This content was created by Tim Draper. This content was uploaded by Tim Draper. This is a YouTube talk titled "An Analysis of Debt & Shares You Should Know for your Startup | VC Tim Draper" (video metadata timestamp: 2015-06-14). The excerpt captures Tim Draper explaining startup finance topics — debt seniority, classes of preferred vs. common stock, share issuance (issued vs. outstanding), dilution, and primary vs. secondary shares at IPO — in an instructional Q&A style with another participant labeled as Speaker B. The content reads like a practical lecture or investor Q&A aimed at founders and early-stage investors.
Chapters
Debt is the most senior, and bank debt is the most senior, which means that their money, the bank's money comes out first. In the case of selling your business or liquidating your business, which by the way are the same thing really, you sell it or you sell off the pieces, it doesn't really matter. The bank debt comes out first. They have the senior debt. But it's the least expensive. And then the debt, like that angel debt, and then the participating preferred, and then other types of preferred stock, and then the common stock. So there's a big— they call that a big stack. There's a big stack over you as you've created— as you've raised money along the way. So you're saying that the And sometimes within classes of preferred, they'll do something called pari passu, which means you'll do it on a pro rata basis, meaning if you put in $1 million and I put in $500,000, we're just going to be treated the same way. Or sometimes new types of preferred come in that are senior to all the other types of preferred. So that they would— seniority means you're the first ones out.
Okay.
You're out before the subordinated stock. So here, let's see, you just want to keep it live. Okay, so that's the preferred stock. Then we've got a price per share, and let's say it's $1. We're doing our deal for $150,000. And so it's $1, and so I'll end up with 150,000 shares. And the founder is going to end up with $1.35 million, right? So that overall— and that's another term. Yeah?
What's the point of creating shares this early in the game? Is it for future investors who are going to come in?
Great question. Here's what happens. The reason you create shares is that you are— you want people to be on board with you. You want people to be owners in your business. You want all your employees to be owners. You want your investors to be owners. You want yourself to be an owner. You need to create shares. Shares are great because if it were percentages, It would very quickly get very complicated for us. We'd start by saying, okay, I'm taking 10% for $150,000. The next guy says, I'll give you $1 million for a third of your business. And the next guy says, I'll give you $10 million for 25% of your business. All of a sudden people are going, wait, wait, how do we work our deal now that they've come in? Shares are simple. Think of shares as an expanding pie. It's just we're giving shares away. So if you start with 1 share and you give me a share, we've each got half of the company. But then we bring Christine in and she— and now we each have a third of the company. She's got a share. And then we bring in Rob back there and now we've each got a quarter of the company. And it's very simple. It's simple, but we're expanding the pie. We're expanding the number of people associated with the business, number of employees, number of everything. Did you have a follow-on?
Yeah, so then can you just create— so like in this case you said $1 per share, so you get 150,000 shares. Can you just arbitrarily create more shares whenever you want?
It's pretty much arbitrary. Legally you have to limit the number of shares as you incorporate, but make that number big enough so that you never have to worry about it. That's shares issued versus shares outstanding. Shares outstanding are the ones you've given away. Shares issued are the ones that you've said, this is how many shares are in my business, but they aren't all given away.
Yeah. But you don't like it if I am the owner and I give my shares away because you Your shares will decrease in value.
Or increase. See, bringing Rob on was a great thing and he only took one share of the company, but we're all going to make this— every share is going to be worth much, much more now that he's on board, assuming he performs the way we expect him to.
Yeah. Why would investors ever agree to allowing you to create more shares? Wouldn't that just dilute the value of their own?
Well, it's interesting. Investors don't— they don't let you— we're going to get to that in a bit, but because the way the terms work, investors do stop you from doing certain things that people obviously did back in 1930, and they had to put up a new term to protect themselves. But the investors want You to increase the number of shares, if you feel that it's the right thing to do, we're both better off, right? If you and I are— if I'm your investor and you're the entrepreneur, and you say, hey, it's worth it, we got to get a new share here, we're bringing Onwit on, and we're going to bring him in for 4 shares of the company, I say, okay, sounds good. Because you're diluted and I'm diluted.
So in the case of an IPO, are the shares that you sell then shares that you created or shares that you— or existing shares that you traded in?
It's both. It's both. In the case of an IPO, there's something called secondary and primary. Primary shares are shares that go into the business. Secondary shares are shares that are traded people who already own them. So a new company, when, I mean, a new IPO, a company goes public, they, let's say they sell 1 million shares at $10 into the public. And half of the 1 million shares are primary. So they get half, they get $5 million into the company. for that half million shares. The other half million shares are for employees to sell at the IPO. And they would sell, and that's why people go, hey, we got to go public so then I can sell some of my shares and keep going. Of course, if you're in a good company, you just want to hold on.
