Academy Investor Network Educational Newsletter

Venture Math

Authored by: Erik Hoffstadt, Edward (E.J.) Leo, Ashley Sogge & Brian Hwang

The following storyline is meant to be illustrative of venture math principles. We will follow the lifecycle of a fictional early-stage venture in order to highlight some of the most common investment vehicles and provisions such as SAFEs, Convertible Notes, Priced Rounds, option pools, valuation caps, and anti-dilution provisions.

Scene Setter

Two founders, William Theodore Door (W. T. Door) and Lillie Pearson Sijan (L.P. Sijan) started a tech startup one year ago. Their company, GiGline, enables users to take a test that indicates their political and fiscal leanings. Based on the results of the test, users are algorithmically fed news articles that are curated to offer viewpoints more centrist than their own views. This allows users to be exposed to ideas and information outside of what they might normally seek, thus creating a more receptive environment for open communication. The two founded their venture exclusively through bootstrapping thus far. To hire outside talent and fund their initial product launch, they realize they need to take on outside investors as they have both already depleted their savings (and their family’s savings).

Initial Data

Pre-Seed - SAFE With a Discount and Valuation Cap

William and Lillie attempt to raise $400K from Pre-Seed investors through pre-money SAFEs (Simple Agreement For Future Equity), with the included provisions of a $5M valuation cap and a 20% discount. After engaging the investing community, they have four separate investors commit to contributing $100K apiece. After this round, the cap table looks as follows. The SAFE investors do not yet have equity in the company. Once the company raises money through a priced round, the SAFE investors will see their investment converted into shares of the company.

It is worthwhile to quickly note the difference between a pre-money and post-money SAFE. Y Cominbator (a notable accelerator) introduced SAFEs in 2013. Initially, they only offered pre-money SAFEs, but slightly changed the terms to create a second form: the post-money SAFE. This was in response to the increased size of funding achieved in the first financing rounds. Post-money SAFEs allow founders and investors to transparently and immediately calculate how much ownership is being sold. You can read more about the differences and see example term sheets on Y Combinator’s website.

Updated Data

Seed - Convertible Note With a Discount and Valuation Cap

Six months after closing the Pre-Seed round, the company launched the first commercial version of its product. User growth numbers were initially very strong and the company enjoyed impressive revenue growth numbers. However, both metrics recently stagnated at $80K in monthly revenues and total paid users at 1,000. After testing their product, the founders have a hypothesis for a product change to reinvigorate their early success. In order to fund the pivot (new talent hires, technology investments, etc.), the founders once again approach the investment community. This time, they are raising $1M through convertible notes with a $10M valuation cap and a 15% discount. These notes will convert on a pre-money basis based on provisions in the term sheet. After closing the round, the company’s cap table and debt picture look as follows. Because equity has yet to be offered, the SAFE investors from the Pre-Seed round still have not seen their investment convert to equity.

Initial Data