s worth a $1 million. You have a $1 million shares, so $1.00 per share. In order for him to give $5 million, he’s essentially going to buy $5 million worth of stock at $1.00 per share. So, he is essentially going to need $5 million shares. And notice, in the situation up here before when I have $200,000.00—well, when I had 1/5 of $5 million, the value of my share was $1 million. And then when I have 1/10 of $2 million shares, I still have 1/10 of $10 million of total asset value because now he threw in his $5 million and so, my share is still worth $1 million. I have a tenth of $10 million as opposed to a fifth of $5 million.

In this situation, I use to have a fifth of $1 million which would be $200,000.00 and now I have $200,000.00 over how many total shares are there now. There are now $6 million shares. So now, I have 1/60. I have now $200,000.00/$6 million, that’s six thousand thousands, so that cancels out. I now own 1/30 of the company before I had 1/5 and we’re valuing it at $6 million because I have $1 million here and $5 million here times $6 million and so, what’s 1/38 of $6 million? 1/6/30 = 1/5 of a million, so this is still $200,000.00. So, no matter what I do between the pre-money and the post-money valuation, my per share value doesn’t change any and I want to show you that. But this matters a lot because based on what this pre-money valuation is; it tells us how many shares and what percentage of the company our angel investor gets for investing his $5 million. In this case, he gets 5/6 of the company. What is that? That is like 84% of the company; I think roughly. And we are left with like 16% of the company. So, it’s a very different scenario depending on what our pre-money valuation is. And of course, the pre-money valuation is you just take the pre-money valuation plus the amount of cash they’ve given and that’s the post-money valuation, the amount of money you get. Pre-money and then post-money, you add the money in and you get the $6 million valuation. I think you have a good sense of it.

And let’s say that we end up lucky. The guy wasn’t a hard negotiator and we ended up with that first situation. So now, if I already draw the assets of this corporation at least at the time of that guy’s investment where it’s a very intangible asset, we call it the idea, now it has a value $5 million and we have some cash. We have $5 million in cash and then we have the shares and off that share, well I have $2 million shares outstanding. I have $1 million to the angel investor. So, he has 50% of the shares and just because I like to keep track of my slice, there’s $200,000.00 shares that go to Sal.

Now, I mean obviously the whole point of this wasn’t just to negotiate, raise money and quit our jobs. The whole point of this was to start a business. So, let’s say we take this $5 million. We start hiring people and really our first step is to build out our website and just kind of have a working site going. So, let’s say we burn through $4 million of that and we build a site. So, let’s say we only have a $1 million left; this is maybe six months in the future. We all quit our jobs. We got some fancy loft like office space. We got a foosball table and we also built a website. We hired some graphic designers and things. And so, we’ve burned through most of our cash. And we’re starting to get a little bit worried because we haven’t made a profit yet but we have a neat website.

When we went to the angel investors, we just had an idea, a business plan and hopefully, we had our charisma and we were able to sell the guy on the idea. He though it was going to be the next dominant sock player in the world. But now, we actually built something, we took his money and as promised, we built a nice website. And now, we need to raise more money. One, because we’ve hired 50 people and this $1 million isn’t going to last as too long and that would be a shame to run out of cash just when we’re getting off the ground. We now actually have a real website and offices and all of that. And we want to raise some money because we want to put up some AdWords on Google, so people know about our site. We want to spend a couple of $1 million dollars for Super Bowl ads, so people know that they can get socks online now. So, we have to raise more money. And now at this stage, we would go back to the venture capital community but we wouldn’t go to the angels. The angels are the guys who like the big picture, who want to just kind of throw some money in to an early idea and it’s usually a relatively small amount. Actually, $5 million would be a large amount for an angel. We want our goal to kind of real professional VCs now. And what we would do is we would go to a seed VC. So, seed VC is our kind of the first round and each round is kind of every time you have to go back to the till to raise money, that’s kind of a round of financing.

Seed investors, so there are a lot of words for it but seed investors are usually VC investors who are actual professionals at what they do. They’re actually managing other people’s money. We’ll do another video on how they raise that money and it’s much related to how private equity firms and hedge funds also raise their money but they are usually managing other people’s money while an angel investor is usually is just sitting on top of big pile of money and likes to play with it. So, they are managing other people’s money and they attempt to have some fancy MBAs that they just hire who’ll make models and do projections and negotiate a little bit harder with you when you’re actually trying to get a value on your business but we have to go to these guys. They have some value, I mean they all connect us with other dudes and they have experience starting businesses. They can introduce us to other people who’ve done similar things and all the rest, help us network and help us manage the business.

So, we go to a venture capitalist and we get the door closed a lot of times but one seed venture capitalist finally comes to us. The terminology can be a little ambiguous here but we’ll call it our series A financing. Sometimes, it will be called your seed financing but we’ll call it series A because we want to formalize it. And just so you know, the A is—because it’s our first real formal round of financing. In our second round which I’ll do probably in the next video, it will be series B and then series C and then series D. Every time we run out of cash, we want to go back to the till. We’ve already done the series A and now we want to do a series B and a series C and so forth and so on. And eventually, we’ll hopefully get to some type of an IPO which I’ll talk about in the next video.