Ownership, valuation, and dilution

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Ownership, valuation, and dilution
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Who is inclined to be an entrepreneur? Why or why
not? An intrapreneur?
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Entrepreneurial Risks Rewards

• Risks
• Security
• Personal time
• Stress
• Health
• Wages
• Investment

• Rewards
• Excitement
• Independence
• Choice
• Financial
• Salary
• Stock

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Forms of Ownership

• Sole proprietorship
• Limited Partnership
• Corporation

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Corporations

• General Corporation
• unlimited number of stockholders
• stockholder's personal liability is usually
  limited to the amount of investment
• Close Corporation (C Corp)
• limited to 30 to 50 stockholders
• must first offer the shares to existing
  stockholders before selling to new shareholders
• S Corporation
• special tax provisions, avoid double taxation
• Limited to 75 stockholders, US citizens only
• Limited Liability Company (LLC)
• No foreign ownership restrictions
• often have a limited life

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Stock
Corporations only

• A financial instrument that signifies an
  ownership position (equity) in a corporation
• Represents a claim on its proportional share in
  the corporation's assets and profits
• Most stock also provides voting rights

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Stock Ownership

• Founders stock
• typically ISOs or incentive stock options
• Investors stock
• Typically Preferred Stock Options which receive
  preferred treatment on distributions and
  liquidation
• Employees stock
• Typically NQEs or non-qualified stock
• Most employee and some founder stock are granted
  as Stock Options as incentives to persevere and
  work hard

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Stock Option
also known as Stock Purchase Plan

• Elective option to giving the holder the right to
  buy or sell stock, at a specified price, by a
  specific date
• Often offered at a discounted rate, typically
  priced when the option is granted

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Stock Option Example

• 10,000 shares at 1.00-per-share
• Timing 4 year vesting with 12 month cliff
• 25 purchasable after 1 year (2500 shares)
• 50 purchasable after 2 years (5000 shares)
• 75 purchasable after 3 years (7500 shares)
• 100 purchasable after 4 years (10000 shares)
• If one million shares are outstanding, you will
  own 10,000/1M or 1.0 of the company

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What is the value of the company if you own 1.0
for 10,000?
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Stock Option
tax treatment for employees
OPTIONAL

• ISOs or Incentive Stock Options
• Taxes paid at the time you sell your stock
• NQEs or Non-qualified Stock Options
• Taxes paid at the time you purchase your stock

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Stock Distribution
at time of Incorporation
Voting stock
Non-voting stock
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Valuation

• The value of a business changes over time
• Attempt at valuation is predicting the future
• Valuation is one of the most hotly contested
  issues between entrepreneurs and potential
  investors
• Entrepreneurs want a high valuation
• Potential investors initially want a low
  valuation
• Pre-money defined Before an investment is made
• Post-money defined After an investment is made

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Valuation Methods

• ROI One dollars investment today is expected to
  be worth how many dollars at IPO?What is the
  multiplier?
• Control How much of the voting stock will the
  investors own after the financing?
• Prior round valuations?
• Next round investments Is there enough
  room?(i.e. are there additional shares in
  reserve that can be used in an offering?)

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Company Value over Time
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2nd round 1M investment
first round1.5M investment
sales growth
sweatequity
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Ownership over Time
Voting Stock
Founders
Key Employees
Investors
Founders
Founders
Investors
Pre-financing ? Early stage financing ? Expansion
financing ? IPO / Acquisition
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Ownership over Time
Number of founder shares is constant
ownership by founders decreases
Hopefully value of shares increases
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Dilution

• A decrease in percentage ownership of a company
  (e.g. resulting from an increase in the total
  number of shares)
• Or
• A decrease in the economic value of an investment
  (e.g. resulting from a decrease in total company
  value)

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Dilution Example

• decrease in percentage ownership resulting from
  an increase in the number of shares at IPO

Additional four million new issue shares
available at IPO
one million original issue shares from
incorporation
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Dilution Example

• decrease in percentage ownership
• You purchase 10,000 shares when there are 1M
  shares outstanding for 10,000
• 1 ownership
• The company issues an additional 4M shares for
  sale during an IPO
• 5M total shares now outstanding
• Your percentage ownership is now 10,000 / 5M or
  0.2
• However if the IPO price is 20/share your stock
  is now worth 200,000

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Ownership over Time
Founders decrease in percentage of ownership but
increase in stock value
Founders
Key Employees
Founders
Investors
Founders
Investors
Pre-financing ? Early stage financing ? Expansion
financing ? IPO / Acquisition
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Dilution Example

• decrease in the economic value
• You purchase 10,000 shares when there are 1M
  shares outstanding for 10,000
• 1 ownership
• The company issues an additional 4M shares for
  sale during an IPO
• 5M total shares now outstanding
• Your percentage ownership is now 10,000 / 5M or
  0.2
• However if the IPO price is 0.25/share your
  stock is now worth 2,500

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Ownership over Time
Founders decrease both in percentage of
ownership and in stock value
Founders
Key Employees
Investors
Founders
Founders
Investors
Pre-financing ? Early stage financing ? Expansion
financing ? IPO / Acquisition
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Financial Success
Founders
Key Employees
Founders
Investors
Founders
Investors
Financial Difficulties
Founders
Key Employees
Investors
Founders
Founders
Investors
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Informal feedback

• Write a 2 minute anonymous journal to be handed
  in immediately.
• The journal should briefly summarize
• Major points learned
• Areas not understood or requiring clarification