Demystifying Venture Terms Pt1
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Demystifying Venture Terms Pt1
You're getting started in venture and see lots of terms thrown around, what does it all mean?
None of the below is financial advice.
No matter what industry you’re in, jargon prevails.
You’re expected to know what it all means. Or you sit there, squinting, thinking of what it could mean. It’s everywhere in venture finance. Some resources try to explain it all, but some require you to be a finance bro (or gal, I don’t discriminate).
I’m not a finance bro; my wardrobe doesn’t have any Patagonia vests inside. So I came to all of this fresh and now understand it. And I’m going to help you understand.
Let’s step into the shoes of a startup founder, Brian, and learn from his journey.
Brian builds a prototype for an idea he has. He thinks the idea has legs, and he can turn it into a business, so he incorporates a company and offers equity for money. He starts raising the money through a ‘seed’ round. The money funds hiring the first few employees, initial marketing and everything that grows the company’s revenue.
Unless Brian is an experienced founder, venture capital firms won’t be interested because he doesn’t have a reputation for building companies. So he looks to friends and family and angel investors (investors who write checks for early-stage companies).
Jessica, an angel investor, is impressed by Brian’s prototype and invests. She doesn’t get equity in the company straight away. Instead, she receives a SAFE (Simple Agreement for Future Equity) note. The SAFE says, “here’s $100k capped at a $1m valuation”.
For Brian, a SAFE is a better option than selling equity at this stage. There aren’t lengthy negotiations, and the terms are simple. So the process is fast, and he can get back to building. And it converts when Brian raises his next round, more on that bit later.
Brian’s got $100k and starts making hires, onboards customers and, importantly, revenue. The business looks like it’s finding product/market fit (PMF). Marc Andreessen, the ‘a’ in ‘a16z’ (one of the top venture capital firms), explains PMF well:
“Product/market fit means being in a good market with a product that can satisfy that market.”
Now that he’s got revenue, good growth and low churn,
Brian decides it’s time to raise the kind of money that leads to explosive growth. He raises a Series A (the first round with big money). Now, venture firms that earlier would have dismissed him enter the ring.After a lot of time negotiating, they reach an agreement. Brian raises $2m at a $20m post-money valuation (post-money means the company is valued at $20m AFTER receiving the $2m). The venture firm, b17y, owns 10% equity in Brian’s company.
Enter Jessica, the SAFE note she wants to redeem, and a lot of maths
.Remember that Jessica gave $100k capped at a $1m valuation? Well, she’s in the *theoretical* money now.
Let’s say b16y received 1m shares for their $2m. So 1 share = $2. Jessica’s SAFE note is capped at $1m. So Jessica receives her equity (and shares) as though Brian’s company is worth $1m. How do we figure out how many shares Jessica gets?
capped valuation / agreed valuation
$1m / $20m
= $0.05/share
So while b16y gets their equity at $1/share, Jessica is getting $100k’s worth of shares at $0.05 share. So she gets 2m shares worth $4m (20% equity) for her $100k. That’s not bad. But remember, Jessica took a risk, so she’s getting paid for it.
We’ll leave it there for now and continue Brian and Jessica’s journey next week.
If there’s anything particular you want me to cover or you’d like to learn more about angel investing, reply to this email or message me on Twitter or LinkedIn.
Churn is how many people are cancelling the subscription. Low churn means few people are cancelling subscriptions.
