Your startup valuation, explained simply.

Here is a quick tutorial on how valuations and investment rounds work, as simple as I could make it. The jargon may sound off-putting but the concepts are simple. Understand the definitions and build the cap table. Ask the investor for their cap table so you are sure there’s no confusion. Compare offers on an apple-to-apples basis by comparing the Price Per Share. Let's dive in. Bonus: a simple cap table you can use

Fundamentals

Angels and Investors will buy newly issued shares in your company. They will invest a dollar amount (say $1M) and buy those shares at a certain Price Per Share (PPS) which is the value of one unit of equity (a share).

Investors look at your existing business and assign a value to it. This value is what is called the Pre-Money Valuation. The Post-Money Valuation is the agreed value of your company + the cash invested in the round.

To calculate the Price Per Share, simply take the Pre-Money and divide by the number of shares currently in existence (# Pre-Money Shares).

Price Per Share = Pre-Money Valuation / # Pre-Money Shares

Here's a super basic cap table with PPS calc:

The Option Pool Shuffle

How many shares exist prior to the round? The answer is less obvious than you might think; it is actually a question of agreed definition ... and a source of confusion. Included for sure are the existing shares and the options that have been allocated. The subtlety is that the total number of shares considered will usually include a number of options that have not yet been allocated or even authorised yet -- new options.

Why include new options? Well, VCs calculate their return profiles based on ownership, and like to know how much they will own by the time you get to the next round. So it is customary to “budget” say 18 months worth of options required for team building ... so that the ownership number is a “true reflection” of what the investors will own by the time the next round comes around.

Think of unallocated Options as “unseen dilution” or “yet to happen” dilution.

Usually in a term-sheet you will see wording such as: “the Pre-Money will include a number of Options such that the unallocated option pool represents 10% of the fully diluted equity”. In plain English, this just means: "we will plug a number of new options in the spreadsheet such that the unallocated number of options after the round is 10% — and these options will be part of the Pre-Money Shares".

You can see that having more options in the Pre-Money number of shares reduces the Price Per Share of the round (and can do so quite significantly), since it increases the denominator.

I cannot resist not to point you towards Nivi's seminal “Option Pool Shuffle”. Throwback! https://venturehacks.com/option-pool-shuffle

Different investors may make offer that have different option pool requirements. So, when you compare funding options, golden rule: always build the cap table and look at the effective price per share. The Price Per Share captures everything. It is your source of truth.

THE PRICE PER SHARE NEVER LIES.

There’s nothing wrong with this option pool shuffle, but some VCs might conveniently fail to explain that math to you and hope you focus only on the pre-money number.

Now you can layer in your new round in top of the new options and see what the result of the round is going to be for all involved.

Voila.

The ownership that exists AFTER inclusion of all new options and all new shares is what is known as “Fully Diluted Ownership” and the resulting cap table is known as “Fully Diluted Equity”.

Convertibles

Convertible Notes (SAFEs, Convers, SeedFast, ASI) are quasi-equity instruments that specify a fixed conversion price for the note into equity or specify a cap (where Conversion Price is lower of actual value or Cap).

Notes are used for rolling closes and make life easy for founders. In a classic "priced round", the round size is agreed, the investors are agreed and everyone comes in together, though sometimes you leave some flex for a second closing.

This is no different - don't get thrown off thinking this is complex - there is a Valuation specified for the company at which the shares will convert based on the rules of the note. Since you can't predict the future, just assume the valuation of your company is equal to the Cap. Just follow carefully the language contained in the Note and apply to your simple cap table -- it's simple arithmetics. It gets a bit more complex if you have multiple notes at multiple prices but not much - I won't cover this here.

What’s up with Pre-Money Note versus Post-Money Notes ?

In a Pre-Money Note, the PRE-money is fixed (and the Post-Money increases as you add more investors and cash). In a Post-Money Note, the POST-money is fixed (and the Pre-Money decreases as you add more cash). Benefit of a Post-Money Note: investors know exactly how much they will own (regardless of how much you decide to raise). They are the simplest to grok but you of course have to make sure you don’t raise crazy amounts. If I invest $1M at $10M post I KNOW I will own 10%. If you’re running multiple notes you MUST run an accurate cap table to ensure you’re not getting silly dilution over time.

Et voila.