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Comment by methodover | Hacker News Reader

Hm. As an engineer relatively new to the world of entrepreneurship, I find myself not really understanding much of the jargon. (Actually, I think I might understand some - but my confidence in my understanding is low.)

It would be cool if there was like, an annotated version of this explaining some of the accounting/investing jargon.

For example, this passage:

Richard attracts Peter, a newly-wealthy budding angel investor, who agrees to put in $1 million as a note with a $5 million cap and a 20% discount.

I think this means that Peter is buying part of Richard's company for 1 million bucks. He's valuing it at 5 million, so that's 20% of the company. However, there's a discount of 20%... Which is where I get confused. Does this mean that Peter is paying only 800,000, but getting 20%? Probably not, given the context. It probably means he gets 24% of the company, right? (He's getting 1.2M worth of shares for the cost of 1M.)

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You mostly have it.

The $5MM is a cap, not a price. If the Series A is raised at $5MM or more valuation, then the angel gets his money ($1MM) converted at $4MM ($5MM * 0.8).

If the Series A goes at $4MM, the angel's money is converted at a $3.2MM valuation (4*0.8)

The 20% discount confused me too.

Am I right then that the discount is to calculate the equity % based on a future Series A valuation.

if so in the scenrio's you posted above what is the new Equity % for the angel.

Looks like it is 20% once it crosses $5m cap as inferred in the article.

You forced me to look it up (thank you for that).

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.

For the record, the parent post is wrong. See the child post of carrotlead's post in this thread for corrected info.

> .. buying part of Richard's company for 1 million bucks. He's valuing it at 5 million, so that's 20% of the company.

No. The purpose of convertible note is avoid that kind of valuation in % of the company. It is very difficult to arrive at a share % valuation of early stage startups and convertible note solves this problem. Its like a loan given to the company which is converted to equity during Series A round when the company is more mature and its easy to arrive at a valuation

> (Peter)... who agrees to put in $1 million as a note with a $5 million cap and a 20% discount.

In the original article BTV does a 40 Million pre money valuation. Lets assume the share price is 10$.

- Peter gets 20% discount : so for him the shares at at 8$ per share

- his valuation cap is $5 million: so for him the share price is ( $8 per share / ( 40M/5M ) ) = $1 per share

- He gets (1M / 1) = 1M shares for company (In comparison, the series A round investor (BTV) invested $10 Million. So they also get 1 Million shares.)

- Since the current valuation is $10 per share, his shares are worth (1M * 10) 10Million

A 10x return for original investment of 1 Million. Looks extremely well !

> .. Plus, they want a senior liquidity preference of 1x to protect their downside

Though on paper peter has 10x profit. But if the company gets into trouble and sells out for 10 million or below, peter get nothing since BTV takes off the first 10M

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