Survey of corporate finance knowledge. Top-of-mind for the CEO / founder: - Company creation, and initial share pool - Raising capital the usual way - Raising capital via debt - Raising capital via bridge loans - Common Shares vs Preferred Shares - Section 409A, and valuation - Employee pool growth (and equity plan, e.g. http://www.slideshare.net/wealthfront/wealthfront-equity-plan) Top-of-mind for employees: - Shares, Options and valuing a grant - Exercise - Tax Scenarios

1. Corporate Finance Primer

2. Disclaimer
This talk is given in my personal capacity, not
work-related, no company related information will
be discussed, and it is neither legal nor tax advice.

3. All About Acme LLC
• Initial valuation $1M (we’ll get back to this.)
• 10M shares, ie $0.10/share

4. Funding Round
• Bring in capital (cash) via sale of new shares
to investors
• Similar to more guests at a pot luck: more
people and more food
• Since cash is king, gets preferential treatment

5. Funding Round
• Acme grew to $4M, pre-money
• Raising $1M

6. Funding Round
• Pre: $4M/10M, so $0.40/share
• Post: $5M/X = $0.40/share (value preserving)
• Need to issue 2M shares

7. Funding Round
$1M
$2M
$3M
$4M
$5M
pre $4M post $5M
Equity Cash
100% 80%
20%

8. Funding Round
• Dilution in percentage ownership
• No value dilution
• Bet that cash can be converted in at least same
equity value

9. Debt Issuance
• Traditional model of funding
• Deterministic returns (if all goes well), and faster
liquidity
• But exposed to company failure without being
exposed to its success

10. Acme Promissory Note
• $500K
• 12% interest, yearly installments
• Capital repaid in full at year 3

11. Bridge Loan
• To bridge between two milestones (eg funding
rounds)
• Avoids valuation process, share issuance,
generally simpler and for smaller amounts
• Incentive via discount at next round (convertible
loan)

12. Acme Bridge Loan
• $500K
• 6% compounded monthly
• Right of first refusal in next round

13. Valuation
• Initial & Seed
• Series A “getting to product/market fit”
• Series B “operationalizing”
• Liquidity

14. 409A
• Under new section, need to value to company to
provide fair market value for common stock
• Strike of options is set at that fair market value to
avoid tax liabilities
• (Introduced post Enron disaster, 2005.)

15. Valuation rules under 409A
• Tangible and intangible assets of the company,
• Discounted Cash-Flows (DCF),
• Comparable companies,
• Recent transactions involving the sale or transfer of stock or equity
interests,
• Control premiums,
• Discounts for lack of marketability,
• Use of valuation for other purposes having material economic effect
on the company.

16. Timeline of 409A
0%
25%
50%
75%
100%
Common Preferred

17. All About Stock & Options
• Stock — subdivision of a company’s value, into a
made-to-measure currency
• Option — … to purchase stock at set price i.e.
the strike. Technically, called a “Call Option.”
(We’ll skip put options, naked options, and other exotic options.)

18. Common vs Preferred
• Preferred has liquidation preference
• Common is a mean to provide in-the-money
value to employees, and comply with IRS rules
• Preferred converted into common at IPO

19. ISO vs NQSO
• ISO has tax advantages over NQSO
(Gains between strike and exercise taxed as capital gains vs income.)
• Can't qualify as ISO if aggregate fair market
value of underlying stock is greater than
$100,000 in a given calendar year

20. Acme Employee Pool
• 10M shares outstanding, $4M valuation total
• Want to have ~10% for new employees
• Create 1M shares earmarked for distribution

21. Employee Pool
• New Hires
• Evergreens
• Promotions & Performance

22. Expanding Employee Pool
• Issue new shares earmarked for distribution to
employees

23. Acme Employee Pool
• Pre: $4M/10M, so $0.40/share
• Post: $4M/11M, so $0.37/share?

24. Acme Employee Pool
• Trick: 1M shares are on the books of Acme
• Ownership of 1 share, also means 0.1 of
employee pool share
• Therefore, still value preserving!

25. Acme Employee Pool
• Dilution when issuing a grant
• Bet that new hire will translate into more equity
value than size of grant
• (Similar concept as cash being converted into
more equity value.)

26. Strike Price
• Strike set when options are granted
• Most “Stock Option Plan”:
• Grant post start date
• With approval & oversight of the board
• That’s Corporate Governance, not IRS rules.
Very touchy area though.

27. Exercising
• Tax benefit, at the cost of liquidity
• Golden handcuffs, not
• Early exercise even better!

28. Tax Implications
Timeline for scenarios
• 2010: Option’s strike at $10
• 2012: In one scenario, exercised at $50
• 2013: Sold shares at $100

29. Tax Implications
$0
$25
$50
$75
$100
Early Exercise* Same Day Sale Exercise
Acme Income Capital Gains

30. Tax Implications
$0
$25
$50
$75
$100
Early Exercise* Same Day Sale Exercise
Acme Income Capital Gains
!
Taxes:
$90 @ ~35%"
!
After Tax:
$58.5
Taxes:
$90 @ ~50%"
!
After Tax:
$45
Taxes:"
$40 @ ~50%"
$50 @ ~35%"
!
After Tax:
$52.5
Assumption:"
income taxed @ 50%, capital gains taxed @ 35%
!