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Ground truth assumed: - founders "Rich" and "Poor" have 50%/50% split, with zero investment so far. - they raise $3M at a $4M pre-money valuation. This is hig

Ground truth assumed: - founders "Rich" and "Poor" have 50%/50% split, with zero investment so far. - they raise $3M at a $4M pre-money valuation. This is highly unusual for a "seed"/"pre-seed" stage, but not unusual if they already managed to bootstrap, have paying customers, etc. - cap table is now: 3/7=~42% investor, 2/7=~28% Rich. 2/7=~28% Poor. (This is your first mistake: poor's stake in the company is worth $3.5M but rather $2M, on paper), and his 28% actually controls ~$850K of cash (assuming perfect democratic voting rights). 1. I am not saying that. I am saying that if the rich founder makes a $500K offer (5 times what the poor founder can afford), the poor founder will easily raise those $500K, because they control about three times as much in voting power. Any offer significantly below $3M * (4/7 * 50%) =~ $850K, e.g. $500K, means that one can raise $500K, and "buy 850K" with it. So the offer, even by rich dude, is guaranteed to not be below $850K. If the company has tangible measurable business, and the real worth is indeed $2M, then the same would be true for any offer significantly less than $2M. 2. Not, they would not. They might buy the founder out themselves, perhaps through the company, but they would not give a carte blanche for that. 3. It is possible to raise money for that, but it would usually be in the form of bonds or loans (essentially different mechanics for the same principle), not in the form of equity.

logicallee 9y ago
Thank you for all of your answers! I've gotten nearly everything from you, you've been very helpful. But I do have a couple of remaining questions. (This comment is not as llong as it seems.) Discussion of pre-money valuation --------------------------------- First of all I have a fundamental followup question that cuts across literally everything around equity raises. I don't understand why you continually use the pre-money valuation for how much a stake is worth! Usually post-money is used, isn't it? This is how I think about it - tell me if I'm wrong: let us see if pre-money or post-money is the more appropriate metric, by looking at the extremes. You create a machine that poops bars of gold and show me. I want to buy 99.9% of your company for a billion dollars. You say okay, because you want to go invent something else using a billion dollars, and anyway you're pretty sure I can grow it to a seven hundred billion commodities company, which will make your remaining stake - which might come with anti-dilusion or ratchet clauses, so you always have 0.1% of the company - worth a further $700M. And the rich guy takes all the risk regarding whether he can actually grow it to $700M or fucks it up. You have your $1 billion today, either way, and obviously anyone who can invent a machine that poops bars of gold has good R&D ideas for how to use $1 billion. So you agree. Ground condition: you had owned 100% of the company. A $1b investment for 99.9% of the company implies a post-money valuation of (1/99.9%) * 1 billion = $1,001,001,001. It implies a pre-money valuation of $1,001,001,001 - $1B = $1,001,001. So how is the $1M relevant in anyway? If the pre-money valuation is $1M then would the founder who just accepted $1B for 99.9% of the company, also accept a 50% buyout of the company for $2 million? After all, it's TWICE the pre-money valuation offer he just received! Of course faced with two options - a 99.9% buyout of the company for $1 billion or a 50% buyout of the company for $2 million, he would accept the first one and not the second one, which to any reasonable person values the company at a much lower value. As an even more extreme example, if the $2 million were for 100% of the company, then any reasonable person would understand that that offer values the company at $2 million. But the pre-money valuation is $0. Which also OBVIOUSLY doesn't make any sense whatsoever. How does a 100% buyout offer of $2 million value a company at zero? Obviously it doesn't. Would a guy looking at a 99.9% buyout for $1 billion and a 50% buyout for $2 million consider the second one to have a higher valuation? Of course not. But the pre-money valuation of the first one is just $1 million and the second one is $2 million - twice as high. So we have three examples of absurd results from using pre-money valuation. 1. A hundred billion dollar investment for 99.9999999% of the company values the company at $100 pre-money ((1/99.9999999%) * (100,000,000,000) - 100,000,000,000 = $100). This is absurd. 2. A 100% buy of any company at any price values the company at $0. This is absurd. 3. A $4 million valuation (50% for $2m) can value the company higher than a $1 billion valuation - as long as the pre-money of the latter is lower. Again, absurd. All of these absurd results make it totally unrealistic to use pre-money valuations so I really don't understand why you're doing it! Please explain in detail, as I've been used to using post-money valuations to talk about the value of a company. I thought this was standard. Maybe I've grossly misunderstood something, so it would be very useful if you told me what! Your other answers ------------------ Thank you for the other answers. Your answer number 2 essentially means these kinds of clauses are only possible where there is not a VC on board, (because if there were, they wouldn't allow it and have protections against it in their standard docs), right? You gave a partial answer to number 3 ("yes, but it would usually be in the form of bonds or loans") but as a practical matter would banks loan money to a company (say, against its assets as collateral) that was explaining to its loan officer at the bank that it was borrowing money to buy out one partner through another? At a practical level I didn't get whether this is something the company would probably be successful doing or probably fail doing. I have no experience with this. So I am asking whether banks would agree to that. Thank you for all of your answers by the way! I am particularly interested in your list of reasons for using pre-money. It doesn't seem useful for me, or match people's intuitive definitions of valuation.
- beagle3 9y ago
  I would recommend reading http://www.investopedia.com/ask/answers/114.asp http://www.investopedia.com/ask/answers/114.asp for how valuations work. Don't take this as a personal attack: To me it seems you are very confused about the difference between share purchase and investment (these are NOT the same thing). In the world of company founding and funding, these go hand in hand with other things like dilution, vesting, rights of first refusal, "double dipping", and many more (and you practically need to be familiar with them to understand why things work the way they do; other wise, things that are very logical and pragmatic like shotgun buyouts don't make much sense). I don't have the time to give you an answer all of these cases, but when you read on it, keep in mind that EVERY DEAL has both a pre-money valuation and post-money valuation, and the difference between them is exactly the money invested (in a "standard" investment deal). It is important to qualify a valuation (whether pre- or post- money) when you discuss it. I did NOT use one or other valuation; I gave both, to make the numbers clear. Again, until you properly understand the difference between share sales and share issuance (which is what is done in an investment), nothing will make sense. Make sure you have a good grasp of these -- a reasonable test if you got it right is to see if my "ground truth" example makes sense.
  - logicallee 9y ago
    I read that. Thank you for the rest of your comment as well (not taken as a personal attack): I think you have identified one source of my confusion. I closely relate the idea of valuation to share price. I will read up to get a fuller understanding, but could I just ask one question before you go: do the terms "pre-money valuation" and "post-money valuation" or does the term "valuation", mean anything when you buy 100% of the company from me (without issuing any extra shares shares, and the company doesn't get any of your money) for a certain amount? If that amount is $500,000 then what is the pre-money and post-money valuation (if these terms apply). This should clear up my confusion as in this case no extra stock is issued. I will read up on the rest. I want to know if these terms (pre-money valuation; post-money valuation; valuation) even apply in such a case! Thank you for taking the time to understand some of my sources of confusion. Other than this one, I'll try to get a handle on the rest of my questions from other sources.

logicallee 9y ago

Thank you for all of your answers! I've gotten nearly everything from you, you've been very helpful. But I do have a couple of remaining questions. (This comment is not as llong as it seems.) Discussion of pre-money valuation --------------------------------- First of all I have a fundamental followup question that cuts across literally everything around equity raises. I don't understand why you continually use the pre-money valuation for how much a stake is worth! Usually post-money is used, isn't it? This is how I think about it - tell me if I'm wrong: let us see if pre-money or post-money is the more appropriate metric, by looking at the extremes. You create a machine that poops bars of gold and show me. I want to buy 99.9% of your company for a billion dollars. You say okay, because you want to go invent something else using a billion dollars, and anyway you're pretty sure I can grow it to a seven hundred billion commodities company, which will make your remaining stake - which might come with anti-dilusion or ratchet clauses, so you always have 0.1% of the company - worth a further $700M. And the rich guy takes all the risk regarding whether he can actually grow it to $700M or fucks it up. You have your $1 billion today, either way, and obviously anyone who can invent a machine that poops bars of gold has good R&D ideas for how to use $1 billion. So you agree. Ground condition: you had owned 100% of the company. A $1b investment for 99.9% of the company implies a post-money valuation of (1/99.9%) * 1 billion = $1,001,001,001. It implies a pre-money valuation of $1,001,001,001 - $1B = $1,001,001. So how is the $1M relevant in anyway? If the pre-money valuation is $1M then would the founder who just accepted $1B for 99.9% of the company, also accept a 50% buyout of the company for $2 million? After all, it's TWICE the pre-money valuation offer he just received! Of course faced with two options - a 99.9% buyout of the company for $1 billion or a 50% buyout of the company for $2 million, he would accept the first one and not the second one, which to any reasonable person values the company at a much lower value. As an even more extreme example, if the $2 million were for 100% of the company, then any reasonable person would understand that that offer values the company at $2 million. But the pre-money valuation is $0. Which also OBVIOUSLY doesn't make any sense whatsoever. How does a 100% buyout offer of $2 million value a company at zero? Obviously it doesn't. Would a guy looking at a 99.9% buyout for $1 billion and a 50% buyout for $2 million consider the second one to have a higher valuation? Of course not. But the pre-money valuation of the first one is just $1 million and the second one is $2 million - twice as high. So we have three examples of absurd results from using pre-money valuation. 1. A hundred billion dollar investment for 99.9999999% of the company values the company at $100 pre-money ((1/99.9999999%) * (100,000,000,000) - 100,000,000,000 = $100). This is absurd. 2. A 100% buy of any company at any price values the company at $0. This is absurd. 3. A $4 million valuation (50% for $2m) can value the company higher than a $1 billion valuation - as long as the pre-money of the latter is lower. Again, absurd. All of these absurd results make it totally unrealistic to use pre-money valuations so I really don't understand why you're doing it! Please explain in detail, as I've been used to using post-money valuations to talk about the value of a company. I thought this was standard. Maybe I've grossly misunderstood something, so it would be very useful if you told me what! Your other answers ------------------ Thank you for the other answers. Your answer number 2 essentially means these kinds of clauses are only possible where there is not a VC on board, (because if there were, they wouldn't allow it and have protections against it in their standard docs), right? You gave a partial answer to number 3 ("yes, but it would usually be in the form of bonds or loans") but as a practical matter would banks loan money to a company (say, against its assets as collateral) that was explaining to its loan officer at the bank that it was borrowing money to buy out one partner through another? At a practical level I didn't get whether this is something the company would probably be successful doing or probably fail doing. I have no experience with this. So I am asking whether banks would agree to that. Thank you for all of your answers by the way! I am particularly interested in your list of reasons for using pre-money. It doesn't seem useful for me, or match people's intuitive definitions of valuation.

beagle3 9y ago
I would recommend reading http://www.investopedia.com/ask/answers/114.asp http://www.investopedia.com/ask/answers/114.asp for how valuations work. Don't take this as a personal attack: To me it seems you are very confused about the difference between share purchase and investment (these are NOT the same thing). In the world of company founding and funding, these go hand in hand with other things like dilution, vesting, rights of first refusal, "double dipping", and many more (and you practically need to be familiar with them to understand why things work the way they do; other wise, things that are very logical and pragmatic like shotgun buyouts don't make much sense). I don't have the time to give you an answer all of these cases, but when you read on it, keep in mind that EVERY DEAL has both a pre-money valuation and post-money valuation, and the difference between them is exactly the money invested (in a "standard" investment deal). It is important to qualify a valuation (whether pre- or post- money) when you discuss it. I did NOT use one or other valuation; I gave both, to make the numbers clear. Again, until you properly understand the difference between share sales and share issuance (which is what is done in an investment), nothing will make sense. Make sure you have a good grasp of these -- a reasonable test if you got it right is to see if my "ground truth" example makes sense.
- logicallee 9y ago
  I read that. Thank you for the rest of your comment as well (not taken as a personal attack): I think you have identified one source of my confusion. I closely relate the idea of valuation to share price. I will read up to get a fuller understanding, but could I just ask one question before you go: do the terms "pre-money valuation" and "post-money valuation" or does the term "valuation", mean anything when you buy 100% of the company from me (without issuing any extra shares shares, and the company doesn't get any of your money) for a certain amount? If that amount is $500,000 then what is the pre-money and post-money valuation (if these terms apply). This should clear up my confusion as in this case no extra stock is issued. I will read up on the rest. I want to know if these terms (pre-money valuation; post-money valuation; valuation) even apply in such a case! Thank you for taking the time to understand some of my sources of confusion. Other than this one, I'll try to get a handle on the rest of my questions from other sources.