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How much money do you get if your startup gets acquired? - YouTube
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pitch deck
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a younger version of me and the younger
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version of this youtube channel
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started this series called startup
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funding explain we went through
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a theoretical company's story while
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analyzing how the cap table evolved
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through various rounds of funding make
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sure to watch parts one through three if
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you want to get a grip on
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how all that stuff works and then we
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left part four unfinished
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and if you're only here for the good
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stuff that's okay this video will
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analyze
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a few exit scenarios for that
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theoretical company and how much money
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everybody makes or doesn't make by the
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way a lot of the topics covered here
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were way beyond my expertise so steve
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barsh
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who you've seen as a guest in this
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channel helped us put these estimations
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together make sure to check out his
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video on startup exits
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and his channel on dream it
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[Music]
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let's look at the last version of the
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cap table we left on episode three
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in a nutshell here's where the company
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is at they raised a seed round of
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funding through a convertible note
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they raised a series a round of funding
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which valued the company at
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10 million dollars the investors on the
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series a
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negotiated a liquidation preference that
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guarantees them
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two times the capital invested a
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traditional series a round probably had
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a bunch of additional terms but we are
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trying to keep this simple
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for youtube purposes so we'll stick with
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that we also had two option pools the
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first one
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with a strike price per share of 0.03125
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and the second one with a strike price
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per share of one
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dollar if some of this stuff doesn't
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make sense again make sure you watch
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the third episode in this series to get
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a grip on how the stock option pools
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worked now we will go over two scenarios
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in this video
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a rescue acquisition or aqua hire and a
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strategic exit for the company in a
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video from a couple of weeks ago
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steve went over what each of these
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acquisitions meant
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make sure you watch that video for more
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context now let's get into the numbers
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scenario one an aqua hire let's say that
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this company started struggling
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soon after that series a round it has
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managed to stay afloat but it's not
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growing very much so the company might
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seek out a buyer that hasn't interested
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in taking profits
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out of the business there are plenty of
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holding companies or funds
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that and what they do is they purchase
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sas companies and they are very good at
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monetizing them a status company usually
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operates
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on a 70 to 85 percent gross margin
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that's revenue
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versus the cost of the servers the
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remaining costs for the company are
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the support staff the technical and
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product team for you know for new
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features and maintenance
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the operational costs the office
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accounting the marketing stuff
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so these holding companies what they do
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is they acquire multiple sas companies
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small-ish sas companies and they have a
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centralized
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shared operation they have centralized
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accounting legal
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developers and support so these
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resources are shared across all those
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sas companies
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in the holding to squeeze a lot more
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profit than the company can do if it
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just operates independently so
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they are not buying the business for
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strategic reasons
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they don't care about the customers and
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what they can do with the technology
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they're buying it
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because they can see that it can
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generate a profit for them so the
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acquisition price
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is probably going to be a 1x to
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2x multiple of their revenue another
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common scenario is for a company to
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absorb
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the team and perhaps a patent or a brand
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name
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in those cases some price references are
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for example
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a million dollars per engineer or merely
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enough to give investors a 1x return on
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their investment
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so they can green light the deal so if
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you think the 1 million dollars per
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engineer sounds like a lot
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it may not be the average base salary in
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new york city or silicon valley is
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130 000 per engineer plus benefits and
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you could hire
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a team of five or six engineers who have
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worked together for years
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and are highly efficient as a team the
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price is maybe not that crazy in
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particular
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if this is an aqua hire at a very low
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purchase price the engineers
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employees stock options may be worthless
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if they're under water
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underwater means the startup's price per
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share at
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acquisition is below the stock option
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strike price for the options the
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engineers have
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so the stock options are worthless and
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the acquirer is giving an incentive
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for the engineers to stay on note that
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that million dollars per engineer may
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involve
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a retention component to make sure the
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engineers don't just get
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the million dollars at closing and then
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they just walk out the door
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again none of these options or reasons
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for an acquisition
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is very exciting but they can provide
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what we call a soft
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landing for the team and some liquidity
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for the investors there can be an
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inherent tension here
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sometimes the founders are more
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interested in retention bonuses for the
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team including themselves
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while on the other hand investors are
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more interested in cash
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for the stock often there is a lot of
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negotiation that takes place around
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these points
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long story short let's say that our
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theoretical business with a
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12.5 post money valuation after the last
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round
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gets an offer to be acquired for 12
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million
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dollars so the first thing that we will
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get with that is a price
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per share remember that we had seven 11
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million
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hundred seven seventy eight shares so
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what twelve million dollar offer means
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that we have one point
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oh nineteen dollars per share however we
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have to start with the liquidation
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preferences
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remember series a investors need to get
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a 2x multiplier on their original
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investment and convertible known
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investors too
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because remember that convertible node
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investors peaky bag on the same terms
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as the series a so out of that 12
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million dollars we will have to take
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five million dollars to pay those series
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a
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investors two times their 2.5 million
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dollar investment
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and one million dollars for the
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convertible known investors to pay
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twice their original 500k investment and
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that's
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six million dollars that effectively
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bought out the preferred shares
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that means that those investors are paid
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up and that leaves us with
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six million dollars for the rest of the
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shares which in this case are the common
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shares that's
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six million dollars divided by eight and
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a half million shares for an effective
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price per share
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of 70 cents and some but we are not done
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yet
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we have to do a small parenthesis to
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talk about these stock
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options stock options are options to buy
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shares at a specific strike
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price they are designed that way for two
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reasons one so that when they are issued
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the person who receives them
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doesn't have any tax implications since
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they're not receiving the actual shares
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they don't have to pay taxes
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for them and number two so that the
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employee receiving them is motivated to
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increasing the value of the company the
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company's price per share
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doesn't grow after they receive those
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stock options and the stock options
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aren't really worth anything because
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again the price per share didn't
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change so let's say that an employee has
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1 000 stock options at a strike price of
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one dollar if the company gets acquired
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for two dollars per share
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they can effectively execute their stock
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options that's technically
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buying the shares at their unique
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special discounted strike price
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and then sell them for double that price
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to the company that's making the
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acquisition so
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1 000 stock options bought for one
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dollar each
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and then sold for two dollars each
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that's a net earning of one thousand
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dollars
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that's great employee stock options have
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a lot of moving parts when structuring
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stock option plans
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you have to make sure that you have
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accountants and lawyers working with you
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who have a ton of experience with them
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if your aunt or uncle is an attorney and
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largely handles divorce or personal
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injury cases and says hey i'm happy to
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help you
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you should say no thanks if this is not
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done perfectly a poorly structured stock
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option plan can have devastating
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consequences for everyone from investing
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schedules to cliffs
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to how long to exercise after separation
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and how long
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until options expire expiring options
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can be a big issue for companies that
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stay private for a long time like uber
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and airbnb where employee stock options
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may expire if it takes too long for the
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company to get acquired
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or go public if the stock options are
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going to expire employees have to
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actually come out of pocket
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and put money down money that they maybe
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don't even have
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to actually exercise and buy out the
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stock option so that they can get the
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actual stock
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before the stock option expires again
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like steve said in this video in
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acquisitions
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you need to bring your a-team now
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looking at our scenario you will see
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the problem the second stock option pool
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this company offered has a strike price
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of one dollar and the price per share on
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this acquisition
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after paying that liquidation preference
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is 70 cents
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it's not worth buying shares to then
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resell them
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for less so we can assume that the
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second stock option
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doesn't get executed it's worth nothing
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that means that the company only has 8
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million shares
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to sell at 8 million shares we have a
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slightly higher
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strike price of 75 cents per share and
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that is the price that we'll be using
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all right so founder one sells four
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million shares at 75 cents
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effectively getting 3 million dollars
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founder 2 gets 1.1
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and some million dollars for the shares
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that they had vested so far
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family and friends investors get 1.5
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million dollars which is a significant
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30x multiplier
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on their investment that is not bad at
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all the employees that hold stock option
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pools have to buy their share so they
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have
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500 000 shares total which they
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purchased at the original
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first option pool strike price of 0.023
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dollars so they have to pay 11 000
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for them again this is all done
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simultaneously because they
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are selling them now for 75 cents each
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which gives them earnings
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of 72 cents or 0.727
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dollars per share since each of the two
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imaginary employees had 250 000 shares
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they are getting profits of 181
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thousand dollars which is not bad at all
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or is it
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well it depends because if they had been
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working at this starter for several
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years
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and they had taken a below market salary
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in hopes
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of getting reached from those stock
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options and they spent that
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they spend working for the company for
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three years and then they get 180 000
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in taxable cash that's 60 000 per year
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which is not that much really
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considering three years and again a
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below market salary now
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all that money is subject to taxes so be
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prepared to take a chunk
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out of it if you're a foreign founder
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not registered as a us taxpayer
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that tax is actually going to be a flat
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30 and then
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that is that for scenario one let's look
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at a
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slightly better scenario too let's say
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that the company gets acquired
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for 35 million dollars in this case the
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price per share
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would be a very sweet 2.97
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dollars per share in this case the
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liquidation preference clause doesn't
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apply since the price per share
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guarantees that the investors are
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getting at least that 2x return that
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they have negotiated so the math for
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this round is a lot easier the number of
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shares owned by each
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shareholder multiplied by 2.97
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and here's how that would look like now
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interestingly enough
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a 35 million dollar acquisition sounds
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like an
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amazing deal for the founders the
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founder who stuck around
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assuming the ceo is getting an 11
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million dollar
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exit which is certainly a life-changing
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amount of money even the second option
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pool of employees
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is getting gains of 1.97 dollars per
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share so they will need
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to virtually pay 500 000 to buy those
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shares but they will get almost 1.5
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million dollars in exchange for them
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remember this is a cashless transaction
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so the option pool holders don't
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actually have to buy the stock
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they just receive the difference on the
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price and then you'd think the investors
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did great
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but maybe not so much they're getting a
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3x return on their investment which is
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good
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but certainly not what a venture capital
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investor
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signed up for the success rate of tech
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companies and tech startups is pretty
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low so investors are looking for
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a big whale that big 10x return that
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makes up for all the companies in their
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batch
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that didn't work out this company is
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making up for three of those companies
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so it is
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good news but it's not amazing news this
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directly connects to a common question
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we get from founders around business
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valuation and even around the type of
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company that can
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afford or that can position itself to
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raise venture capital
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you know by many measures this is a
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pretty successful theoretical company
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it's getting acquired for 35 million
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dollars but it's still a
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meh story for the investors if you
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intend to raise venture capital you need
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to have a clear path
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to that 100 million or more valuation
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and now
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hopefully you understand why so we can't
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turn a one million dollar company into a
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hundred million dollar company but what
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we can do is make sure that your pitch
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deck tells
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the best possible story about your
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business either by having our team help
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you write it
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or by having our team help you design it
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or if you use our self-service ai design
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so check out slidebean.com pitch tech to
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learn how we can help you with your deck
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hit that subscribe button and we'll see
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you next week
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[Music]
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you
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