Selling equity at this stage clearly is not attractive – they would have to give up most of the company, as little value has been created so far. So the founders are considering a different funding scheme to skirt the valuation issue (or at least to delay it until there is more proven value in the company). They want to sell convertible debt to raise the $250k, with a 5% interest rate, and a 20% bonus at conversion. Suppose they are successful, and at the end of one year they have opened the first small restaurant, shown it to be a success, and are now ready to open two slightly larger restaurants. Their estimate is that they will need $1 million for this next stage, which they will raise by selling preferred stock.
If the company now has a valuation of $2 million (present value), how much of the company will they need to sell to raise the $1 million?
The founders own 100,000 shares among them. How many shares will the company sell to the new investors, and at what price?
The debt will now convert, also into preferred shares. How many shares will the convertible debt holders receive?
How much of the company will each group own: founders, the first round (convertible debt) investors, and the second round investors?
Suppose there were a valuation cap of $1 million. What would the ownership shares be after conversion for the founders, first round investors, and second round investors?
How would your answer change if the valuation cap were $2 million?