The document discusses negotiating the pre-money valuation and Series A share price for a startup company receiving investment. It explains that the pre-money valuation includes an option pool that makes the effective valuation lower. This is because the option pool shares are added to the pre-financing shares to calculate a lower Series A share price. Investors want a larger option pool to reduce the company's valuation and share price. The post-money valuation is calculated as the pre-money valuation plus new investment minus any convertible notes.

1. Doing an Equity Round –
Negotiating Price
Jen Berrent
Inga Goldbard
October 22, 2013
Attorney Advertising

2. Negotiating the Series A Price
Economic Terms of a Series A Investment:
 Pre-Money Valuation
 Series A Investment (“New Money”)
 Any outstanding Notes that may convert
 Post-Money Option Pool
– Expressed as a percent of post-money shares outstanding
– Change in option pool is implemented immediately prior to the
financing (so included in pre-money fully diluted shares
outstanding)
 Post-Money Valuation
© 2014 Wilmer Cutler Pickering Hale and Dorr LLP
WilmerHale
2

3. What is Pre-Money Valuation?
 Generally negotiated by the Company with the “lead” investor
 As a rule, the investor wants a lower valuation, and Company
wants a higher valuation
– However, there can be drawbacks to setting the valuation TOO
HIGH in an early financing round (“valuation overhang”)
 More an art than a science for early stage companies
– Often determined based on the percentage of the company
investors and founders are willing to exchange for the amount of
cash being put in (e.g. 20% for $1M = $5M pre-money valuation)
© 2014 Wilmer Cutler Pickering Hale and Dorr LLP
WilmerHale
3

4. Calculating Pre-Money Valuation
 Company-Specific Factors investors may consider:
– Market opportunity (size, growth potential, competition)
– Strength of management team (track record, vision, credentials)
– Strength of product
– Progress to date
 Ask investors to explain their valuation analysis
– This may not get you more money, but will at least give you more
information
 Negotiable in tandem with other terms of the financing
(liquidation preferences, dividends, anti-dilution, etc.)
© 2014 Wilmer Cutler Pickering Hale and Dorr LLP
WilmerHale
4

5. What is the Series A per share price?
Price per share =
Pre-Money Valuation ($)
(Current Shares + Options Outstanding [+ Conv. Note Shares]
+ Unallocated Option Pool)
But this is circular!
© 2014 Wilmer Cutler Pickering Hale and Dorr LLP
WilmerHale
5

6. What is the Series A per share price?
Quick Note on Convertible Notes:
 If there are convertible notes outstanding that either
automatically convert into Series A shares, or may elect to
convert into Series A shares, the value of the notes may be
included as part of the pre-money or the post-money
valuation
– More favorable for the Company for Notes to be part of postmoney (higher price per share)
 Can be negotiated in tandem with other financing terms
© 2014 Wilmer Cutler Pickering Hale and Dorr LLP
WilmerHale
6

7. What is the Series A per share price?
Post-Money Option Pool
The circularity is:
 The price per share for the Series A stock is based on the fully
diluted number of shares prior to the financing including the
option pool
 The size of the option pool is based on the fully diluted
number of shares after the financing
 The fully diluted number of shares after the financing is based
on the price per share for the Series A stock
© 2014 Wilmer Cutler Pickering Hale and Dorr LLP
WilmerHale
7

8. The Option Pool Shuffle
The following narrative is from a blog
(venturehacks.com/articles/option-pool-shuffle) and it
illustrates the option pool circularity
 The punch line is: Don’t let your investors determine the size
of the option pool for you. Use a hiring plan to justify a small
option pool, increase your share price, and increase your
effective valuation.
 Our focus: The Series A per share price calculations (i.e.,
math).
© 2014 Wilmer Cutler Pickering Hale and Dorr LLP
WilmerHale
8

9. The Option Pool Shuffle
You have successfully negotiated a $2M investment on a $8M premoney valuation by pitting the famous Blue Shirt Capital against Herd
Mentality Management. Triumphant, you return to your company’s
tastefully decorated loft or bombed-out garage to tell the team that their
hard work has created $8M of value.
© 2014 Wilmer Cutler Pickering Hale and Dorr LLP
WilmerHale
9

10. The Option Pool Shuffle
Your teammates ask what their shares are worth. You explain that the
company currently has 6M shares outstanding so the investors must be
valuing the company’s stock at $1.33/share:
$8M pre-money ÷ 6M existing shares = $1.33/share.
Later that evening you review the term sheet from Blue Shirt. It states
that the share price is $1.00… this must be a mistake! Reading on, the
term sheet states, “The $8 million pre-money valuation includes an
option pool equal to 20% of the post-financing fully diluted capitalization.”
You call your lawyer: “What?!”
© 2014 Wilmer Cutler Pickering Hale and Dorr LLP
WilmerHale
10

11. The Option Pool Shuffle
As your lawyer explains that the so-called pre-money valuation always
includes a large unallocated option pool for new employees, your
stomach sinks. You feel duped and are left wondering, “How am I going
to explain this to the team?”
The option pool lowers your effective valuation.
© 2014 Wilmer Cutler Pickering Hale and Dorr LLP
WilmerHale
11

12. The Option Pool Shuffle
Your investors offered you a $8M pre-money valuation. What they really
meant was
“We think your company is worth $6M. But let’s create $2M worth of
new options, add that to the value of your company, and call their
sum your $8M ‘pre-money valuation’.”
For all of you MIT and IIT students out there:
$6M effective valuation + $2M new options + $2M cash = $10M post
or
60% effective valuation + 20% new options + 20% cash = 100% total.
© 2014 Wilmer Cutler Pickering Hale and Dorr LLP
WilmerHale
12

13. The Option Pool Shuffle
Slipping the option pool in the pre-money lowers your effective valuation
to $6M. The actual value of the company you have built is $6M, not $8M.
Likewise, the new options lower your company’s share price from
$1.33/share to $1.00/share:
$8M pre ÷ (6M existing shares + 2M new options) = $1/share.
© 2014 Wilmer Cutler Pickering Hale and Dorr LLP
WilmerHale
13

14. Post-Money Valuation
So what is the Company actually worth after the Series A
financing?
$5M
Pre-Money Valuation +
$1M
New Money +
$500k
[Value of Convertible Notes]
_______________________________________
$6.5M
Post-Money Valuation
Wilmer Cutler Pickering Hale and Dorr LLP is a Delaware limited liability partnership. WilmerHale principal law offices: 60 State Street, Boston, Massachusetts 02109, +1 617 526 6000;
1875 Pennsylvania Avenue, NW, Washington, DC 20006, +1 202 663 6000. Our United Kingdom offices are operated under a separate Delaware limited liability partnership of solicitors
and registered foreign lawyers authorized and regulated by the Solicitors Regulation Authority (SRA No. 287488). Our professional rules can be found at www.sra.org.uk/solicitors/codeof-conduct.page. A list of partners and their professional qualifications is available for inspection at our UK offices. In Beijing, we are registered to operate as a Foreign Law Firm
Representative Office. This material is for general informational purposes only and does not represent our advice as to any particular set of facts; nor does it represent any undertaking to
keep recipients advised of all legal developments. Prior results do not guarantee a similar outcome. © 2014 Wilmer Cutler Pickering Hale and Dorr LLP
© 2014 Wilmer Cutler Pickering Hale and Dorr LLP
WilmerHale
14