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Great article. Would love a simple, colloquial explanation of the following phrases: * $1 million as a note with a $5 million cap and a 20% discount. * senior

Great article. Would love a simple, colloquial explanation of the following phrases: * $1 million as a note with a $5 million cap and a 20% discount. * senior liquidity preference of 1x to protect their downside since they feel the valuation is rich * Peter, is stoked that he is getting his $1 million investment converted into roughly 20% * senior 1x liquidation preference * the preference overhang of $211 million * They ask prior investors to recap * the ‘overhang math’. * senior preference and a 2x guarantee. * waterfall spreadsheet

nirmel 11y ago
> $1 million as a note with a $5 million cap and a 20% discount. This refers to an investment done on a "convertible note." These particular terms mean that the valuation at which their investment will "convert" from what is nominally a loan into equity will be at most $5m, but if a subsequent investor invests in an equity financing at less than 6.25m, their investment will convert to equity at 20% less than the valuation. Read up on convertible notes for more detail. > senior liquidity preference of 1x to protect their downside since they feel the valuation is rich Means that in a sale, the investor will get the full amount (1x) of what they invested before others (i.e. founders, employees) see anything. > Peter, is stoked that he is getting his $1 million investment converted into roughly 20% Since the valuation was > 6.25m his valuation was capped at $5m, whereas the investors who are investing got a valuation of $40m "pre-money" or $50m "post-money" which are much less favorable terms than what Peter invested at. > the preference overhang of $211 million Means that if the company is to be acquired, it would take an acquisition offer of at least $211 million for founders and employees to see even a penny. That is because that amount was invested with the "1x" preference. > They ask prior investors to recap I think this means they are asking previous investors to lower the amount of liquidity preference they have such that in the event of a sale under $211m the founders would see some return. > the ‘overhang math’. The wiser employees understand the math that says an acquisition has to be enormous for them to see anything. If they don't think that's likely they will see little motivation to continue working at the company. > senior preference and a 2x guarantee. 2x guarantee means that they would be guaranteed twice the amount the invested in the event of a sale, possibly ahead of other investors, but I'm not sure. > waterfall spreadsheet Indicates how much each interested party would get in proceeds in the event of exits of various amounts. E.g. if company sells for X, investors get Y and founders get nothing. If company sells for Z, investors get X1 and founder gets Z. Etc.
- hackaflocka 11y ago
  That was very helpful. Thanks.
- shalinmangar 11y ago
  Can you please explain how did you come up with the figure of 6.25m?
  - michaelt 11y ago
    5 million / (1-0.20) = 5 million / 0.8 = 6.25 million A "convertible note" is a cash investment that "converts" into an equity investment when the company starts doing equity investments. The have two separate mechanisms for rewarding investors for getting in early. The "20% discount" means the investor can convert the note into shares paying 20% less per share than later investors. The "$5 million cap" means, if the company has a valuation greater than $5 million, the investor can convert the note into a fraction of the company as if the company was valued at $5 million. The investor then chooses whichever of these options is better. Take the example of a $1 million as a note with a $5 million cap and a 20% discount, when series A funding comes along. If Series A values the company at $4 million, the investor can choose between taking shares at a 20% discount (they get shares valued at $1.25 million for their investment of $1 million) and taking shares at a $5 million valuation (they get shares valued at $0.8 million for their investment of $1 million) and they obviously choose the former. If Series A values the company at $10 million, the 20% discount still lets them get shares valued at $1.25 million for their investment of $1 million - but now taking the shares at a $5 million valuation lets them get shares valued at $2 million for the same investment. Obviously they choose the latter! A $6.25 million valuation is the crossover point, where the 20% discount and the $5 million cap give the investor the same number of shares. At a valuation below that the discount is the better choice, and at a valuation above it the cap is the better choice.

nirmel 11y ago

> $1 million as a note with a $5 million cap and a 20% discount. This refers to an investment done on a "convertible note." These particular terms mean that the valuation at which their investment will "convert" from what is nominally a loan into equity will be at most $5m, but if a subsequent investor invests in an equity financing at less than 6.25m, their investment will convert to equity at 20% less than the valuation. Read up on convertible notes for more detail. > senior liquidity preference of 1x to protect their downside since they feel the valuation is rich Means that in a sale, the investor will get the full amount (1x) of what they invested before others (i.e. founders, employees) see anything. > Peter, is stoked that he is getting his $1 million investment converted into roughly 20% Since the valuation was > 6.25m his valuation was capped at $5m, whereas the investors who are investing got a valuation of $40m "pre-money" or $50m "post-money" which are much less favorable terms than what Peter invested at. > the preference overhang of $211 million Means that if the company is to be acquired, it would take an acquisition offer of at least $211 million for founders and employees to see even a penny. That is because that amount was invested with the "1x" preference. > They ask prior investors to recap I think this means they are asking previous investors to lower the amount of liquidity preference they have such that in the event of a sale under $211m the founders would see some return. > the ‘overhang math’. The wiser employees understand the math that says an acquisition has to be enormous for them to see anything. If they don't think that's likely they will see little motivation to continue working at the company. > senior preference and a 2x guarantee. 2x guarantee means that they would be guaranteed twice the amount the invested in the event of a sale, possibly ahead of other investors, but I'm not sure. > waterfall spreadsheet Indicates how much each interested party would get in proceeds in the event of exits of various amounts. E.g. if company sells for X, investors get Y and founders get nothing. If company sells for Z, investors get X1 and founder gets Z. Etc.

hackaflocka 11y ago
That was very helpful. Thanks.
shalinmangar 11y ago
Can you please explain how did you come up with the figure of 6.25m?
- michaelt 11y ago
  5 million / (1-0.20) = 5 million / 0.8 = 6.25 million A "convertible note" is a cash investment that "converts" into an equity investment when the company starts doing equity investments. The have two separate mechanisms for rewarding investors for getting in early. The "20% discount" means the investor can convert the note into shares paying 20% less per share than later investors. The "$5 million cap" means, if the company has a valuation greater than $5 million, the investor can convert the note into a fraction of the company as if the company was valued at $5 million. The investor then chooses whichever of these options is better. Take the example of a $1 million as a note with a $5 million cap and a 20% discount, when series A funding comes along. If Series A values the company at $4 million, the investor can choose between taking shares at a 20% discount (they get shares valued at $1.25 million for their investment of $1 million) and taking shares at a $5 million valuation (they get shares valued at $0.8 million for their investment of $1 million) and they obviously choose the former. If Series A values the company at $10 million, the 20% discount still lets them get shares valued at $1.25 million for their investment of $1 million - but now taking the shares at a $5 million valuation lets them get shares valued at $2 million for the same investment. Obviously they choose the latter! A $6.25 million valuation is the crossover point, where the 20% discount and the $5 million cap give the investor the same number of shares. At a valuation below that the discount is the better choice, and at a valuation above it the cap is the better choice.