Nivi · April 11th, 2007
Summary: Focus on your share price and the number of shares you own — metrics like valuation and percent ownership can fool you.
If valuation is your only pespective on a company’s capital structure, you can get fooled by games like the option pool shuffle which make your valuation seem large but actually depress your share price.
Focus on share value, not share quantity or valuation.
The most naive shareholders focus on the quantity of shares they own. That’s a mistake. The company can double your share quantity with a simple stock split. Do you feel rich now? We know companies that have 200M shares outstanding after the Series A just to fool their employees!
Merely uneducated shareholders focus on the percentage of the company they own. News flash: owning 99% of a company that is worth $10 is not going to make you rich.
Experienced shareholders (and Venture Hacks readers) focus on the current value of their shares and the company’s prospects. Investors in public companies with wacky capital structures don’t fancy that they own 0.0003% of a company that is worth $1B. Instead, they multiply today’s share price by the quantity of their shares to determine their share value. They track percentage ownership and valuation, but they focus on share price.
You should do the same:
Understand how any proposed change to the company’s capital structure affects the share price.
Employees should track share price too.
The number of options that new hires receive drops quickly as the value of the company increases and risk decreases. But the value of these options declines much more slowly because the increase in share price partially compensates for the reduction in share quantity.
On the other hand, if the share price is going down, the CEO and other “key” members of the management team often receive more shares to boost their share value — particularly after a new financing with inside investors.
The employees and founders who are left out of this little party should crash it.
Appendix: How to derive the share price.
These terms are negotiated in a simple Series A:
p = pre-money ($)
c = cash invested ($)
o = option pool size post-money (%)
and we hope you already know this:
x = existing shares outstanding (shares).
With these known values, it is easy to calculate all the unknowns:
value symbol equation post-money ($) t t = p + c new options (shares) n n = (x · o · t) ÷ (p − o · t) share price ($/share) s s = p ÷ (x + n) investor shares (shares) i i = c ÷ s effective valuation ($) e e = s · x