This document defines key terms related to startup funding rounds and equity. It discusses typical vesting schedules for employee equity, how pre-money and post-money valuations are calculated, how options pools work to dilute founders, and examples of how prorata rights and convertible notes are handled. The stages of funding are also outlined, from angel/pre-seed rounds typically involving individual investors, to larger seed rounds, and later series A and B rounds involving institutional investors aimed at scaling the business.

1. Prepared for Cornell’s Entrepreneurship CWG 2015

2.  Fully diluted: Taking into account all outstanding shares, including those that
may have not been exercised yet
 Options pool: Pool of equity set aside for new hires
 Post-money: A company’s value after receiving a round of funding
 Pre-money: A company’s value prior to receiving a round of funding
 Prorata rights: Right to partake in subsequent rounds of funding to maintain
ownership %
 Vesting: Period of time over which equity accrues
 Vesting Cliff: Period of time before vesting begins

3.  Early employees at a start-up may receive some portion of their compensation in
the form of equity, drawn from the options pool (more on this later)
 Typically this equity needs to be earned, and is a reward for effort and
commitment. This is handled through a vesting schedule – note that founders can
also be put on vesting schedules
 A typical vesting schedule will include: the amount of equity, the period of time
over which is accrues, and any period before normal vesting begins (the cliff)
 For example a vesting schedule might be: 5% over 4-years, monthly, with a 1-year
cliff
 This means my 5% will accrue monthly over the next four years, except in the first year
 At the end of my first year, my cliff period, I will accrue the entire years worth of equity
at once: 1.25% and 0.104% monthly thereafter

4. FUN
 If Investor A wants to invest $1M for a 10% stake in your company:
 You have a post money valuation of: $1M/10% = $10M
 You had a pre money valuation of: $10M - $1M = $9M
 Say you started the company with 900,000 shares (sole ownership) issued at a
nominal price of $0.01/share
 Investor A would get 100,000 shares [0.1(900,000+X)= X] at $10/share
 Your portion grew from $9,000 to $9M!
 Then Investor B comes in and purchases 10% for $2M ($20M Post, $18M Pre)
 B would be issued 111,111 shares [0.1(1,000,000+X)=X] at $18/share
 Your portion is now worth $16.2M, but you only own 81% of the company
 A’s portion is now worth $1.8M and owns 9% of the company

5.  Options pool: Investor A wants to invest $1M for a 10% stake in your company, but
includes a provision for a 15% fully diluted post money options pool
 For a $10M post money valuation, there needs to be a $1.5M option pool pre-money
 This takes your pre-money valuation from $9M to an effective $7.5M
 How much stock is issued (assuming you start with 900k)?
 300,000 [0.25(900,000+x)=x] new shares have just been created for a total of 1.2M shares
 120,000 shares (10%) are issued to Investor A at $8.33/share, compared to the $10/share
paid in the same case without a pool.
 For A, this is essentially the same deal as $833,333 for 10% without a pool ($7.5M pre, $8.3M
post)
 However in this case you would truly only be diluted 10% as opposed to 25% with a pool
 180,000 shares are set aside for the options pool (15%)
 You now own 75% of the company valued at $7.5M

6.  Prorata example: Investor A owns 10%, and your company is raising a $10M
round at a $50M post money valuation (20% ownership up for grabs).
 Case 1: Investor A did not have prorata (or chose not to exercise it)
 Investor A would be diluted to 8% ownership and the company would be split: 72%
founder, 20% new investors, 8% A
 Case 2: Investor A did have prorata and chose to exercise it
 Investor A will need to purchase an additional 2% equity to maintain 10% ownership.
This comes out to be 10% of the round (2/20) or an additional $1M. Note the percentage
of the round is equal to Investor A’s current ownership stake.
 Ownership is now: 72% founder, 18% new investors, 10% A

8.  Convertible note: a loan that converts into equity upon a subsequent priced
round; really only seen in angel and seed rounds
 Discount rate: The percentage off of share price that the note converts
 Valuation cap: The maximum price at which the loan converts into equity
 In the notes where both a discount rate and a valuation cap are included, the
more favorable terms (for the investor) will be used
 Interest rate: Convertible notes are loans, so there will be an interest rate and
it will apply towards additional shares
 Maturity date: Date by which the company needs to pay back the note, if
unconverted, but investors will likely extend it if needed

9.  This is just one of the many ways a convertible note could be handled
 Assume we have a note for $100,000 (inclusive of interest) that converts with a
20% discount and a $5M pre-money cap from Angel C, and 1M shares outstanding
 Investor A wants to purchase 10% of our company for $1M
 First we check what our discounted price/share is:
 Let P be the price/share for Investor A
 Therefore Angel C will pay 0.8P (20% less than A)
 The number of shares that Investor A will get is then: $1M/P, and our angel will get
$100,000/0.8P
 Let T be the total number of shares after the round is closed
 We know that Investor A will own 0.1T shares in the end (10% of the company), and
Angel C along with the founders will own the remaining 0.9T

10.  Thus we have two unknowns and two equations:
1.
$1,000,000
𝑃
= 0.1𝑇
2. 1,000,000 +
$100,000
0.8𝑃
= 0.9𝑇
 Solving these two equations we get: P= $8.875, 0.8P= $7.10 and T= 1,126,760
 Now we need to check our capped price
 Take the cap and divide it by the number of outstanding shares: $5M/1M shares =
$5/share
 We see that our capped price per share is less, so we apply those terms
 Founders remain at: 1,000,000 shares
 Angel C gets: $100,000/$5.00 = 20,000 shares

11.  Now, Investor A won’t end up paying $8.88/share, because it would result in less than
10% ownership because Angel C converted at such a favorable rate
 Instead, we calculate the total number of shares Investor A needs to own 10% of the
company:
 1,020,000 = 0.9T; T= 1,133,333
 Then 1,133,333-1,000,000-20,000 = 113,333
 Investor A receives then 113,333 shares at $8.82/share
 Our final breakdown is then: 88.2% founders, 10% Investor A, and 1.76% Angel C
 If the note was uncapped, we would have just used the numbers we found solving
for the discounted rated, and ended up with 88.7% founders, 10% Investor A, and
1.2% Angel C
 The difference doesn’t seem like much, but with the cap in place Angel C received
a 44% discount compared to the 20% on the note

13.  Angel/Pre-Seed:
 Company is extremely early stage, somewhere between an idea and a rough prototype
 Individual investors
 Median check size is roughly $600k usually in the form of a convertible note
 Seed
 Company is on the path towards product-market fit and prototyping
 Company might be hiring a few additional employees outside of founders
 Can be a mix of individual and institutional investors
 Average check size is ~$750k-$1M could be a note but could also be priced
 Series-A
 At this point product market fit has been solved, and business model is taking shape
 The funding here will go towards scaling operations

14.  This is the first institutional only round
 Rounds are likely between $3M-$7M and priced
 Series B
 All about growth and scaling
 Institutional rounds raising $10M+