Thread by @ShoutsAndMiras

@netotse Sure! Let’s start from the top. The first investment is “$400k on $2M post.”

Let’s say you started your company and registered it with 100 shares. You own all 100. But you need money so you can operate.

So you decide to create more shares and sell them to investors.

@netotse You find investors who are willing to give you $400k, but in exchange for their investment they want to own 20% of the company.

$400,000 / 20% = $2 million

So $2 million is the “post money” value of your company - it’s the value of the company once these folks have invested.

@netotse Ok so these investors want 20% of your company, meaning you will be left with 80%. You need to creat enough new shares so that your 100 shares represents 80% of the new total.

100 / 80% = 125

So you’re going to create 25 new shares and sell them to your investors for $400K.

@netotse $400K / 25 = $16,000 per share.

Wow! You are like Warren Buffet with these expensive shares! 😂

So now your “cap table” looks like this:
Founder: 100 shares (80%)
Friends and Family: 25 shares (20%)
Total: 125 shares

On to round 2!

@netotse Now you want to raise $2M. You would really like to find investors who say “we’ll give you $2M for 20% of your company” like last time. But the investors tell you “we don’t think your company is worth as much as you do. We want 30% of the company for our money.”

You negotiate.

@netotse Eventually they agree to invest $2 million on the basis that your company is worth $5 million today (pre-money) and will be worth $7 million after they invest (post-money).

Math time!

$2M / $7M = 0.285714

So these new guys will get 28.5714% of the company for their investment.

@netotse More math!

100% - 28.5714% = 71.4286%

So you and your “friends and family” investors will now own 71.4286% of your company. Let’s figure out how many shares you need to create and sell.

125 shares / 71.4286% = 175 shares.

Ok. You need to make 50 shares for the new investors.

@netotse $2 million / 50 = $40,000

Each of your shares is now worth $40,000. So your first investors are pretty happy. Their 25 shares, which they bought for $400K, are now worth...

25 x $40,000 = $1 million.

Ok so what does the ownership structure (or cap table) look like now?

@netotse Owner: 100 shares (57.14%)
Friends and Family: 25 shares 14.28%)
Seed: 50 shares (28.57%)
Total: 175 shares

175 x $40,000 = $7 million, the “post-money” value of the company.

Thank goodness all this math is checking out 😅

Shall we keep going?

@netotse By now you (hopefully) have a sort of established company that can be more easily valued than just by investors saying they want to own X% in exchange for Y dollars.

Companies are usually valued based on their financial statements or by comparing them to other similar companies.

@netotse This time around you’re raising $5 million. Sadly, because you are in Africa you are told there are no comparable companies that can be used to value yours. So it’s another negotiation...

Your “Series A” investors agree to put in $5 million. How much do they want to own?

@netotse Eventually you agree that the $5 million will be invested on a $16 million “post-money” basis. So these investors will own...

$5M / $16M = 31.25% of the company.

That means all the previous shareholders will now own...

100% - 31.25% = 68.75% of the company.

@netotse 175 shares / 68.75% = 255 shares.

So you need to make 80 new shares to sell to your Series A investors.

And each share is now worth...

$5M / 80 shares = $62,500 per share

So how much of the company does everyone now own? Let’s break it down.

@netotse Owner: 100 shares (39.2%)
Friends and Family: 25 shares (9.8%)
Seed: 50 shares (19.6%)
Series A: 80 shares (31.4%)
Total: 255 shares

This is the way that venture capital investing in the US works. You give up pieces of your company for money so you can keep growing.

@netotse The investors typically don’t expect any cash right away, but they hang on because the value of their shares keeps going up. Remember your “friends and family investors” bought shares at $16,000 each. Now those shares are worth $62,500. They have appreciated almost 4x in value!

@netotse Of course, that value can only be realized when someone buys their shares. That’s why venture capitalists want to know about your “exit” or how you eventually plan to sell your company. They don’t want dividends, they want to sell their shares for way more than they bought them.

@netotse (By the way the numbers I used here are hypothetical - TJ has raised three rounds of financing but on different terms than those outlined above. One day when I’m all through with this business I’ll write a book and give you guys the real breakdown...)