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Startup Funding Explained - Incorporation and First Investor (Part 1) - YouTube
Channel: Slidebean
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seed post seed Series A Series B
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convertible notes and price browns
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common versus preferred shares and stock
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options the fundraising process for a
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startup requires a crash course on some
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terminology that you've probably never
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heard of before there's no evil
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corporation law firm making it confusing
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on purpose you know like banks and
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credit cards this is just a very complex
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topic that requires an understanding of
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some legal and financial terminology
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when companies have such vast potential
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like startups and when you deal with
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such large sums of money
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everybody wants protection to make sure
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their time or their cash investments are
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safe to better explain all of this we're
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gonna tell this story of a startup
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company a theoretical startup company
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from funding to IPO so this is startup
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funding explained part 1 of I don't know
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how many starting the company ok so
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let's take a classic scenario two
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founders get together to start a
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business they bring nothing but their
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skills and an idea so they decide to
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split the company two ways we have a
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video on that so check it out
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incorporating a business is expensive
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plus there are the tax and legal burdens
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of having a corporation so these
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founders decide to hold off on that for
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now they both have day jobs and are
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building the product in their free time
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so they seek out some capital to speed
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things up at this stage they can't go to
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venture capitals or they can't even go
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to angel investors the money they can
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race at this point needs to come from
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friends and family so it turns out they
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have a close friend who believes in them
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and is willing to invest fifty thousand
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dollars in the business great so now
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what so this is where a corporation is
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going to be necessary a Delaware
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c-corporation is the most standard type
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of legal structure you can use and most
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investors in the US will want that we
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have a video on the process of
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incorporating and we'll also link that
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in the description so this Corporation
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allows the founders and the investor to
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agree on the terms of ownership and the
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decision-making for the business it
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provides a layer of protection for
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example in case the company gets sued
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that lawsuit doesn't necessarily
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translate into a liability for the
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founders or the investors so a
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corporation is made up of shares we are
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more used to hearing about the
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percentage of ownership still in legal
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term
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ownership is not represented by a
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percentage but by an actual integer
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number of shares people own a given
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number of shares of the business which
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therefore represents a percentage of the
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total shares the company has issued in
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the simplest of terms you can have a
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corporation with just one share whoever
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owns that share owns 100% of the company
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our two founders for example could
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incorporate the business with two shares
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one for each one half of all the shares
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represents 50% ownership the problem
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with such small number of shares is that
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splitting them up is heart and this will
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represent issues if they want to give
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shares to investors or to their team
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that's why most companies are
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established with 10 million shares of
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stock which provides enough pieces of
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the company to be able to split the
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corporation with plenty of people
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without having to worry about decimal
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numbers and rounding up or down okay so
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we'll get back to shares in a second
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valuation let's remember our investor
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he's willing to put $50,000 into the
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business how many shares does he get
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that question relates to how much the
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business is worth established companies
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typically base that valuation on the
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number of sales or the tangible assets
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they own like cars or properties but our
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two founders just have an idea and a few
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lines of code at this point it's a
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matter of agreeing on something that
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feels fair to the investor and to the
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founders those numbers can vary a great
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deal but let's use 20% for this example
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that's not out of the ordinary for our
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friends and family investor the founders
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and the investor agree that he will
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invest $50,000 in exchange for 20% of
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this new business if 20% of the company
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is worth $50,000 then that means that a
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hundred percent of the company is worth
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two hundred and fifty thousand dollars
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that is the effective business valuation
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in this case two hundred and fifty
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thousand dollars is just an it's really
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just an arbitrary number
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it's the 20% that showed that balance of
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risk reward that the investor was
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willing to accept however that valuation
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number will be much more relevant in
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future rounds of funding back to
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incorporation so to accept this money a
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corporation will be established again we
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I use a ten million dollar share
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standard in the most basic of terms
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here's what's gonna happen a corporation
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will be established with 8 million
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shares total 4 million shares for each
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founder the company will define an
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arbitrary number of how much the shares
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are worth usually at the get go that's
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going to be $100 for the whole company
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so that's zero point zero zero zero zero
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one to five per share at this point the
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owners own 50% of the company each that
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means each of their chunks is worth 50
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bucks this transaction uses such a low
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number to avoid any extra tax
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complications now for the investment the
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company is going to issue 2 million new
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shares to their investor issuing shares
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means that the company will create new
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shares the number of shares each one of
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the founders has is gonna remain
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unchanged this is very important by
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issuing 2 million new shares of stock
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the company now has a total of 10
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million total shares issued that's a
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beautiful round number the 4 million
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shares each founder had has remained
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unchanged the difference is they used to
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represent 50% of the total number of
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shares and now they just represent 40%
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of the total number of shares once again
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shares didn't change hands nobody gave
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shares to the investor the company
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issued new shares now this is all done
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simultaneously by the way all you
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founder will see at the end of the whole
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process is just a bunch of paperwork and
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a slot to sign but it's all done within
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the scope of probably one business day
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now all the intellectual property that's
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the code that the founders have written
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and the assets like the logos are
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designs will now be owned by the company
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which means everybody legally owns those
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assets in the agreed proportion of the
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shared distribution great now the
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investor will also want some protection
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in case one of the founders decides to
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leave if one of the founders left 40% of
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the intellectual property and the assets
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would be owned by someone who no longer
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works for the business
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that's where vesting comes in so in a
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nutshell a vesting a
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and says that each one of the founders
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will only own their assigned shares
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after a certain period of time
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a typical agreement has a one-year cliff
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and a four year period with monthly
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installments so the total number of
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shares that the founder is supposed to
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own will be divided into 48 months for
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years during months 1 through 12
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no shares are assigned to the founder on
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month 12 12 months worth of shares so
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that's 1/4 of the total are vested that
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means that founder owns them after that
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one 48th of the total number of shares
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gets assigned at the end of each month
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for our founders that means that by the
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time they work on the company for one
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full year they will unlock 1 million
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shares the remaining shares will be
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unlocked at the end of each calendar
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month to around 80 3333 shares per month
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now
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spoiler alert in this hypothetical
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company scenario one of the founders is
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going to leave before their shares are
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fully vested we'll get a chance to
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calculate that in next week's episode
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hit that subscribe and we'll see you
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next week
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