Question 14.1: You founded your own firm two years ago. Initially you contr...
You founded your own firm two years ago. Initially you contributed $100,000 of your own money and, in return, received 1.5 million shares of stock. Since then, you have sold an additional 500,000 shares to angel investors. Now you are considering raising even more capital from a venture capitalist (VC). This VC would invest $6 million and would receive 3 million newly Issued shares. What is the post-money valuation? Assuming that this is the VC’s first investment in your company, what percentage of the firm will she end up owning? What percentage will you own? What is the value of your shares?
PLAN
After this funding round, there will be a total of 5 million shares outstanding:
Your shares 1,500,000
Angel investors’ shares 500,000
Newly issued shares \underline{3,000,000}
Total 5,000,000
The VC would be paying $6,000,000/3,000,000 = $2 per share. The post-money valuation will be the total number of shares multiplied by the price paid by the VC. The percentage of the firm owned by the VC is the number of her shares divided by the total number of shares. Your percentage will be the number of your shares divided by the total number of shares, and the value of your shares will be the number of shares you own multiplied by the price the VC paid.
EXECUTE
There are 5 million shares and the VC paid $2 per share. Therefore, the post-money valuation would be 5,000,000 × $2 = $10 million, which, by Eq. 14.1 equals the pre-money valuation ($4 million) plus the amount invested ($6 million). Post-Money Valuation = Pre-Money Valuation + Amount Invested (14.1)
Because she is buying 3 million shares, and there will be 5 million total shares outstanding after the funding round, the VC will end up owning 3,000,000/5,000,000 = 60% of the firm.
You will own 1,500,000/5,000,000 = 30% of the firm, and the post-money valuation of your shares Is 1,500,000 × $2 = $3,000,000.
EVALUATE
Funding your firm with new equity capital, whether it is from an angel or a venture capitalist, involves a tradeoff—you must give up part of the ownership of the firm in return for the money you need to grow. If you can negotiate a higher price per share, the percentage of your firm that you will have to give up for a specified amount of capital will be smaller.