The year is 1999 where promising dot-coms seem to be popping up in the blink of an eye. The startup your buddy Ken invested in quickly attracted venture capital and on it went to the IPO wonderland. Ken is handing out cigars and telling you his success stories. “I’d be crazy if I don’t get in the game now,” you thought. So you decided to play angel and throw some seed money at a sexy dot-com set up by some pretty bright college kids. You’re ready to fly.
The founders hold a total of 700,000 shares of the company. You’re eager to play so you offer to buy, on the spot, 30% of the company for $300,000 (or 300,000 new shares at $1 per share).
A year later, the dot-com bubble bursts and the startup is no longer sexy. Luckily for you, it’s at least meeting milestones and generating a little revenue. But cash is tight and it needs to raise additional capital to survive – and it needs it fast. So you make a few calls to Ken, who later agrees to inject some cash into the startup, but at a price lower than what you’d originally paid.
Ken offers to invest $500,000 in exchange for 50% for the company. This works out to 1,000,000 new shares issued at $0.5 per share. Since the stock price has dropped from $1 in the 1st round to $0.5 in the 2nd round, your 300,000 shares now only worth $150,000 ($0.5/share x 300,000 shares) rather than $300,000.
This is called a “down round,” which results in a lower price per share and decreases the value of your holding. But neither you nor the startup has a choice – it’s either down round or down six feet under. Yea, you guys are feeling pretty down, too.
* For series, references are published in the last installment of the series.