If you're an investor with access to a private equity market you can just look at the cap table and see the current asking price to determine the discount.
Brad Feld says the typical discount is 20% - 40%. I think a lot of investors ask for caps as well, which is essentially pricing the round (so don't let them pick one that you would regret).
Hey Jason, thanks a lot for your reply. Your answer is helpful. Since posting, I discovered investor's tend to be forthright with discount and cap expectations. Going into early discussions I wanted to avoid being caught off guard. Thanks again.
I'm unclear on how the cap would be a starting point? To DelaneyM & pcmaffey's point, it then becomes a proxy for price, so you've effectively set a valuation.
Would it be more appealing if you the round was closed in the next few months, so you investing early would be well rewarded with the discount?
I agree mostly, but it is true that in private equity, it's not always taken for granted that you can take a small stake's buy-in price and multiply it out to get a valuation. It depends on why that investor bought in, what the prospects for similar investors are, etc. It's taken with much bigger grains of salt than the standard (share price * shares outstanding) valuation for public companies is, anyway.
If it's publicly tradable equity in a stable company it's worth SOMETHING, but only as much you as a hypothetical buy and hold investor would give it over the cliff period. It obviously also comes with some risk so I'd give a public equity offer with a future vesting date a considerable discount vs cash now.
No price cap or a high cap means the discount is your max return during the period between when you wire your money and the priced round. Compare that to what an Seed VC or A Round VC would look for between their round and the next.
As an angel in that scenario, you’re investing with the risk profile of a very, very early company but the return profile of a later investor.
It seems like either the cap xor the discount applies (investors' option), so anything over $6.25MM valuation, the cap would apply and anything under that the discount would apply.
It's too late for me to edit the GP post, so I'll try to correct it here:
At a $5MM priced round, the discount would apply and the investor's note would convert $1MM at a $4MM valuation (25%). I believe that conversion is done pre-money, which means the angel is diluted (like all shareholders) from their initial 25% by the addition of the new money. (None of my angel investments have [yet] raised a priced round, so I haven't gone through this process, though I obviously hope to... :) )
If someone else invests $1MM at $5MM pre-money valuation, all prior investors are diluted by 16.6667%. (Someone who held 10% of $5MM pre-money company will hold 8.333% of a $6MM company post-money. Either way, their position is worth $500K.)
So, to know the angel's ownership in the scenario, you need to know how much dilution happened due to the new money, meaning you need to know not just the pre-money valuation, but also the amount of new investment money. In any scenario where the discount applies, the angel's position will be worth $1MM. In any scenario where the cap is better than the discount, the angel's position will be worth more than $1MM.
If all you want to know is what % of the company you are getting, why not ask them just that? The cap table has a lot more information about the internals of fundraising and ownership that the founders may not be willing to share with every employee.
Number of shares outstanding and current 409a valuation are both semi public info, and you should absolutely be getting access to them as part of your offer.
Which is a bit silly as the price per share of the last preferred equity financing round and the authorized number of shares are filed in the corporate charter which anyone can access. That gives you at least a lower bound on the valuation.
Investors in venture capital generally will protect themselves on the downside with things like liquidation preferences. Lookup the term and you’ll see why. In practice it will mean that there company must first pay investors at cost and only then split the rest on a per share basis.
On the upside scenario, your payout will converge to the number of shares.
Asking to see the cap table is not unreasonable but you will be asking for much more information than necessary for your purposes.
You might just ask how much you should get under different scenarios, but sincere founders will not have an answer because they can’t know for sure and they would be irresponsible to set expectations that they might not fulfill.
I understand the hesitation to predict future funding or dilution, but would hope to get straight answers about liquidation preferences in the current cap table.
The startups I’ve received offers from have been very upfront when I asked about shares outstanding and also willing to give order of magnitude estimates of where they were in terms of growth. I never thought to probe further in terms of liquidation preferences. The startup I’ve worked at the longest did have a sane cap table thanks to the founders finding good investors, but I didn’t learn that until long after I joined.
I'm expecting an offer from an early stage start-up. Would I sound unreasonable to see their cap table? Are there other questions that I can ask that can help me determine what % of the company I'd be getting in this stage?
Ultimately the terms are going to depend on investor consensus, but my strong preference is to go uncapped w/ discount.
Having a cap is an incentive for me to "grow until I'm 6 months away from X, then focus on raising instead". For some seed investors an early valuation & equity conversion may be desirable, but I'd rather "grow until I'm 6 months away from needing funds to (grow faster|survive)".
Having no cap, on the other hand, encourages me to stay lean, grow quickly & ask for money only when it has the greatest value. That's behaviour which may not be friendly to opportunistic short-term VCs looking to get a quick valuation bump, but which is strongly correlated with long-term success and eventual home-runs.
I want to give a discount because seed investors are taking a big risk on me, they deserve it.
Others in this thread have posted great advice. You want to know the most recent 409A valuation, and you want to see the cap table (you might be asked to sign an NDA, which is a reasonable ask). Also, its unlikely your role is going to give you enough pull for an acceleration clause or similar (in either the event your role materially changes or an acquisition occurs), so if you do want equity and they're willing to provide it, get as much as you can so you capture as much value as possible during your tenure and vesting period. The difference between 10 basis points can be material in the event of rapid growth and eventual liquidity. The answer is always no if you don’t ask.
The equity is more likely to end up worthless or a trivial amount more often than not, but you can take steps to derisk the devaluation of this component of your compensation.
Potentially stupid question: If they could sell the company today at $20-30mm, why would they take a pre-money valuation of only $15mm? Or is this standard for VCs to take a 'discount' on valuation? (instant upside!)
I know YC does this, but thought that was peculiar to that situation...
"On paper, the shares in the latter are worth much more (based on the current public valuation)."
By 'public valuation' I assume you mean a $ figure that was announced after the last funding round. Your shares probably don't have liquidation preferences, whereas the investors' shares probably do. So, you can't rely on a valuation calculated by a journalist. You need to do the math.
"How much of this could a candidate expect to know about and should it factor into a decision?"
Companies are used to dealing with people who don't understand, or do not look too deeply into the numbers. So, I guess they will expect you not to ask for details. However, without knowing the details of the cap table (including, as you say, the volume of shares outstanding, and the different rights attaching to different classes of shares) you can't hope to arrive at a useful valuation. Many people on HN suggest valuing startup equity at $0, and this is one of the reasons.
reply