Demystifying Venture Terms Part 2

Continuing on from part one, we go further in Brian's and Jessica's stories

Mar 21, 2022

Most of what I’m writing here will make more sense if you’ve read part one. To recap, Brian is a founder who is building a B2B SaaS company. Jessica, an angel investor, invested early and gave Brian what he needed to grow. Brian raised a Series A investment from b16y. And Jessica’s early investment, which she redeemed a SAFE for, is now worth $4m. From $100k.

Let’s continue their respective journeys.

It’s been 18 months since Brian started his company, and everything's going well. He’s raised money, plenty of revenue is coming in, and staff are happy. After delivering a new product feature that will win more customers, he looks to raise more money. Series B time.

As he looks at his cap table, which lists who owns what equity in his company, he sees three names: his, b16y’s and Jessica’s. For the Series B, he wants more investors.

Athrotaxis, a venture fund, hear that Brian is planning a Series B. The LPs (Limited Partners), who give Athrotaxis the money they invest, indicated that they want more companies that generate consistent revenue. So, the GPs (General Partners), who are responsible for the investment decisions, decide to look at Brian’s company.

They see a business with steady revenue and a strong moat. A moat is how well a company can distinguish itself from the competition. Athrotaxis decide they want to invest.

And so does b16y.

Brian speaks to Athrotaxis and b16y, both provide a term sheet. Term sheets set out the terms of the investment. b16y gave Brian a term sheet at the Series A, but this time, he compares terms between Athrotaxis and b16y. After deliberation, Brian decides to let both invest with b16y getting a greater amount of equity, making b16y the lead investor.

More shares are issued because of this additional raise, and the share price rises. A consequence of newly issued shares is that equity ownership is diluted. Everyone’s shares are diluted.

Jessica now has a fewer proportion of shares than she did before, although individually, they’re worth more. But she negotiated to have pro-rata rights. By having pro-rata rights, Jessica has the right to retain her ownership percentage if she forks out the cash for it. Brian raised his Series B at a $100m valuation.

We’ll say the dilution event caused Jessica’s shares to go down to 10%. Remember, that despite her ownership decreasing, her shares are worth $6m more than they were in the previous round because they’re more valuable. To exercise her pro-rata rights, Jessica has to make up the amount at the current valuation. So to get to 20%, she’ll need to invest $10m (20% = $20m in the current round. Jessica now has 10%, she needs to buy 10%’s worth of shares). Instead of going for 20%, Jessica chooses 15% and contributes a further $5m.

Fast forward a couple of years, Brian raised a Series C and now he’s about to go public and list on the NYSE.

Jessica is diluted down to 7.5%, Brian has 12.5% left, b16y 10%, Athrotaxis 8%, miscellaneous investors and funds 42% and employees 20%.

The market rewards Brian for delivering the world yet *another* B2B SaaS company. When the bell rings and trading begins, his company is worth a whopping $3b.

Brian’s net worth becomes $375m and Jessica’s $225m. From $5.1m invested, Jessica has 45x’d her investment.

Obviously, this story is pure fiction and doesn’t highlight the level of work somebody like Brian would have to put into building a company that succeeds like this. Or the number of companies Jessica invested in that didn’t make her any money. But that doesn’t make for a fun story.

I hope this has helped you understand some of the common terminologies in venture if you didn’t know it already. In the future, I’ll explain some advanced terminology.

But next week is all about the convergence of the creator economy and angel investing. Speak to you then.

If you want to keep up with the terminology I use as I write these newsletters, you can find an ongoing glossary here.

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.