- In a venture capital deal, one of the two primary categories of terms that matter are economic terms. Now, you'll often hear things like the price of a deal or the valuation of a deal, and that's sort of the headline economic term. What's the price that the investor paid for the equity that they got and what valuations did the company get when it raised that money. For example, if you say, oh, we raised $2 million at a $10 million valuation, that means that you roughly sold 20% of the company for $2 million.
However, there's a lot of other components to that economic terms. First is whether that was on a pre-money basis or a post-money basis. Did the investor invest $2 million at a 10 million post-money which means that the valuation of the company after you've raised the money was 10, or did they raise money at a 10 million pre-money, which means that the valuation before the money went in was 10, and after the money that went into valuation was 12, and that's a pretty meaningful difference in terms of ownership by the investor between having a $10 million valuation and $12 million valuation.
Another component that often gets hidden as part of the economic terms is what's called an unissued option pool. This is a percentage of the company that's not issued but allocated for future employees. Most startups, most venture-backed companies issue equity to some or all of the employees in the company, and a lot of investors will negotiate as part of the valuation, part of the terms, some portion of that equity pool to be allocated but not issued.
And so for example in our previous deal, let's say we had a $10 million post-money deal, so the $2 million that went in bought 20% of the company. However, you also had in that 10 million post-money valuation, a 20% option pool. And that's another $2 million worth of economic value, so if you look at that, $2 million of value or 20% go to the investors, 20% go to the unissued option pool, and that leaves 60% for all the other shareholders, versus 80% if there was no unissued option pool, so there's a lot of pieces in these economic terms, and it's important as an entrepreneur not to focus just on the headline of what's the valuation, but what are those other terms in the valuation or that make up the valuation in terms of the capitalization of the company.
- Exploring potential stakeholders: friends, family, and more
- Finding a venture capital firm
- Breaking down the term sheet
- Taking on debt
- Asking for NDAs
- Accepting a no