In this video, we'll walk through a spreadsheet that
you can download that'll help you analyze a
convertible note or a pre money SAFE
to see what the impact of that instrument will
be on your share dilution.
We'll walk through two additional spreadsheets in
subsequent videos.
The next one will walk through the post money SAFE
to analyze how it can have an effect on your
share dilution. And then finally, we'll walk through
what I think of as the ultimate share dilution
spreadsheet, which will look at multiple convertible
notes, multiple pre many SAFEs and multiple
post money safes.
So you can analyze a broad range of situations
to see how they will affect your share
dilution. I'm Steve Morse and I use this StartupSOS
channel to provide practical how to advice for first
time entrepreneurs.
So again, the topic this time analyzing
the pre money, SAFE and/or convertible
note to see how it will impact
your share dilution.
Let's jump right into that.
The scenario is you've closed a note or a SAFE
for some current funding.
And later then you have a Series, A funding
that converts that convertible security
into stock.
We'll walk through two different situations.
On the one hand, the Series A Investors requires
that you issue some additional stock options prior
to the Series A investment.
Once those are issued, then they make the investment
against that larger base of fully
diluted shares and then the convertible
security converts and it dilutes both the
Series A and the founders.
That's a reasonably balanced approach and a very
typical approach for an early
stage investment.
Option number two is the fixed percent approach.
Here t he investor decides they don't want to be
deluded by all of those convertible securities that
you have. So they're going to require that the
option pool and the
Series A ownership at the end of the round
after everything converts is some fixed
percentage. A percentage for the option pool and a
percentage for the Series A.
So the Series A is not getting diluted by the
convertible security.
Instead, it's the founders.
They're getting diluted.
One other the note on the spreadsheet, you'll see
that some of the cells have green text.
Others have black text. The green text is where you
plug in your numbers. The black text is either you
know titles or descriptions or the results
of actual formulas.
You won't want to change the formulas unless you
really understand the spreadsheet and understand
what you're doing. Here's the first part of the
spreadsheet where you get to plug in how
much stock initially do the founders have?
Here we're starting with a million shares.
And we assume you've closed either a note or
as pre money SAFE for some funding - I plugged
in five hundred thousand dollars.
And I'm assuming this is a note.
So it has an interest rate of 8 percent and it
has a period that you expect
it will go until it converts in that
Series A round. We need to put that in because that
becomes part of the funding it will convert.
In this case, we're assuming the conversion happens
in 12 months. It's 8 percent.
So that'll add forty thousand dollars to that five
hundred thousand dollar note.
And we're assuming a pretty money cap of 4 million
and a discount of 30 percent.
Again, all of these green numbers, you can plug in
whatever other numbers you want.
If you want to plug in for a SAFE, just make the
interest rate zero and the calculations work
exactly the same for a pre money SAFE as for
a convertible note. Next we assume there's a Series
A investment. A Series investor gives
you a pre money valuation of 8 million dollars
and invests 2 million and they're going to require
that upfront you issue an additional
10 percent of the company's shares to
build up your option pool.
Now without any convertible securities
converting. This implies that the Series A investors
would own 20 percent of the company, right?
They're investing 2 million.
The post money would be 8 million plus
that 2 million or 10 million, and 2 million is 20
percent of 10 million.
So their ownership would be 20 percent.
Again, assuming there aren't any other
securities converting.
So let's look at scenario 1 where they're requiring
you to allocate options before
they invest.
In this scenario, you've got a million shares
sitting there owned by the founders.
So you'll need to issue an additional one
hundred and eleven thousand one hundred and eleven
shares to get a total of just over
one point one million, because that's
how many shares it takes such that 10 percent
of the full capitalization fully diluted
shares of the company, gives you that stock option
number. Great, so that's how that math
works. Now that we've figured out how
many options or how much stock we have
to allocate to options, next, we figure
out what is the share price that the
Series A investors will pay.
Well, simple enough to calculate.
It's the pre money value divided
by that fully diluted capitalization,
Pre money's is 8 million, fully diluted
capitalization is just over one point one million.
Do that division and the price per share
comes out to seven dollars and twenty cents.
Next, we'll figure out what the
convertible security holder, either the note
or the SAFE will pay for their shares.
To do that, we'll calculate what is
the price that the cap would dictate?
What's the price that the discount would dictate?
What's the price that the Series A investors
will pay and just take the minimum of
those three numbers. That's what the
convertible security holder will pay.
In this case, the best deal comes from the cap
because it's a very low cap compared to the pre
money value.
So that's going to determine the price
that is paid by the convertible security
holder. Now that we have the prices, we can figure
out the cap table. So we begin with a million shares
that the founders have and then we
calculate that the convertible
security will get a hundred and fifty thousand
shares, just the amount they invested five
hundred thousand plus the forty thousand an interest
in this example, divided by the price
that we calculated for the convertible share
holders.
Next, we have already calculated the number
of options we needed - one hundred eleven thousand
one hundred and eleven.
And then finally we calculate the number of shares
that go to the Series A investors, which is simply
the amount that they're investing.
Two million dollars divided by the share
price they pay, which is seven dollars and
twenty cents.
So that then gives us a total number
of shares of just over one point five million.
You can see that the founders
have been diluted some fair amount now.
They started out with one hundred percent of the
company. Now they have 65 percent.
The convertible security holders have nine point
seven percent.
The option pool got diluted
by the convertible securities converting.
It's not ten percent anymore, it's seven point two
percent. And the Series A investors got diluted.
Also, they don't have 20 percent.
They have eighteen point one percent.
So, again, that's a very common approach to doing a
Series A and converting the convertible securities
where the dilution after
the options are issued, the dilution of the
convertible securities is shared by
founders and the Series A investors.
But that's, of course, not the only approach.
Let's look at scenario number two, where we're going
to fix the percent of both the option pool
and the Series A investment post investment.
So how do we figure that out?
Well, we know that the founders have a million
shares. Now, let's assume
the same stock price for this round as
in the earlier, simpler case.
Seven dollars and 20 cents.
Well, in that case, the convertible security holder
to either the convertible note or the SAFE holder
will pay that low price determined by
the cap and and get the same number of shares
as in the previous example.
A hundred fifty thousand.
The Series A them is going to come out with 20
percent and the stock options are going to come
out with 10 percent after all
of those shares are issued for the
note holder or the safe holder.
So how do we figure out how many additional
shares have to be issued?
Well, we have a total of one point one five million
shares, the one million plus hundred thousand
for the convertible security.
And we want that to be equal to 70 percent
of the total number of shares.
So we have room for, you know, 10 percent for the
options, 20 percent for the Series
A investors.
How do you figure out how many shares that will
take? You simply divide point seven
into one point twenty five million?
And that gives us just over one point six million
shares that we need.
Now we can build the cap table.
So, again, the founders have a million shares.
We've calculated with an assumed Series A
price of seven dollars and twenty cents, which means
that the convertible securities have a price lower
than that. We've assumed that and calculated their
share count.
We have a required option pool that's 10 percent
of the total one point six four
million, 10 percent of that, about a hundred sixty
four thousand. And the Series A investors
will get shares determined by their investment,
divided by the stock price at seven point two
dollars, two hundred and seventy seven
point seven thousand shares.
But now we have a problem that adds up to about one
point five million shares.
That's not the number we calculated before.
That was over one point six million.
The other problem is the serious investors don't own
20 percent at the end of the round, they own sixteen
point nine one percent.
OK. So what went wrong?
Well, what went wrong is we chose the
wrong stock price.
We started with a reasonable enough guess.
Seven dollars and 20 cents, the same price as was
paid in the first scenario, but clearly
in order to give the Series A investors
20 percent of the company, that price is too high.
The price needs to be lower than that
in order to get more
stock to those Series A investors so their money
will go farther to get them up to 20
percent. Well, how do we calculate what
that exact price is to get them
the right number of shares?
And that is the tricky part.
And here's why.
Let's start with the share price that determines how
many convertible shares, whether it's convertible
note or SAFEs, there are.
It also determines the number of Series A shares,
and that added up gives you the total capitalization
along with the preexisting shares for the founders.
That total capitalization then
determines the share ownership and the share
ownership depends on the
share price.
Well, that's a problem.
Now, we've were circular.
We've mapped right back up to the share price.
You need the share price to figure out the total
capitalization.
You need the total capitalization to figure out the
share price. So in other words, this is an iterative
calculation.
Now, some spreadsheets like Excel can do iterative
calculations if you set that mood in
the spreadsheet.
But that can be a little bit of a challenge.
Sometimes those iterations can like go on
forever. So it's a little tricky.
Also, the spreadsheet I usually use is Numbers
on a Mac and it doesn't do that kind
of iteration. So the approach I took in
this spreadsheet, so it will work on
any spreadsheet and so it won't get into an
endless loop is to let the user do
the iteration. So you get to iterate the price.
So let's walk through how that works.
So looking at the spreadsheet, there's this part
that's labeled the iterative share price
and it's green, meaning you get to set that.
Now we set that initially to seven dollars and
twenty cents. You can see now the target
ownership for the series is 20 percent
and the calculated ownership with that
share price is sixteen point nine one
percent. So clearly that price is too low.
To make this spreadsheet work what you get to do
is to crank down that price, try
lower prices until you get to
the right price that sets that
percent to 20 percent.
Well, we know it has to be a lower
price because we know that the
Series A shareholders need more shares.
So there are two million investment needs to pay
a lower price so they get more shares.
So we're going to ratchet the price down
to something below seven dollars and 20 cents.
After a little experimentation, you'll find that six
point zero eight six dollars is
the right number, out to at least four digits, that
gets you the 20 percent that the
Series A investors are insisting that they have.
So now that we have the right price,
let's plug that into our cap table.
So now we have one million shares
for the founders as before.
The convertibles are still at 150 thousand shares
because they're pretty money cap is still
a better deal for them than, say, the
discounted price of even this new lower
Series A price.
So they're still at a hundred and fifty thousand.
The required option pool is
10 percent of that earlier number that we calculated
for the total fully diluted
number of shares.
And the Series A investors now get three hundred and
twenty eight point six thousand shares.
And again, that's their 2 million divided
by that new lower share price
that we just calculated.
Now the percentages turn out
right. Things do add up to the total number
of shares we calculated before.
The Series A investors do have 20
percent of the company. The option pool has 10
percent. And you can see that the founders now
have been diluted down to sixty point nine percent
of the company.
So let's see how that compares to our
first scenario, the prior
simpler approach.
With this second calculation, we had sixty point
nine percent ownership by the founders
and that compares to 65 percent ownership
in the earlier example.
That's four point one percent difference in
dilution. That's an important difference to
founders. And it's not just the founders, of course,
that are affected in this particular scenario.
The convertible security holder, either the
convertible note or SAFE had nine point
one percent in this new calculation.
Before they ended up with nine point seven percent.
So they, too, are ending up with
less of the company.
The reason for that is that it's their
pre money cap that's driving their price.
If the discount had been driving
the price, then their price between these
two scenarios would have come down in this
this newer example and
their ownership actually would have increased
in this new scenario. So you never know until you
run the numbers whether it's going to be good
for the convertible security holder or not so
good for them. But this this
scenario of fixing both the options
percent and the stock percent for the Series A
investors pretty much always going to be bad
thing for the founders because they're going
to absorb at least the majority of
the dilution. Quick summary.
When it comes to dilution in a Series A different
approaches to conversion of your convertible
securities can have very different
implications, specifically different implications
for the founder dilution.
The spreadsheet that we put together, which you can
download, there's a link in the notes, will help
you work through some different scenarios to
understand the implications in
more detail. And that's a wrap of our discussion of
a spreadsheet to forecast your dilution.
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now, we'll add that to the playlist of this whole
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That's it for now. Thank you very much for watching.