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hello and welcome to today's webinar pre and post money states choosing the right one for your startup I'm Cassie palsun head of content here at atrium and your moderator for today's webinar before I get into webinar logistics I wanted or introducing the speaker I want to tell you a bit about atrium atrium is a full-service corporate law firm that uses modern technology to deliver legal services that are fast transparent and price predictable founded by Justin Kahn and backed by andreessen horowitz YC general catalyst and more we are trusted by over 300 of the top startups and hyper growth companies in and outside of Silicon Valley now on to webinar logistics this webinar would roughly be 45 minutes of content with Q&A at the end you can submit questions at any point during the webinar on the left-hand side of your screen today I'm excited to introduce to you our speaker Jared Rozelle Jared primarily acts as outside counsel to venture back tech startups personally guides company companies three general corporate matters such as formation fundraising hiring employees and managing board meetings he also acts as a guide to atrium to many specialists to help navigate through the unique challenges faced by many high-growth companies let's get started all right thank you everybody for joining today we're going to get into this we've got the agenda on the screen now we're gonna do a really quick overview of the history of saves kind of how we got here and then we're going to talk about the key changes in the new post money safe which was just published by YC back in Wednesday October of 2018 so we're about six months into this now and then most importantly you know for those of you who have been using safes for the last five years or so we've now got these two options so it's really important to understand how do I choose the best safe for my company for my situation and I really take actionable insights away from this presentation so let's get into it so as a reminder short history of a state the context here is you're raising money right you're funding your business and the most fundamental way to think about that is you're selling a percentage of your company ownership for cash now before saves the the most fundamental way to do this was we would literally issue people stock you'd sell them preferred stock for a certain percentage of your company and there's a bunch of reasons why that's great there's a bunch of reasons why we use that transaction structure for Series A and B and C but it's pretty time-consuming and it has pretty high transaction costs there's legal fees and there's a lot of management time involved with those transactions so and kind of a workaround is a convertible note and and convertible notes are great they basically are an IOU right they say you give me cash now I understand that IOU investor shares of my company which I'll give you later and later is when we do a price round when we do an equity round so it's really great it's a great way to capitalize companies with low transaction costs to be able to really enable early-stage startups to move fast the issue with convertible notes is that technically they're dead instruments and so as debt instruments under US law they must carry an interest rate they must have a maturity date and at a more nuanced level there's even some questions about interest income reporting and things like that for the investors and so Y Combinator really took a a really innovative move and they created the first save and published it which was really intended to be all of the best components of a convertible note right low transaction costs a way to capitalize businesses quickly with a promise for equity in the future but they came up with the solution which they believed got around the pitfalls of debt issuance in the United States so no interest rate right no maturity date you don't have to worry about hitting a maturity date a year after you do your note financing and then maybe an investor who's not bullish on your company anymore actually once their money back plus the interest that they were through that can be a disaster for an early stage business so they came up with the same as a way to get around these things and and really I think it took Silicon Valley wise for me it took a few years to gain momentum but I would say in my practice the vast majority of companies in Silicon Valley zhing really convertible kind of precede angel friends and family rounds are all using saves and it's definitely gaining popularity throughout the United States and to a lesser extent throughout the world it's really designed to comply with US laws so it's not as popular internationally but but it kind of the nucleus was here in Silicon Valley and and it's very strong here now this kind of so I guess I guess this leads us to the evolution of the shape which is the new clothes Wednesday and here I've kind of got a slide which shows you some of these some of these things that I was that I was talking about you know you're selling a percentage of your company for cash you're using standard transaction standard documents to lower transactions costs but the original safe which was published in 2013 was a pre money safe meaning let's decide what the value of the company is today before we get any investment at all and then we can just tack stakes onto that valuation right I built a business we all think it's worth four five six million dollars and I can tack on a hundred thousand dollars safe and then another $25,000 safe and then a $250,000 safe and I can just keep tacking on those saves with the same assumption that the business kind of before all that investment is worth X and then we can just tack on as much fundraising as as the market will give us access to it so the evolution of the safe is that YC changed that from a pre-money valuation to oppose money back we're deciding what is the value of the business we're no longer thinking about it in terms of before the investment dollars come in but after the investment dollars come in so if you've got a business that's worth five million dollars plus you're raising a hundred thousand dollars save that means the post-money valuation is five point 1 million dollars or five million one hundred thousand dollars so this actually creates a lot of benefits but some downsides and I want to get into that eventually that's kind of the pre versus post but then for the next thing that I want to get into is just doing a deeper dive on the exact changes because they're not limited to just determining the valuation on a free money versus upper 20 basis so without going into all of the nitty-gritty details which I think are probably more interesting for lawyers than they are for most clients let me let me hit a couple of highlights so the first point is now at the top of the post went ape and by the way these are all published on Y Combinator's website they're they're open source documents you're able to use them and and you can even modify them for non-commercial purposes but at the very top of the new post might state there's basically a legend that says hey this is the same post money safe that is published on ycs website and what that prevents people doing is during into the kind of body of the document and changing things without anybody you know being on notice because one of the benefits of using the state is that your standard terms that come office age they're hopefully your fund raising in you and an investor agreed we're gonna do a staged finance and everybody really knows what terms tumbler that and the only thing that you really have to negotiate is what's the company's valuation and how much money are we formed to raise but you don't have to go to line item by line item now occasionally people were going there and tweaked wings and may not highlight it to people so they thought they were getting the standard state field but then they signed a document maybe without reading it closely and and there was now a bunch of things that are changed and they thought they were getting pro-rata rights and they rip those out and they didn't realize it so now there's this legend at the top which encourages transparency and just says okay well this is a standard safe and if you've changed anything you really have to remove that legend and if you don't I think the idea is that the parties are held for the standard of the standard runs to save so that's actually kind of nuanced but interesting and important and helps keep those transactions costs low because the parties know what terms they're getting into without necessarily feeling like they have to do a word by word reading of that document which can be pretty legal having a bit dry so so the other thing which I mentioned about the pro rata rights is this is a big departure in the original pre money stage every investor received pro-rata rights after the state converted so so what does that mean let's say that you're doing a pre seed round for your safe financing and then you raise your first equity round and call that your sweet round and then after that you want to raise a Series A so you've got kind of a precede seed and series a what that mean the old system was you buy your safe as you proceed round you get no pro-rata rights at the seed round but then when the a finally comes along every single station by the lights and this was kind of different I think a lot of people found this a bit confusing and it really didn't distinguish between large strategic investors who are typically thought of as the key kind of recipients of pro-rata rights and and everybody else so the change here was that they rip the pro-rata rights out of the safe altogether and they have published a standalone side letter which contains pro-rata rights and they've really simplified the process which is now the default for post money safes are no investors give pro-rata rights there's no skin being the seed round anymore and coming back in at the a just nobody gets pro-rata rights unless you specifically negotiate for and the company grants you pro-rata rights in which case you'll enter into a separate side letter agreement that governs your pro-rata rights and I think this is a good move I really like this I think it keeps things simple another another point is that the safes are now what we call amendable by a majority in interest which just means that you can actually treat the stage as around now so if you think about the series a round all of the investors come in maybe they're investing six or seven million dollars total and they all get rights they all get similar rights and then if you need to negotiate anything with your investors we go to the investors and you ask for consent and once a majority typically of the investors consent and you can change things or you can raise another round of financing or you can sell your company or do whatever but you can do things based on majority rule within the best investor class in the old pre-money safe there was no such thing as kind of majority rule or or majority consent every single safe holder had a standalone document and if you wanted them to consent something you had to get their specific sign-off and so what you can do is you could find yourself having a safe round of $1,000,000 and having got nine hundred and eighty thousand dollars of those investors to agree to your amendment and kind of chasing around toward five thousand dollar chats and it ended being very administrative Lieberman's them and it really wasn't relevant that often but I think as YC was doing this amendment and changing the safe they realized that this was a good opportunity to kind of inform to industry standards which is kind of majority rule within the investor class we realized that the investors have aligned incentives and that would be very unusual for nine hundred and eighty thousand dollars of the 1 million to want to do something at the twenty thousand to not want to do that so I think this was a good move on their part makes a little bit more found or friendly and company friendly there's also some some changes to kind of agreed accounting treatment and and agreed liquidation treatment in the case of the dissolution or in early kind of Apple hire a little bit cutting a little bit dry there some of that stuff was a little bit empty he was before because safes were a brand-new invention and there wasn't a lot of legal precedent on how to deal with some of these kind of nuanced concepts and so I think YC capitalize on the opportunity here to just put those in the contract and clarify some of those things but again kind of that's probably a little bit more of interest for any attorneys that we have for we're looking a level up on this rather than founders and on all this kind of leads us to the to the next kind of big point which is it supposed money safe and it's not a pretty money safe anymore and that's what I touch them at the beginning in and this is really where we're gonna spend the majority of our our substantive time because this is really critical all the other stuff are kind of small tweaks little improvements I don't think they're very controversial I think there's you know an area for reasonable minds to disagree about whether or not a pretty money safe or a post money safe is in the best interest of our companies and so let's try to all level up on that and spend some time here so in my opinion this fly that were on right now is the most challenging slide of the presentation I know it's dense but I think this is a good thing to kind of have bookmarked and revisit and try to level up on over time so it's challenging but it's also the most important concept that we're going to cover today and it really adds it's at its core goes back to venture math and how well the reader understands venture math concepts and is able to translate kind of the natural language the natural contract language of legal documents into mathematical formulas where you can then kind of plug it into a model or optimize and see what might be in the best interest of your company so for this slide you know what I'm asking everyone to do is kind of take my word that I have gone through painstakingly in the documents and the contracting language and I have translated them into a slightly simplified but accurate mathematical formula here so the idea is if you understand each of these variables right you understand what the state price is if you understand what the pre-money valuation cap is you understand what the company capitalization is you can plug in the specific numerical values for your particular company in your financial situation and it will spit out a number that's accurate and that track still save documents before we get into that I think that this the simplest approach to understanding the difference between the pre-money and the post money capitalization impact here is the following the investor meaning the person who's purchasing the state right the investor will not take a new die Lucien from any interest that's represented in the denominator of these formulas okay again the investor will not take dilution from any interest that's represented in the denominator now if you look at the formulas the denominator is the same right it's capitals the company capitalization now that's a defined term in the contract and the way that that term is defined it changes from the pre money safe to the first point stakes but that's why I underneath that I have company cash equals now that's the definition you'll see it's its own formula but let me just before I dig into this make sure that we're all understanding what I say when the better will not take that Lucien think about a company that raises a series a and then a series B and let's say the investors buy 20% of the company at the Series a I think intuitively we all understand that okay now the investors own 20% of the company and everybody else owns the remaining 80% of the company which totals to 100% when you go on to raise that series beanie and new investors come in and say buy another 20% of the company everybody in the series a cap table takes that dilution right the Series B investors are are buying 20% and that 20 percent comes out of every other shareholders piece on an on a percentage bas s okay so they all take the dilution what I'm saying when I say the investors will not take dilution from any interest representative the denominator is this if you're a Series A investor and you about 20% of the company and if the series being interest was in your denominator then we the company goes and sells that 20% to the Series B investors you don't take any dilution as a Series A in mossberg normally you would take another 20 percent dilution would be material but you wouldn't take care so the actual concept of Series A in series B is not is not actually applicable for staves but what I'm trying to do is use the most basic formula that people are familiar with to communicate the flexible so let's dive in now about this dilution and and understanding this dilution really helps one identify which formula is in the best interest for there couple so the things that are the same are and again this is this is these are all the things that do not create that illusion for the safe investor okay so all of the outstanding stock at the time of the company write your co-founder you and your co-founders have shares outstanding when we sell the company when we sell part of the company to your safe investor you understand that you're the ones taking the dilution from their investment that the stage investor isn't going to take that Lucien from their own investment that's very intuitive that's what that's all that outstanding companies doctors in the same vein outstanding options right if you have employees where on your cap table who have options perhaps they have an exercise then yes but they're not shareholders but they really have a claim to a percentage of the company and the understanding is they will exercise them eventually again investors don't take that Lucien from that that's very intuitive we kind of understand those people were already there in the company on the cap table and and we expect them to to be diluted this and its fundraising for that the option pool again that's that's where the options come from it's a pool reserve that the company sets aside for future equity incentives or hires when you in the old pre-money stage there was an understanding that this is a convertible round and eventually you'll do a full-blown equity financing and when you do that that lead investor will negotiate a certain size of option for that they want me to have as an incentive for them to come in and make their investment and that that new investor at the equity round wouldn't be diluted by that option flip-top normally that that number is 10% but when you have templates meant for so what would happen is we'd be able to be a stage stage company we have some shares outstanding maybe it made one two three four hires and have 5% of the companies left in your option pool for future hires when you go on you do your series a well if that new equity investor wants you to talk your pool up from 5% to 10% that's 5% of the company that's a material amount the new investor is not going to take any dilution from that and under the pre-money state neither would your existing schooler's we when you added an extra 5% of the company to that pool that would not dilute any of your existing safe holders right those people would put in 10,000 or hundred thousand or $250,000 so what that means is that extra 5% would come out of the shares of all of the existing team including the founders so that was the way it's been since 2013 and and that has now changed for the for the post money state YC is now taking a different approach and what they're saying is you know what oftentimes what we see now is save the investments really look more like state rounds as opposed to small bridge loans or one-off finance things concept so when you have around you know the series a investors if we're going back to our kind of traditional model of Series A Series B you know this series investors if they invest within a year or two years later your company will not to raise a Series B and you had a top-up your auction pool well that top-up would dilute all of the series a investors that's normal so since state financing awesome look like safe rounds now YC conceded that it makes sense to exclude the option pool topper from that from that dilution carve-out so I think that makes sense and is fair and really models what we would expect to see in a Series A and series B scenario and really what we're saying the new series a is really a safe route right and that's kind of what this is getting out I think it's the mental model of a lot of us who do a lot of these transactions and see companies regularly you know maybe raising two hundred fifty to five hundred thousand on an early steam you know proceed round friends and family or some burly angel investors may be using that for six to twelve months and then going on and raising you know usually a one or two million dollar round on a safe and sometimes even a three or four million dollar round on the state and using that for another 12 th and once I've run away before they really engage with their first equity round financing so this is just kind of YC adapting to the way that the states are being used by the market I think it makes a lot of sense the key difference here however is what I've put in bold which is converting securities or in other words other stage from convertible notes and remember my simple takeaway here is anything in the denominator does not dilute your safe investors so what we're doing here is we're now adding staves and notes to the dynamic to the denominator so what does that mean what it means is if you raise a hundred thousand dollars from a safe and then one week later raise another hundred thousand dollars and then a week later raise another hundred thousand dollars and then a week later raise another $100,000 if those had all been done as equity rounds which is really unrealistic because you know the transaction costs are too high to justify doing equity round for $100,000 investment but to demonstrate it if those are all been you call that your series a series B series new series D and each new equity issuance your prior investors would receive some dilutions right because your series a investors get that we buy series P and your series a and B get that little bike seriously well under the new post money save what this is saying is all of the subsequent stage issuance is or subsequent convertible note issuances the prior post money safe holder doesn't receive any dilution from those folks so what that means is if you could enter into an agreement with a party that says hammer I'm gonna value your company at five point 1 million dollar post-money valuation or in other words we think your company's worth five million we'll put in a hundred thousand that's a five point 1 million for money safe valuation and then as you raise another hundred thousand and then another hundred thousand and another hundred thousand that in the five point 1 million dollar valuation they don't take any dilution from the subsequent investments which another way of thinking about that is they're saying we're not gonna give you any credit for increasing your company valuation even though you've put an extra three hundred thousand dollars in your bank and normally you would think hey my company all things being equal if I have an extra three hundred thousand dollars in the bank I'm more than three hundred thousand dollars more because I have that much more operating capital and and if you're live in Silicon Valley and fundraise here really even get a multiplier on that because of all the things you can potentially do with your three hundred thousand dollars in the row of it create the market sure that you capture so this is actually a very big deviation from the pre-money save and it's not a bad thing it's just a different framework for thinking about your fundraising and so if we if we kind of go into the actual math behind it it changes the way that you do round construction and the way that you think about taking that Lucia and at the most fundamental level what you really want to make sure you're doing is when you're creating that person when save you're not thinking about what's my pre-money valuation plus the amount that this investor is putting in right my five million plus 100,000 is I'm a 5.1 million personal evaluation you really want to think about hey I'm gonna I'm gonna raise a hundred thousand dollars from each of these four individuals over the course of the next month so really I want to sign up each of them on a 5.4 million dollar purse might say right because that way I get the credit of having all four hundred thousand dollars operating capital and now they are all in the same pool together and I don't have to worry about any of them carving out the dilution from the others so that's really important that's different from the pre-money stage because you didn't really have to think about that before all you have to do is decide what's my value today and I can just keep tacking on investment as long as I have market interest now you have to take a little bit more thoughtful approach and really treat it as a round and think about hey what kind of round can I raise how big can it be cetera et cetera and and and and that's a little bit harder to do frankly right because a lot of times when were in the early days of fundraising we don't know how much it just we have you don't know how much money we may be able to attract and this is kind of I think requires a slightly more measured and aggregated approach to fundraising but now let's actually dive into the math and look at well all things being equal if I chose to do pre money stay for the post money state how much of the company would I be selling and so in order to do this again this is kind of a venture map an exercise adventure math which a lot of uh a lot of founders you know kind of sporadically immerse themselves in right you might fundraise every year or every two years and kind of knock the web stop and remind yourself how this works and then you have investors who deal with it more and then you have bencher and lawyers who like mean you could just deal with this stuff every single day so when we're doing our kind of back-of-the-envelope venture math and you're thinking about hey I know I'm I know I'm raising a hundred thousand dollars from this investor how much of my company my selling to her really the the back of the envelope math is not that hard you take the investment amount and you divide it by the pre-money valuation over the investment amount or in other words the postman valuation so let's look at scenario one right we're gonna raise $500,000 on a four point five million dollar pre-money valuation that's 10% of the company right and all that is is it's five hundred thousand over four point five million plus five hundred thousand equals ten percent so that ten percent remember I said these are IOUs right they don't actually get the shares yeah but in my scenario here right January 2019 we do the safe round we've raised five on four point five and then a year later we actually end up doing our equity round at that point in time the safes actually convert into preferred stock and it'll be approximately ten percent of the company on a kind of pre equity round basis so that's how that works in scenario number two which is a more common scenario there's going to be two convertible round or two stage financing rounds before we finally make it to our equity round so on January 20 1997 on a 4.5 million pre-write and again that's an IOU there's no dilution that's happened yet today because none of the dilution happens until we raise the equity round so ignore that for a second because if you just looked at that line item alone that would that should be 10% because it's five hundred over five million is two percent but that's not actually what happens in reality just this conversion event happens later so then three months later two months later we realized I got some momentum here we're gonna strike while the iron's hot we're going to take more money we're gonna raise another five hundred thousand but because we have a lot of interest we're gonna raise our pre-money valuation and by the way we've got another five hundred thousand dollars in the bank when I get credit for that so you raise another five hundred thousand on a five million free and now the one line item kind of math on that would be five hundred thousand divided by five point five million but again what we have to do is we have to wait until January 2020 and then calculate how all of these notes can burn and because this is a pretty money save and if you go back one slide which I'll do right now if you go back one slide you'll see that in the pre-money safe column the convertible instruments the convertible securities are not in the denominator right because they're not included in the definition of company capitalization so they're not in the denominator what that means is that the safe investors will be diluted by those issuances so now let's go back to our scenario slide so what that means is we have a two separate rounds they're both converting immediately prior to the equity round on January 2020 and because neither of them included the other in its denominator they both take that Lucien from each other so and that's what I try to represent in the black parentheticals thing each line item right you know where the 10% comes from that's the 500 thousand divided by 4.5 million plus 500 thousand that's kind of the being the percentage of ownership we would expect if there were no other diluting event but we also know that the five hundred thousand divided by five point five million right that we would expect to sell them nine point one percent right because five hundred over five point five million equals nine point one so what we have to do is we have to dilute each of these by the others relative state so it ends up being pretty straightforward right you multiply the ten percent by the dilution from the second round you multiply the nine point one percent by the dilution from the first round and you get this result where instead of converting into ten percent these investors convert into nine point one percent and eight point two percent respectively because all of that dilution didn't come out of the founding team the done the investors had to eat their own pro rata portion of the round dilution from each other so this is a this is a pretty good result and what it what it ends up with is about you know seven twenty point three percent of the company would be owned by the safe holders immediately prior to doing the equity route now the reality is then you can come in and do the effort you typically spell 20 to 30% of your company and those investors would have even more dilution at that point but maybe they choose to participate in that round in which case they kind of close themselves up but that's going to be on the scope of today's conversation but I just want to lay the the order of operations for how you do this map because as we all know order of operations is really important for getting the NOC rep and that is how you do it so if you're still with me that's great I know that this is really heavy and and and I really tried to kind of lay this out as best I can but I totally realized that you may need to spend some time with these slides and work with you know competent advisors and legal counsel to really digest this and understand this but let's now change gears and sit and look at the exact same scenarios what a founder who maybe isn't really paying attention the pre-money state versus personally safe and they're just grabbing the most recent thing off the YCC website which is the first when you save and they're just slapping numbers on there and using the same kind of mental model that they've used with 2013 on the old free money space so let's see if you kind of do that which I think a lot of people are doing right now and not really fully understanding the difference between these these vehicles what situation might you get yourself into if you do that so scenario 3 right you have your initial fundraising ground you do 500k on a five million post and you equal ten percent now here we're giving credit to me t the entrepreneur that hey they get the difference between free money and post-money valuation like that's not rocket science that stuff that we're all that we're all used to engaging with when you're thinking about equity rounds so we're not gonna make a mistake of doing a post money safe and giving a 4.5 million valuation they understand that it's a 4.5 million plus the amount we're raising the amount they're raising is 5 so that gives them a 5 million folks and it's a 10% dilution in that case so that scenario is the same as scenario one you know with the assumption that you've correctly priced it at a post money and not made the mistake of pricing it close when you save at a pre money drop scenario for I think is one thing ok so January 20:19 we waste 500 that 500k on a 5 million pills okay and again at this point let's just ignore the percentage dilution because you haven't taken any damage yet you just have an IOU to investors to give them shares in the future few months later you've got some momentum it's time to take more money off the table but you're gonna give yourself credit for that earlier 500k that you raised so you bump up your post-money valuation by 500k and you and you take another $500,000 investment that's forward 9 months you've got momentum you're doing a real equity round and now it's time to calculate the conversion percentages so again let's let's look at the black parentheticals the first number here the 10% and 9.1% respectively are the numbers that we would assume the safe investors from that round to hold if they were the only safe brown okay and that's just the simple 5 over 5 200k over 500,000 over 5 million and 500,000 over five point five months so that's ten and nine point one respectively but now they're still gonna take dilution what they're going to take dilutions from changes here they're not going to take the aleutian let's go back one slide to our our our formulas here so if you look in the post money saved column now we're looking at all of the definite the definition of the company capitalization within the perfectly safe what are the things that they take dilution from one of the things they don't take that we should from again anything listed in the denominator you will not take the aleutian as an investor so the big item here is the convertible converting securities right the thing in our pre money scenario was 10 we have to say brown those are both converted securities each of those rounds they lose the other well now in the post many states that emerging securities are in our denominator which means our investors will not take that Lucien from those so it's actually a relevant that we did Tuesday frowns the post when you stayed because doesn't matter if it's to save Browns or 5 say Brown returns a brown the investors don't take that Lucien from those safe routes so the question is what do they take that mission from and what we have to look at is that parenthetical at the very last point sorry I changed like Susan the parenthetical of the very last point under the company capitalization of course money safe which is the pool is included but the top-up is not again I know this is really I'm almost talking in circles here but the thing that we're looking for is what is not included in my denominator because I have to take the aleutian from that and the thing that's not included in the denominator of the post money save is option pool topper okay so now let's go back to our scenario slide so now look at the black parentheticals I'm assuming here and I have a little asterisk you know explaining my assumptions but I'm assuming that this company is going to do a 5% top all right so they raise some money on their pre money safe they raise the million box they probably spent almost all of that if they've got nerd falls all the way to an equity round they've issued say 5% of the company to early employees and they still have 5% of the company reserved for future employees now it's January 2020 their internship negotiations with their lead investor for their equity round and the lead investor is saying love your company but we need to get that auction cool back up to 10% I need you guys have a 10% for that's very very typical so what that means is you need to top your pool up by another 5% getting from 5 to 10 and because that tapa is not in the denominator of your post money safe calculation all of your safe investors you're totally safe investors are gonna some of that dilution and they're gonna you know they're gonna eat their pro rata portion of that so that's what we're last what I've represented here in E flat parenthetical you've got somebody who you would expect to get 10% of the company except now we need to figure out what's gonna be diluted for them it's gonna be the option for pop up we've assumed an option pool topper for 5% we're just going to take them from 10 percent down to 9.5 percent and in the case of the nine or 1% down to eight point seven percent and the math hopefully if he's kind of been following along and you can listen to this you're you're following the math and you can kind of work through oh I get it it's a 5% pool so they take five percent solution on their respective shares so does everybody else on the cap table that's how we make five percent open on the cap table and and that's where you get so what you end up with is that the equity round immediately before you bring on those new investors all of your safes convert and they're gonna represent eight about eighteen point and you know bear with me a little bit because when we do this in reality we actually build Excel models and they're much more sophisticated and we drill down you know to to you know multiple decimal points and this is very precise and it's a big part of ground construction but trying to give you the back of the envelope math presented concepts you know allow me some flexibility to have kind of approximate math here on this so what you're seeing is seventeen point three percent versus 18.2 percent dilution based on whether or not used that pre or post money saved and again I'm assuming that you didn't make me dumb mistakes like use a post money state and do a pre money valuation right like that just makes things worse for you but if all things being equal and use a pre money safe birth there's a post money state in this situation we're talking about almost an extra 1% dilution which is a material amount right I mean imagine imagine doing that a few times or or think about it like this what kind of talent could you hire early in your company for 1% of the company that's that's that's an executive higher or very senior higher or some you're a couple of very good hires at their very least if not more so it really puts into context eating this right because equity is one of the most valuable forms of compensation that you have as an early stage business that's that's typical cash-poor okay so assuming people's heads haven't exploded yet with all of that let's kind of go back and and and revisit kind of these key changes so and I'll just quickly read through these but you know you have these flights to digest them it's easier to track your ownership and dilution on a post money state because there's only one variable that you have to think about which is your option pool top robbed and typically that's pretty small you know it's simply going to be five or less 5% or less whereas if you're trying to figure out your relative equity percentages we're pretty money stays you've got to go you got to jump through all these hoops and figure out all my other stays how did they dilute my former saves out of the former stage - louder stage they become pretty complicated to keep all that straight and so what happens oftentimes is you end up building that full Excel model with you're turning at the equity round and you realize wow I didn't I didn't realize exactly how much did the company I had sold and those safe grounds you know and you know worst-case scenario is you know you really regret it and feel like you would have done things differently had you known but you know second point here fundamentally is just it's the math is different the math is different and and and you can't apply the mental model you have for calculating the math but free money safe with the post when you say because this isn't worth like the zero pro-rata rights I think is helpful and its founder friendly identifying the the instrument as that same instrument that's that's published on ycs website is helpful and helps keep the transaction cost low and make sure that neither party is trying to pull a fast one on the other that's helpful and then some of these other things we went over earlier and I won't have any more time on them because they're a little bit more of legal nuance so so we'll kind of carry on yeah so now that we've kind of done the deep dive on how to do the math and calculate these things the question really becomes okay that's interesting that's pretty dense is there a simple framework that I can use having listened to the presentation and gotten on board with the fact that like I think this person knows what he's talking about this down this downs right well I I just don't have the you know mental space to keep all this top of mind that too many other things that are important to me that I'm doing can I have a mental model and a framework to take away here that I know is based off of this deep dive that this expert has done and I think the answer is kind of I think so but you know these are early days and the market is still telling me what its gonna do with this information but here's what I think is gonna happen so if you are fund raising a convertible round and you have a high degree of confidence that your next fundraising activity will be a priced round okay then I think that you're pretty you should be pretty comfortable maybe the post money takes over all if you're not careful you can take you can end up taking more dilution from first money saves but that really only happens when you follow a stay frown with another safe route if you thought well you're safe round with a priced around you will reward you and and then what you get is you're not you're not kind of getting the worst aspect of it and you're getting all the benefits that the cleanup and all the things that I kind of gave short attention to are actually really important so do I think that after I raise this five hundred thousand 1 million two million dollars my next round will be a full-blown equity round with a with a lead venture investor yeah then post money say it's probably a pretty good bet for you if you don't have a high degree of confidence that your next round is going to be a and price to equity round I would I would say that post money stage is risky and and you probably should err on the side of doing the freemen safe and you know you'll give away maybe program some pro-rata rights the people who you otherwise might not have but you're gonna ensure that all of those safe investors take the dilution from subsequent rounds which follows six months later with another safe round and at least you know you're sharing that dilution burden with your prior investors and most people they would rather give people pro-rata rights and share dilutions then the opposite so how do you that kind of leads to the question of well how do I know what my next round is going to be a priced round and that's a hard question dance answer because it's very context dependent so here's a rough framework that I think would be pretty easy to poke holes in but I'm gonna err on the side of trying to be helpful and you have your luck framework but just know this really depends this is a multi variable analysis it depends on who your current investors are what kind of access to capital do you have we're kind of operating in success history do you have as a founding team what industry you're in right fundraising and consumer cat versus biotech completely different right completely different capital needs so with that kind of caveat I think we'll probably see happen as people get educated on the instruments and start to see the pros and cons of each is that if you're raising less than a million dollars you're gonna be using a free money safe and the reason for that is I'm just not confident that many people will raise less than 1 million dollars and then follow that up with a full-blown price everyone I just don't see it happen for you and typically you just don't have enough runway to do that if you're raising more than two million dollars I think what we're gonna see is as investors really level up on these instruments they're gonna start demanding that people use a perfect money state and I think they're gonna have a realistic argument that hey if you raise two million bucks you can get to a you can get to a Christ round even if it's a small price ground and as an investor base we want some of the added securities and assurance rules money safe I think that's what will happen I think in between the one and two million dollar range which frankly is a lot of companies who are raising saves a lot of companies are under one to two million dollar range I think it could go either way but I think as a founder you want to really exert your influence over leaning toward the pre-money safe because you want to err on the side of being cautious and you want to err on the side of maybe giving pro-rata rights away but making sure that if you get to an equity round in your next round that your investors are sharing the dilution so we want to make sure we have some time to address some comments that have come in and some questions that have come in this conclusion slide really kind of sums up everything and I won't read this verbatim because I've just gone through this but if you read this conclusion slide and you still like you're following it you've followed all the points you felt like they were articulated well and that you know even if you couldn't maybe turn around and explain it to somebody yourself but you have a high degree of confidence and these conclusions I think that's a win for this presentation because I think this is a pretty dense subject matter the one thing I'll highlight is please don't take away that free money state is better than post money safe that's an oversimplification they're really different tools that have different applications and they look very similar but the nuance the understanding of these investment vehicles will really allow a founding team to optimize their fundraising and I think it's important when you're looking for legal counsel to make sure you're talking to someone who really understands the differences and isn't just assuming that they're all the same because it matters it really matters and it matters about how much dilution you take it matters about setting expectations with your investors and about your ability to continue to hire top talent and have equity to do that so with that being said let's jump into some questions great ok so you can just submit your questions in the left-hand side of your screen we'll jump right into the few that have come in along the way why does the value of a company change before and after raising there isn't much difference before I ask if a value valuation of the company is representative value how is it that the value changes in such a short period of time yeah this is a great question and really there's a little bit of an equivocation in this because we're using the term value or valuation of a company but in the venture world who really have dissected this into there's pre money value and there's and the pretty value is all of the value that the business brings to the table before they do any fundraising and the post money the value is all of that value plus the capital that they've raised right because you could you could think of two companies that have the exact same team exact same intellectual property exact same product roadmap and exact same go to market strategy but one has a million dollars in the bank and one has five thousand dollars in the bank you know intuitively we would all agree that well yeah the company worth a million dollars in the bank is a lot more valuable because they actually had the operatin capital execute on their strategy and to acquire top talent so that's really why it changes right because you brought a bunch of value to the thing your fruit now you're pretty money value hasn't changed immediately after the finance and that's the same but now your post money value has changed because you have operating capital and some people would even argue that your pre money value because now you've got capital to actually execute on your plan and that makes their planning but more valuable but that's kind of supporting it great is it a good idea to use your free money in your first say fundraising and post and use post money in your second if you know you have a price ground what I did touch on this a little bit and I think I think that's not a bad idea and and actually in my opinion I think this is really captured by the framework which I said which is if you think your next fundraise is going to be an equity round you're okay to do a suppose money safe if you think your next fundraiser is going to be another convertible round and that could be either stage or convertible notes then you probably better do a pre money safe so if we look at it kind of in a chronological order your first round you're raising some money you know because of the way this question is structured we're assuming to two portable rounds before you get to an equity round so if you've got the crystal ball and you're looking into it clearly and you have perfect forecasting which is sometimes that's both new but that first round you're thinking well I know I'm gonna raise another safe round so this round I ought to do a free mini tape and then at that second state ground you're not really looking retrospectively you're saying what's my next fundraising where I'm going to be I think my next fundraising round is going to be an equity round so this fundraising round I'm gonna do a person let me say so yeah I think you can do that now I don't think it's as simple as saying you should always do Tuesday rounds the first one should always be a pre the second one should always be a post then you should go into it and equity round it's just it's unfortunately not that cut and dry but I do think that the framework holds up even in this and it allows for some optimization within the fundraising we're out for how you're going to structure it great so in you mentioned in the post money saves there's a majority investor approval is that the majority of the number of investors or the majority of the amount of money invested it's the majority of the amount of money invested and so there's different kind of terms that this goes by and there's there's a lot of jargon with legal terms but it's what we typically call a majority in interest right so you know and I use kind of like an analogy of democratic voting or majority rule when I was explaining it which is a little misleading because in adventure it's not one person one vote it's one dollar one right so so that that really is what governs here and so if you have a round where you have one large investor who bought 60% of the round and everybody else comprises 40% then you might just need to go to one person and that consent is enough to drag everybody along and again the idea there is we should really have aligned incentives the 60% holder in that case can take the time to make an informed decision and really actually the best interest of the entire group and reduce kind of the administrative burden of chasing down everybody but yeah it is it is by money invested or quite dollar amount not by each individual investor great and then in the calculation comparisons our converter Mon notes treated as too many states for the conversion comparisons that's an interesting question let me so I'm going to just take us back to my slide with the pre-money capitalization post-money capitalization so the question is really asking my interpretation of question is asking well which one of these formulas applies to notes right and and the answer is neither one or really the answer is I don't know because remember these formulas were derived by me taking a legal contract which in this case are safe there that are posted on Whitey's website reading through the legal terms and translating the legal terminology in the contract into a mathematical formula so you know the reason that this pre-money stage is this pretty safe and personally stable is putting they say because that's what the contract says so for your know you'd have to go into your note you have to do the same exercise of reading through it now if you're on a kind of a standard Silicon Valley note then typically there's gonna be a section that says automatic conversion you're gonna look for some a keyword called a qualified financing and you're gonna see somebody's basically taking a mathematical formulated formula and express it in prose or kind of in natural language which is it not very unnatural for mathematics but but that's how kind of do legal contracting works so you'd have to dissect that and kind of interpret it back into a formula and then if it happened to match one of these well that's great these slides would be really useful for you kind of digesting what your note governance but I suspect that it probably wouldn't match either one of these exactly and you really need to work with competent legal counsel to look at what are the specifics of that of that investment document awesome alright we're gonna wrap up for today the webinar recording will be emailed out within 48 hours so you will have all of this meaty content to go through and listen to again thank you so much sir yes thanks everyone for attending