I think a little bit of a review is in order now and
maybe just taking a little bit of a step back to say well,
why does a company even raise equity?
And why do the people who buy the equity even do it in the
first place?
So the whole idea of what we were doing in the last several
videos is that a company wants to raise money to start a
website, or build a factory, or do whatever else-- kind of
invest in the world and in its kind of productive capacity,
so it can build the things that the
company is meant to build.
And in every example so far-- we have the example where me
and my buddies, we have just a business
plan, that's the asset.
And then we own all the equity.
We're the board of directors initially.
So that's all the equity.
So let's call this the assets right now.
This is the equity.
And we could go to a venture capitalist-- it could have
been an angel investor.
It could have been-- we talked about Series A,
Series B, all of that.
And we could say OK, we need to raise x million dollars.
What percentage of your company do we have to give
away for that?
And it'll say OK, well we'll value what you have right
now-- I'll do a different number than what I did in the
past-- we'll value what you have right now as $1 million.
And so, if you need another $2 million-- so let's say we
value what you have right now as $1 million.
Let's say right now you have one million shares.
So the company's pre-money valuation is $1 million.
So you are essentially saying that the company right now is
worth a dollar per share.
There's $1 million worth of assets, and there's a million
shares, so a million divided by a million is $1 per share.
So they're valuing it at $1 per share.
And essentially they're saying that we're willing to give
you, or we're willing to buy more shares from you at $1.
So, if we give you-- let me see, let me do green, I'll do
a different color, I'll do purple-- we'll give you-- draw
the box-- we'll give you, I don't know, $2 million.
And since we're buying it at $1 per share, we get two
million shares for that.
And now all of this is the equity.
This is what the founders had, and this is all the equity.
And so now the company has what we say was worth a
million dollars.
And this is kind of an arbitrary thing, and we'll
talk more about how you can actually value these
intangible assets and things.
But now they had that, and now they have another $2 million.
So the post-money valuation-- pre-money was $1 million--
post-money is now $2 million.
And now, we had one million shares, now we have three
million shares.
So essentially, for giving $2 million, these venture
capitalists, or whoever-- so these shares go to some VC or
angel investor-- they have now 2/3 of the company.
They have two out of three million shares, or 66% of the
company for giving the $2 million.
So that was kind of a private raise of capital.
And so you've probably heard the words private company and
public company.
A private company is one whose shares are not traded on a
public exchange.
So if this company wants to raise money by selling equity,
the only place it can do it is to venture capitalists or to
private equity firms. And we'll talk a little bit more
about kind of the difference.
A venture capitalist really is a private equity firm because
it's buying private equity.
But private equity tends to invest in more established
business, when people just talk about
private equity by itself.
But we'll do several videos on that.
So this is, essentially, this company is a private company
raising private equity.
Now, the example we did in the last video is, let's say this
company grows to a certain size.
Let me just do another company so it's clean.
Let's say I have another company, these are its assets.
And this is its-- let me draw its current
equity base right there.
They should be the same size, but you get the idea-- and
these assets, it could be it has some cash.
It has some factories or land.
It could have a bunch of stuff.
It could have some technology, or we could have some
intellectual property.
Maybe it's a drug company, or maybe it's
a technology company.
It has a bunch of patents and stuff.
And then it has some intangibles-- a brand-- who
knows what it has.
These are the assets of the firm.
This is the equity of the firm.
So this company right now has no debt.
And we'll talk about that in a second, what it
means to have debt.
And this is its current shareholder base, maybe some
of these are some VCs who invested in the company when
it was private.
Maybe the founder has these shares.
But this is the equity base right here.
And let's say this company wants to raise a lot of money,
and as just kind of a review of the last video, it can do
an initial public offering.
So right now it's private.
All of these shares right now that are owned by the VCs and
the initial founders of the company, they are not traded
on a public exchange.
This VC can't go to the NASDAQ and sell their shares.
They can't go to the broker and say hey, sell my million
shares I have in Company X.
They have to just sit on them.
Maybe they can find another private equity investor to buy
their shares, or maybe these founders-- there's no
liquidity here.
There's no other person they can sell the shares to.
And also, if this company wants to raise money right now
it has to kind of go to a VC and do the whole process where
you negotiate what this value is-- what the
pre-money value is.
And they have to come up with all these legal documents, and
all of these stipulations around, we'll give you this
money, but if this happens, then you have to give us this
interest rate.
And just all these type of things.
So, what they might want to say is, we need to
raise a lot of money.
All of these guys want a way for them to be able to sell
their shares easily if they need to.
And this company says well, we need to raise a ton of money.
Let's say we want to raise $100 million.
And that's hard to raise from just any one individual
investor, even if they are a big institution.
So they'll do an initial public offering, and that
really just means and-- the IPO, and this is review of the
last one-- is that for the first time this company is
going to register its shares with the SEC, and because it
does, it's going to list its shares on an exchange.
It will get a ticker symbol, it will maybe be company--
this'll be its ticker, T-I-C-K, or in the last video
could be SOCKS, because it's going to sell socks.
And then people can trade these shares on that exchange.
It could be on the NASDAQ or something.
And I think some of you all have had experience doing that
where you go on your Charles Schwab account and you say I'm
going to sell SOCK.
Well, that company that you're selling, at some point, did an
initial public offering, and registered with the SEC, and
got listed on an exchange.
And the way it really works is, it's fundamentally the
same as when you raise money from a VC.
But now, instead of raising money from a VC, all the money
comes from, essentially, the public.
It goes through these banks and brokerages, but it's
coming from a bunch of small-- I'm just
divvying it up right here.
It could be coming from millions
and millions of people.
But the same process kind of holds.
In order to see what price these shares are bought at,
someone has to say well, what is the company worth before it
gets the money?
What is the company worth before it gets this money?
Kind of a pre-money valuation.
That still has to happen, and that's what the
investment bank does.
The investment bank will essentially do a model and
they'll say oh, this is worth-- the company beforehand
was worth $50 million.
They'll kind of go out into the market to say well, our--
and let's say the company right now has
five million shares.
So that this piece right here is five million.
So if the banks value the company at $50 million, and it
has five million shares, they'll say OK, right now, the
pre-money valuation is $10 a share.
And the bank will go out there.
It'll kind of gauge interest and say well, does it seem
like the market's willing to pay $10 a share for a
company like this?
Or give this company a $50 million pre-money valuation?
And if so, they'll move forth with the IPO.
And, hopefully, the market actually wants to
not pay $10 per share.
The market maybe wants to pay $20 a share.
So all of these guys, let's say they'll pay $10 a share,
so let's say that they sell 10 million shares at $10 a share.
So the company is able to raise $100 million.
10 times $10, $100 million.
Then they can do big ads and all of that.
And what the bank hopes is by selling these shares at $10 a
share-- so let's say this is days, and this is price.
Let me change colors-- so what the investment bank wants to
hope is that, on day one, you sell it at $10 a share, and
then the price moves up.
That the demand was actually to sell it for much more.
And there's a bit of a balancing act, because if they
sell for too little, then the company won't get as much
money as it deserves.
But if they sell for too much, then the stock price goes
down, then you kind of have a stigma
associated with the IPO.
But anyway, this begs the question of sure, I understand
why the company is selling shares.
It needs money.
It needs to operate.
It needs to build factories or put out
advertising, and all that.
But why are people buying shares to begin with?
Why do people buy shares in the stock market?
And frankly, there's two answers.
And one is kind of the obvious one, because they think the
shares will go up.
But to some degree, that's speculation.
If I'm buying a share at $10, just because I'm hoping that
there's some other dude out there who, maybe a few weeks
later, is going to pay $15, I'm just speculating.
I'm just saying oh, IPOs go up so let me buy it.
But, economically, why was this even worth
$10 to begin with?
How do we even think about that valuation, at a very even
high level, why is this even worth $10 a
share to begin with?
And the idea is that these assets-- assets are nothing
but claims on future benefits, right?
A house is an asset because you get the future benefit of
getting to live in it, right?
Or the future benefit of not having to pay rent.
So, the future benefit of these is, they'll hopefully,
at some point in the future, generate an income stream.
And even more, they'll generate cash.
And at some point in the future, and a lot of companies
don't do it right now, they'll actually
dividend out that cash.
So there's a couple of things that will make this equity
have kind of an economic-- it'll ground it economically.
And it could be these assets starting to pump out cash, and
then each of the shareholders will get a dividend.
A dividend is just cash that is given to the shareholders.
So let's say that this is a stock certificate in SOCK.
So at some point when the assets of this company start
generating cash, each of the shareholders might be getting
a dividend.
Or maybe a large company, at some future date, says wow,
this is an awesome technology.
It'll complement what we already have. And maybe
they'll buy out the company.
Maybe they'll pay $300 million for this company.
And then, essentially, they're paying $300 million-- and
there's, what, fifteen million shares?
So they're paying $20 a share.
So those are the economic kind of grounding points that why
these shares even have a value.
And I'll go into a lot more detail, I'll do a whole
playlist on how do you even think about whether this is
worth $50 million, or is it worth $5 million, or is it
worth $500 million.
And it's kind of an art, more than a science, because you're
going to make tons of assumptions in terms of how
fast the company grows, what's the risk free rate of return
that you could get on other assets?
Essentially, where else you could you put your money?
When does the company dividend out its-- there's so many
assumptions, so it's more of an art.
So it's really kind of you try to get a handle on things.
But there's no real right answer.
The real right answer is kind of what someone's willing to
pay for it.
But anyway, I'll see you in the next video.