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The Finance of Startups: For Dummies (Part 3)

Onwards and upwards with more finance learnings! Part 3… yes, that means I’ve effectively kept this learning thing going for three months already. I’ve learned a ton about finance itself, and some of its roles in startups.

At the end of Part 2, I noted a few points I wanted to dive into with more detail. So today, I’ll cover a handful of them including:
  • Pre-money and post-money valuation
  • Earnings-per-Share
  • Equity Financing
  • Debt Financing

Pre-money and post-money valuation.

In Part 2, I touched on a lot of stocks and investments by VCs. Simplistically, the equity a VC receives in exchange for funding is:
Except, valuation can also be parsed into pre vs. post-money valuation. You can probably guess what these terms mean, but they can have a big difference in equity. Pre-money refers to the valuation of the company BEFORE the injection of capital; whereas, post-money refers to the valuation of the company INCLUSIVE of the investment round. For example…

Pre-Money Valuation
Post-Money Valuation
Hugh Invests
Valuation of Company at Investment
Valuation After Investment
Hugh’s Equity %

What’s happening? As you can see, if Hugh invests $10M at a pre-money valuation, the company is then valued at $60M after the investment. Hugh’s equity stake is 16.7% because the company is valued at $60M ($10M + $50M) à $10M/$60M = 16.7%.

With a post-money valuation, Hugh is investing his $10M into a company valued at $50M which is already including his investment. Thus, Hugh has a 25.0% equity stake in the company.

8.3% can mean a lot of money on the table for either side – the investor or the company when going public or some other liquidation event.


Ah, another pretty “straight-forward” financing metric. Straight-forward in that its name is exactly what it is… “earnings” per share; where share is the number outstanding shares. Note: outstanding shares is the number of shares issued to company officials, stock holders, etc.
Earnings is the net earnings less taxes and dividends paid out to preferred stock owners (recall from Part 1 that preferred stockholders receive dividends before any other common stockholders).
EPS is a metric used as a gauge for how well a company is performing, and evaluate the performance of a company to its shareholders.

Equity Financing.

Mostly up to now, I’ve shed more light on equity financing. In the startup world, equity financing makes the headlines like Yik Yak raising $61M or BitPay raising $30M back in May 2014.

As a recap, with equity financing, companies are exchanging ownership in the company for capital (and partnership). As equity investors are investing on the potential upside of future success, they may be more lenient on recent financials with an eye on the future. Further, there usually isn’t a fixed return to investors which frees up working capital for the company. However, investors, as owners of the company, do usually get a share in the profits and have a say in the direction of the company.

Debt Financing.

Debt financing is very common place in everyday life ranging from homes, cars, and of course, businesses. In debt financing, loaner and loanee (the company) agree on a principal amount + interest to be returned on a period basis for some time (or when the note (another word for loan) is paid up).

The principal and interest can be marked as a fixed cost which raises the break-even point of a company (costs + revenues = 0; costs = revenues). As you can imagine, this can be a significant burden on a company’s cash flow, and thus, loaners typically require strong financials in addition to credit.

On the upside of debt, the company does not give up ownership in the company, and thus, the company maintains all profits (present and future) as well as the direction of the company. Also, interest on the loan can be tax-deductible for the company.

There’s obvious upsides and downsides to both equity and debt financing. Making that decision is hugely dependent on a myriad of factors for the company.

Onwards to Next Month

Here’s the open list of topics for me to research and share starting next month. Happy I knocked a few off the list from last month.
  • Convertible
  • Dividend
  • Pro-rata
  • Leveraged
  • Term Sheet
  • Etc.

What questions, thoughts do you have about the above? Any other topics from a startup’s finance point-of-view you’d be interested in learning more about, and having me research for you?



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