Raising capital can time consuming and a slow, tedious, bumpy and all together exhausting journey. This article explains a few things you need to know before you venture into the market.
Pre-money v Post-money valuation
Pre-money valuation is the value of the company before receiving any funds. Post-money valuation is the value of the company after the funds have been received. In otherwords, post money valuation equal pre-money value plus investment funds. Investors will normally invest on a pre-money valuation basis and shares will be invested on a post-money valuation basis. it is essential the correct terms are use to avoid a significant dilution of your ownership.
Convertible debt is debt that is convertible to equity at a future date. Investors are usually rewarded through a discount on the issue price when the loan is converted or a warrant for addition shares. An advantage of convertible debt is that it to some extend avoids the discussion of business valuation. That is to say if there is no value set (capped value) at which the notes convert to equity. If a capped value is set, then the business value will clearly need to be agreed. The downside of not setting a capped value is that there is no valuation ceiling at which the note holders debt converts. There is no limit on the dilution of their investment.
An another advantage of convertible notes for the business is they are cheaper and easier to issue than equity.
Preferred stock and participating preferred stock
Preferred stock has attached certain rights, versus regular common stock. For example, in the case of a liquidation or sale, preferred stock holders would get all their money back (providing there is sufficient cash) before common stock holders get any distribution. If there is more money available to distribute than invested then the preferred stock holders covert to common stock and get their share in the proceeds.
Participating preferred stock holders get the best of both worlds. In the case of a distribution, they get their money back, in addition they also get their share of the remaining pool of funds.
Options and option pool
The option pool is often included in the pre-money valuation. The equity you will be sharing from your stake. Option pools are often expressed as percentage of the post-money valuation. Therefore, as investors come on board, the option pool value increases. As a consequence your stake is diluted.
The vesting schedule is the schedule of equity to be issued to employees. Investors will want to see the vesting schedule. The schedule will include a period for which employee must remain in the company to be entitled to equity. Once that period has been completed, there is then a release period, for example 25% for the next four years.
Simon is a CA Accredited Business Valuation expert, Chartered Accountant and a Certified Fraud Examiner. Simon specialises in providing forensic accounting and valuation services. Prior to founding Lotus Amity, he was a Forensic Accounting partner with BDO Australia and led their National Forensics practice. He has worked as a forensic director for a major offshore forensic accounting practice which included assisting in multi-billion-dollar litigation in relation to giant Bernie Madoff Ponzi scheme. Simon provides valuation services in disputes, for raising finance, for restructuring, transactions and for tax purposes.
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Copyright © 2017 Lotus Amity Pty Ltd. All rights reserved. This article is the property of the author. This article is intended for general information purposes only and is not intended to provide, and should not be used in lieu of, professional advice. The publisher assumes no liability for readers’ use of the information herein and readers are encouraged to seek professional assistance about specific matters.