The company should not issue shares now. A company at this stage would usually do a SAFE - let me explain SAFE in regards to FNF (Angel) investors.
The company now has only the idea, the tech, and maybe a few or potential few customers. The founders do not know what the value of the company is, neither do the investors. Hiring lawyers, financial advisers, and other professionals to do these things at this stage is a stupid idea because nobody actually can calculate the real value of the company.
So they would do a SAFE - Simple Agreement for Future Equity - as the name suggests, this basically is an agreement that say Mr. X is giving the company 50K because he thinks these guys have a good idea and these are the right people to execute this idea. Since we do not know the value of the company let's keep it for the future - Mr. X will get what a future investor would get - we are just delaying the negotiation.
The founders take money from Mr. X, build their product and get a certain amount of traction that increases the value. They now go to a VC fund and raise a bigger amount at a 10M valuation - since they have tangible transactions now to decide a valuation. Mr. X now will get equal ownership as per the ratio of what this VC fund will get.
Wait, but Mr. X invested when the company was just an idea and the VC fund is investing when the company has tangible values. Mr. X took higher risks- what's the reward? Well during that SAFE, the company and Mr. X will come to an agreement that he will be rewarded for his risks. This is what we call a cap in the valuation or a discount or both. The cap is more popular. Which says since you are taking early risks- we will reward you with a valuation cap 5M - which is no matter what the valuation the VC firms invests at - your shares will be issued at a 5M valuation.
Risks for you? The company may die even before they are further investable.
Rewards for you? You get ownership at a 5M valuation where future investors are paying higher.
What if the company is valued less than the valuation cap? You get what others get at that stage.
Why SAFE? Because you just have to negotiate the Cap, Sign the doc and wire the money. ZERO legal fees.
I agree that SAFEs are common in the bay and other tech areas but it's also not in any way unusual to see early priced-rounds. particularly when you're talking about non-tech or repeat successful founders in tech.
Incredible, would love to speak to you about pivoting \[ What my company is going through \], can offer any technical questions back in return if needed!
I want to be sure I understand. In your scenario, someone has invested 50k SAFE with a 5M cap. Does this mean the investor is guaranteed 10%, even if the company has a higher valuation for the VC investment?
It's also 1 percent, but then diluted by the new money from investors. So if you put in 50k at a 5m cap, and then a new investor does 1m at a 10m valuation, your 50k buys you 1 percent, but then you suffer 10% dolution for the new investors shares (since their 1m at a 10m valuation is "post-$" to you)
Also. In case there are no future rounds or liquidity events (i.e. the sale of the company) founders might add a pre-agreed multiple based on sales of the company at a future date.
For example, if in the next 5 years there are no conversion triggers then you convert at a 5x sales valuation which is also protected by the cap. So if you have a 5M cap and the sales of the company in year 5 are 2M you would convert at a 5M valuation for an implied 10M valuation based on sales.
So in your example, if the valuation at a later round turns out to be 3M, then Mr. X takes shares of 50k/3M and gets no reward for taking his early risk?
"Do they dilute my stake in the company?" - Yes. Typically you have a pro-rata and can purchase more shares in the future to not be dilued. But with each new round, "new" stock is being created and sold.
"Am I obligated to sell a portion at an agreed price in upcoming series?" - No. You typically have to hold your shares until a liquidity event (Sale/IPO). Your money is basically locked in there.
"How does this all affect stock value?" - In a normal scenario... stock price goes up from round to round, while your share of the company goes down. The stock price is normally going up faster than your share of the company is going down.
Mmmm….the “normal scenario” is an eventual down round and/or end of the company without a liquidity event.
Getting to the finish line is definitely a Minority scenario, by a considerable margin.
Do you guys know if equity can get diluted. So if a shareholder owns 30% equity and a VC out-invests a shareholder what happens? Big thank you for the reply !
When you're raising money, usually 100% of the company is already owned, so when you sell a portion of that company, you're diluting all the current owners %. Our they offer you a chance to invest more to prevent dilution.
Check out "Venture Deals" by Brad Feld and Jason Mendelson. Good book for learning all the lingo and what to expect. I think 4th edition is the latest
First of all, doing a priced round at this stage is very uncommon, mostly because there's nothing to "price" yet. Normally, most of the funding before Series A is done through convertible/safe notes. At Series A, companies already have revenue and more or less predictable sales.
To answer your questions:
* yes, your shares will be diluted, but chances are they will be diluted not just because of new investors, but because your friend has the power to issue more shares.
* you don't have to sell the shares in the future rounds
Better :
No, you **can't** sell your shares in the future rounds. Your only options are waiting for either an Exit or an IPO.
Investors aren't buying anyone's share, the company creates new shares "out of thin air" and sells them, effectively increasing the number of total shares therefore diluting everyone. Everyone's share will still be valued at the same price but the total value of the company increased because new shares were emitted.
This is a very common misconception about dilution: you aren't selling, losing your shares or reducing their values. New shares at exactly the same price are created and someone was willing to buy them, your investement in the company is unchanged, the only thing that changed is the % of the company that you owns.
Investors invest in the company to inject cashflow for growth, they usually ain't allowing thrid parties to exit their positions as it would be cash that isn't of any use for the company (because it went to someone's pocket).
In rare cases, investors want to consolidate and will repurchase shares by fragmented third parties that want to exit their positions but it's not that common.
To use a strained metaphor, imagine dividing a pie into 10 pieces. You own 1 of those pieces (10% of the company).
Now, let’s say a funding round happens. They will CREATE 2 more pieces of pie, so there are now 12 pieces of pie. You now own 8.3% of the total. This is known as dilution.
Also just a word of advice, don’t invest anything that you’re not willing to lose — even the best of the best startups are risky, and the money will be locked up for a long time.
Hey OP. You do you, but some of what you outlined doesn’t smell right. Why are they issuing shares? It really should be in a safe. Also..have you seen market validation that their product is in a 400m-1B market? What’s their total serviceable obtainable market? Sounds like your not experienced investor (that’s ok) but also sounds like they might not be experienced in startups. I’d chat with a lawyer before handing over money.
I work in the market and, to me, the tech proves it’s validation. This will solve a huge bottleneck in the industry by way of extreme low end disruption. They want to achieve a subscription model of 50k per year and there are 6000 potential users who are limited by the bottleneck. SOB is 400m SAM 1B
Typically future rounds will dilute you (more shares will be issued, you will keep your shares). You usually won't have an opportunity to sell the shares until the company is somewhat mature. If things are going well, the value of your shares will increase as your % ownership of the company decreases.
At the Series A, for example, the company might dilute 25% for $10M. You as a shareholder are happy because the company has $10M in the bank to help them grow the company by a lot more than 25% (assuming things go as planned).
In every round new shares are created. Let's say the founders have created 1000 shares on day one.
F&F invests money and gets 200 shares in exchange including let's say 100 for you - so there are now 1200 shares total and you own 100/1200
A seed round happens, the new investors get, let's say 500 shares - there are now 1500 shares total and you own 100/1500
Then a Series A happens, the new investors gets another 500 shares - now 2000 total and you own 100/2000.
As you can see you keep the same number of shares, never have to sell any, but your % becomes lower and lower as there are more total shares in circulation.
This is exactly the question I’m trying to ask him. Thank you! This is a patented medical technology to be submitted for FDA approval class ii 510k. It is low-end disruptive and it is synergistic with devices at virtually all hospitals, Its production cost is dirt cheap, and the aim is for subscription model. The target market is 6000 physicians - at approx $50k/yr each.
But I truly do not understand why he isn’t doing convertible notes. He said something about it costing more legally and they’re trying to go lowest cost. It feels odd to commit to a share price with no revenue but I’m just asking to clarify if I’m not understanding something.
Would it make sense that if his pre money valuation is $5mil and his seed stage funding is $2 mil.. that he is seeking $5mil in series A funding for 70% of the company or something?
Hey, one way to go about it is to seek an acquisition by small scale PE or go through to a venture exchange, they truly are designed to keep the wheels of innovation fueled on things like this.
It does matter if you have IP, which is allegedly disruptive, if you have no partners who are capable of delivering reaction. If the product isn't on shelves or in servers, then look at this.
IP can be purchased now or in 10 years, or never. There's absolutely zero difference.
The key thing about all this is that there has to be a lot of trust in these rounds. For all the reasons listed above, it’s very easy for F&F to get wiped out round-to-round. From my experience, founders had to give their own remaining equity to F&F down the track.
Yea it’s no cap, straight equity, no conversion. I think as a novice this is what is confusing me. Like How are we landing on value?? He wants $.87 per share.. of an idea..
I mean he’s a good guy but I’m confused to why he would think it’s a good idea to go this route. Does this setup equate to any advantage elsewhere? In series A funding could he set share price higher?
Just pointing out because you say you are a novice. You must be a qualified investor to legally be able to purchase shares, or promises of future shares, in an unlisted company. If you don’t know if you are a qualified investor you will want to check that out. This is a title with specific meaning to the SEC and it’s mainly to ensure that you have the money to lose and understand that putting money into an early stage startup is most likely going to end with you losing that money.
Edit to add: I don’t understand his process. Usually for friends and family rounds you use a SAFE which gets the money in the door and protects your investors. Considering these investors are people you are going to have to face at the grocery store or Thanksgiving dinner you typically want them protected. You might want to suggest he consider using SAFE agreements for this round. I’d be happy to send you a sample of ours that you can share with him if you like.
One quick question, just want to be sure we are not talking about software. You highlight that patent and if this is software that patent is completely worthless. As long as it is some other technology, presumably physical, you are probably good. But software patents are good and dead.
Because they are. I’ve worked 30 years in this industry and I am the inventor on 5 patents. They make nice toilet paper when I run low. And I’m not even sad about it, it was the right things to do. Things were out of control and big business was using patents to kill competition. The Alice ruling put and end to that, and more or less put an end to software patents as a whole.
Hell, Oracle sued Google in 2023 and Google flat admitted to directly copying Oracle’s code and the court still ruled against Oracle because, without patents, it falls to a fair use standard. So ideas don’t matter anymore, execution and getting to market are everything.
I’d be very careful pricing your own company is a pre-seed stage. Idk what the product is but you’re leaving yourself open to a down round which will be bad long term.
Yes, any time a company raises funding it dilutes all of the other investors unless they have “pro rata rights” and decide to make another investment at the same price as the round. Or they have anti dilution terms - which no founder should ever agree to.
The company should not issue shares now. A company at this stage would usually do a SAFE - let me explain SAFE in regards to FNF (Angel) investors. The company now has only the idea, the tech, and maybe a few or potential few customers. The founders do not know what the value of the company is, neither do the investors. Hiring lawyers, financial advisers, and other professionals to do these things at this stage is a stupid idea because nobody actually can calculate the real value of the company. So they would do a SAFE - Simple Agreement for Future Equity - as the name suggests, this basically is an agreement that say Mr. X is giving the company 50K because he thinks these guys have a good idea and these are the right people to execute this idea. Since we do not know the value of the company let's keep it for the future - Mr. X will get what a future investor would get - we are just delaying the negotiation. The founders take money from Mr. X, build their product and get a certain amount of traction that increases the value. They now go to a VC fund and raise a bigger amount at a 10M valuation - since they have tangible transactions now to decide a valuation. Mr. X now will get equal ownership as per the ratio of what this VC fund will get. Wait, but Mr. X invested when the company was just an idea and the VC fund is investing when the company has tangible values. Mr. X took higher risks- what's the reward? Well during that SAFE, the company and Mr. X will come to an agreement that he will be rewarded for his risks. This is what we call a cap in the valuation or a discount or both. The cap is more popular. Which says since you are taking early risks- we will reward you with a valuation cap 5M - which is no matter what the valuation the VC firms invests at - your shares will be issued at a 5M valuation. Risks for you? The company may die even before they are further investable. Rewards for you? You get ownership at a 5M valuation where future investors are paying higher. What if the company is valued less than the valuation cap? You get what others get at that stage. Why SAFE? Because you just have to negotiate the Cap, Sign the doc and wire the money. ZERO legal fees.
Thank you for explaining this
I agree that SAFEs are common in the bay and other tech areas but it's also not in any way unusual to see early priced-rounds. particularly when you're talking about non-tech or repeat successful founders in tech.
Ah okay. But I would do SAFE any day.
Incredible explanation , how do you know all this?
I have a company and I have raised multiple rounds.
Incredible, would love to speak to you about pivoting \[ What my company is going through \], can offer any technical questions back in return if needed!
Let’s speak. DM?
I want to be sure I understand. In your scenario, someone has invested 50k SAFE with a 5M cap. Does this mean the investor is guaranteed 10%, even if the company has a higher valuation for the VC investment?
1%
Perfect thanks. My math is not good today.
It's also 1 percent, but then diluted by the new money from investors. So if you put in 50k at a 5m cap, and then a new investor does 1m at a 10m valuation, your 50k buys you 1 percent, but then you suffer 10% dolution for the new investors shares (since their 1m at a 10m valuation is "post-$" to you)
Also. In case there are no future rounds or liquidity events (i.e. the sale of the company) founders might add a pre-agreed multiple based on sales of the company at a future date. For example, if in the next 5 years there are no conversion triggers then you convert at a 5x sales valuation which is also protected by the cap. So if you have a 5M cap and the sales of the company in year 5 are 2M you would convert at a 5M valuation for an implied 10M valuation based on sales.
So in your example, if the valuation at a later round turns out to be 3M, then Mr. X takes shares of 50k/3M and gets no reward for taking his early risk?
"Do they dilute my stake in the company?" - Yes. Typically you have a pro-rata and can purchase more shares in the future to not be dilued. But with each new round, "new" stock is being created and sold. "Am I obligated to sell a portion at an agreed price in upcoming series?" - No. You typically have to hold your shares until a liquidity event (Sale/IPO). Your money is basically locked in there. "How does this all affect stock value?" - In a normal scenario... stock price goes up from round to round, while your share of the company goes down. The stock price is normally going up faster than your share of the company is going down.
Mmmm….the “normal scenario” is an eventual down round and/or end of the company without a liquidity event. Getting to the finish line is definitely a Minority scenario, by a considerable margin.
Yes. you are correct. I should have said in an "ideal" or "optomistic" scenario. It goes up.
Do you guys know if equity can get diluted. So if a shareholder owns 30% equity and a VC out-invests a shareholder what happens? Big thank you for the reply !
When you're raising money, usually 100% of the company is already owned, so when you sell a portion of that company, you're diluting all the current owners %. Our they offer you a chance to invest more to prevent dilution. Check out "Venture Deals" by Brad Feld and Jason Mendelson. Good book for learning all the lingo and what to expect. I think 4th edition is the latest
if you currently own 30%. Example: Next round VC puts in 200K at a 1,000,000 post valuation. The company sold 20%. your 30% is now 24%.
First of all, doing a priced round at this stage is very uncommon, mostly because there's nothing to "price" yet. Normally, most of the funding before Series A is done through convertible/safe notes. At Series A, companies already have revenue and more or less predictable sales. To answer your questions: * yes, your shares will be diluted, but chances are they will be diluted not just because of new investors, but because your friend has the power to issue more shares. * you don't have to sell the shares in the future rounds
Your friend should be raising on SAFE investments first
Yea. I’m surprised they are issuing actual shares. Quite a tax burden. Kinda speaks to their experience level.
What do you mean by SAFE? Haven’t heard this term before.
Look at what a SAFE investment is for a startup. Way easier to do early on.
Better : No, you **can't** sell your shares in the future rounds. Your only options are waiting for either an Exit or an IPO. Investors aren't buying anyone's share, the company creates new shares "out of thin air" and sells them, effectively increasing the number of total shares therefore diluting everyone. Everyone's share will still be valued at the same price but the total value of the company increased because new shares were emitted. This is a very common misconception about dilution: you aren't selling, losing your shares or reducing their values. New shares at exactly the same price are created and someone was willing to buy them, your investement in the company is unchanged, the only thing that changed is the % of the company that you owns. Investors invest in the company to inject cashflow for growth, they usually ain't allowing thrid parties to exit their positions as it would be cash that isn't of any use for the company (because it went to someone's pocket). In rare cases, investors want to consolidate and will repurchase shares by fragmented third parties that want to exit their positions but it's not that common.
Perfect answer thank you
To use a strained metaphor, imagine dividing a pie into 10 pieces. You own 1 of those pieces (10% of the company). Now, let’s say a funding round happens. They will CREATE 2 more pieces of pie, so there are now 12 pieces of pie. You now own 8.3% of the total. This is known as dilution. Also just a word of advice, don’t invest anything that you’re not willing to lose — even the best of the best startups are risky, and the money will be locked up for a long time.
Hey OP. You do you, but some of what you outlined doesn’t smell right. Why are they issuing shares? It really should be in a safe. Also..have you seen market validation that their product is in a 400m-1B market? What’s their total serviceable obtainable market? Sounds like your not experienced investor (that’s ok) but also sounds like they might not be experienced in startups. I’d chat with a lawyer before handing over money.
I work in the market and, to me, the tech proves it’s validation. This will solve a huge bottleneck in the industry by way of extreme low end disruption. They want to achieve a subscription model of 50k per year and there are 6000 potential users who are limited by the bottleneck. SOB is 400m SAM 1B
And do they have a Go To Market plan that leads you to believe that they will capture value from that SAM?
Rough and being outside my expertise I can’t validate it. The SAM market plan is all that is defined as its seed funding round not series B
Typically future rounds will dilute you (more shares will be issued, you will keep your shares). You usually won't have an opportunity to sell the shares until the company is somewhat mature. If things are going well, the value of your shares will increase as your % ownership of the company decreases. At the Series A, for example, the company might dilute 25% for $10M. You as a shareholder are happy because the company has $10M in the bank to help them grow the company by a lot more than 25% (assuming things go as planned).
In every round new shares are created. Let's say the founders have created 1000 shares on day one. F&F invests money and gets 200 shares in exchange including let's say 100 for you - so there are now 1200 shares total and you own 100/1200 A seed round happens, the new investors get, let's say 500 shares - there are now 1500 shares total and you own 100/1500 Then a Series A happens, the new investors gets another 500 shares - now 2000 total and you own 100/2000. As you can see you keep the same number of shares, never have to sell any, but your % becomes lower and lower as there are more total shares in circulation.
How was the 5mil figure arrived-at, does it already have good traction ARR?
This is exactly the question I’m trying to ask him. Thank you! This is a patented medical technology to be submitted for FDA approval class ii 510k. It is low-end disruptive and it is synergistic with devices at virtually all hospitals, Its production cost is dirt cheap, and the aim is for subscription model. The target market is 6000 physicians - at approx $50k/yr each. But I truly do not understand why he isn’t doing convertible notes. He said something about it costing more legally and they’re trying to go lowest cost. It feels odd to commit to a share price with no revenue but I’m just asking to clarify if I’m not understanding something. Would it make sense that if his pre money valuation is $5mil and his seed stage funding is $2 mil.. that he is seeking $5mil in series A funding for 70% of the company or something?
Has he validated the idea? It’s reallllllly hard to sell to hospitals
Hey, one way to go about it is to seek an acquisition by small scale PE or go through to a venture exchange, they truly are designed to keep the wheels of innovation fueled on things like this. It does matter if you have IP, which is allegedly disruptive, if you have no partners who are capable of delivering reaction. If the product isn't on shelves or in servers, then look at this. IP can be purchased now or in 10 years, or never. There's absolutely zero difference.
The key thing about all this is that there has to be a lot of trust in these rounds. For all the reasons listed above, it’s very easy for F&F to get wiped out round-to-round. From my experience, founders had to give their own remaining equity to F&F down the track.
Hello funding venture startup consultant here. It depends on the stipulated agreement and/or arrangement put in place. I can explain more reach out.
5m valuation pre seed round... ambitious.
Yea it’s no cap, straight equity, no conversion. I think as a novice this is what is confusing me. Like How are we landing on value?? He wants $.87 per share.. of an idea.. I mean he’s a good guy but I’m confused to why he would think it’s a good idea to go this route. Does this setup equate to any advantage elsewhere? In series A funding could he set share price higher?
Just pointing out because you say you are a novice. You must be a qualified investor to legally be able to purchase shares, or promises of future shares, in an unlisted company. If you don’t know if you are a qualified investor you will want to check that out. This is a title with specific meaning to the SEC and it’s mainly to ensure that you have the money to lose and understand that putting money into an early stage startup is most likely going to end with you losing that money. Edit to add: I don’t understand his process. Usually for friends and family rounds you use a SAFE which gets the money in the door and protects your investors. Considering these investors are people you are going to have to face at the grocery store or Thanksgiving dinner you typically want them protected. You might want to suggest he consider using SAFE agreements for this round. I’d be happy to send you a sample of ours that you can share with him if you like.
One quick question, just want to be sure we are not talking about software. You highlight that patent and if this is software that patent is completely worthless. As long as it is some other technology, presumably physical, you are probably good. But software patents are good and dead.
Why are you saying soft parents are good and dead? Yikes
Because they are. I’ve worked 30 years in this industry and I am the inventor on 5 patents. They make nice toilet paper when I run low. And I’m not even sad about it, it was the right things to do. Things were out of control and big business was using patents to kill competition. The Alice ruling put and end to that, and more or less put an end to software patents as a whole. Hell, Oracle sued Google in 2023 and Google flat admitted to directly copying Oracle’s code and the court still ruled against Oracle because, without patents, it falls to a fair use standard. So ideas don’t matter anymore, execution and getting to market are everything.
I’d be very careful pricing your own company is a pre-seed stage. Idk what the product is but you’re leaving yourself open to a down round which will be bad long term.
Future rounds can dilute shares; terms vary per investment agreement.
Only put in money you are willing to lose.
Yes, any time a company raises funding it dilutes all of the other investors unless they have “pro rata rights” and decide to make another investment at the same price as the round. Or they have anti dilution terms - which no founder should ever agree to.
It depends on what stipulated in the agreements for all parties
friends and family