1
00:00:00,770 --> 00:00:04,640
Most people are familiar with debt, but
what is equity?

2
00:00:04,640 --> 00:00:07,730
Equity is ownership interest in a company.

3
00:00:07,730 --> 00:00:10,120
Now, what do we mean by that exactly?

4
00:00:10,120 --> 00:00:11,620
When a business is set up,

5
00:00:11,620 --> 00:00:15,300
you can imagine a company comprising of
many little units of ownership.

6
00:00:16,330 --> 00:00:20,040
When you raise money through equity
financing, you're basically asking for

7
00:00:20,040 --> 00:00:23,230
money in exchange for ownership in the
company.

8
00:00:23,230 --> 00:00:26,400
This is pretty important because unlike
debt financing,

9
00:00:26,400 --> 00:00:29,860
you don't have to pay back the money you
raised through equity financing.

10
00:00:30,870 --> 00:00:35,110
Businesses first starting out might find
equity more favorable than debt, for

11
00:00:35,110 --> 00:00:35,710
many reasons.

12
00:00:36,710 --> 00:00:39,450
Debt on your balance sheet can be seen as
a bad thing.

13
00:00:39,450 --> 00:00:40,940
Equity isn't.

14
00:00:40,940 --> 00:00:42,010
When you raise equity,

15
00:00:42,010 --> 00:00:45,100
it puts your company in a better position,
on paper at least.

16
00:00:46,330 --> 00:00:48,670
When you take out a loan to expand your
company,

17
00:00:48,670 --> 00:00:51,530
you immediately have to start paying that
loan back.

18
00:00:51,530 --> 00:00:54,230
This means that whatever you spend that
money on has to

19
00:00:54,230 --> 00:00:58,130
increase cash flow immediately so that you
can pay back the loan.

20
00:00:58,130 --> 00:01:01,300
With equity however, when investors give
you money,

21
00:01:01,300 --> 00:01:03,700
they don't expect returns immediately.

22
00:01:03,700 --> 00:01:06,160
They understand that they're in a long
term agreement, so

23
00:01:06,160 --> 00:01:09,160
there's less pressure on you to make their
money work immediately.

24
00:01:10,520 --> 00:01:13,060
With equity financing, since unlike a
loan,

25
00:01:13,060 --> 00:01:16,635
you don't have to return that cash
immediately, you can use the money for

26
00:01:16,635 --> 00:01:19,840
long-term purposes, like the expansion of
your office.

27
00:01:19,840 --> 00:01:20,980
Conducting research and

28
00:01:20,980 --> 00:01:25,180
development or hiring more staff to ramp
up revenue growth.

29
00:01:25,180 --> 00:01:29,510
When you raise funds through equity you
give away a portion of the company.

30
00:01:29,510 --> 00:01:33,190
This means that when you earn profits you
have to distribute those profits to

31
00:01:33,190 --> 00:01:36,380
the investors in proportion to how much of
the company they own.

32
00:01:37,635 --> 00:01:41,280
One thing important to note, is that when
you have both equity and

33
00:01:41,280 --> 00:01:42,710
debt on your balance sheet,

34
00:01:42,710 --> 00:01:46,950
you pay off the debt before you distribute
your profits to your investors.

35
00:01:46,950 --> 00:01:48,320
If your company goes bankrupt for

36
00:01:48,320 --> 00:01:52,340
some reason or another, debt is paid off
before equity.

37
00:01:52,340 --> 00:01:55,590
If you don't have enough money after
paying off debt, oh well,

38
00:01:55,590 --> 00:01:57,500
investors don't get anything.

39
00:01:57,500 --> 00:02:00,390
Debt always has a higher priority.

40
00:02:00,390 --> 00:02:03,290
There are lots of advantages to raising
equity over debt.

41
00:02:03,290 --> 00:02:05,330
So why doesn't everyone do it?

42
00:02:05,330 --> 00:02:07,380
Well first off, it's not that easy.

43
00:02:07,380 --> 00:02:09,240
There are different types of equity.

44
00:02:09,240 --> 00:02:13,150
Stock that a company issues to its
founders is different from stock issued to

45
00:02:13,150 --> 00:02:14,430
private investors.

46
00:02:14,430 --> 00:02:18,160
Which is completely different from what is
issued to the general public.

47
00:02:18,160 --> 00:02:20,930
Before we can talk about the different
types of stock though,

48
00:02:20,930 --> 00:02:24,180
let's take a look at what we mean when we
say stock.

49
00:02:24,180 --> 00:02:27,510
Now, the terms used may vary depending on
where you are,

50
00:02:27,510 --> 00:02:29,690
but the concept is the same.

51
00:02:29,690 --> 00:02:33,230
I'm going to use terminology that you
would use here in the United States.

52
00:02:33,230 --> 00:02:35,420
If you're in another country, don't worry.

53
00:02:35,420 --> 00:02:38,230
You should still keep watching to
understand how equity works.

54
00:02:39,310 --> 00:02:42,490
The equity of a corporation is called
stock.

55
00:02:42,490 --> 00:02:45,710
Companies can issue and sell stock to
investors in exchange for

56
00:02:45,710 --> 00:02:50,020
money, which as we just discussed is
equity financing.

57
00:02:50,020 --> 00:02:55,310
Once an investor purchases company stock,
he or she is an owner of the company.

58
00:02:55,310 --> 00:02:58,080
Now, stock ownership is considered
perpetual.

59
00:02:58,080 --> 00:03:00,840
This means that a stock has no maturity
date.

60
00:03:00,840 --> 00:03:04,000
You can hold onto that stock and remain an
owner until you sell it

61
00:03:04,000 --> 00:03:06,850
off to someone else or the company buys it
back from you.

62
00:03:07,990 --> 00:03:09,760
So where does stock come from?

63
00:03:09,760 --> 00:03:11,960
How many units of a company's stock are
out there?

64
00:03:13,090 --> 00:03:15,790
When a company files its incorporation
documents,

65
00:03:15,790 --> 00:03:18,980
it usually has to write down the number of
shares it wants to authorize.

66
00:03:20,280 --> 00:03:24,750
Authorized stock is the total amount of a
stock that a company possesses.

67
00:03:24,750 --> 00:03:27,457
Well, let's say I incorporated my company
and

68
00:03:27,457 --> 00:03:31,140
authorized ten million units of stock or
shares.

69
00:03:31,140 --> 00:03:35,940
Knowing the amount of stock allows you to
establish a baseline when raising equity.

70
00:03:35,940 --> 00:03:37,650
If you didn't have a pool of shares and

71
00:03:37,650 --> 00:03:42,370
randomly decided to issue 10,000 shares to
an investor, what does that mean?

72
00:03:42,370 --> 00:03:44,720
Do they now own 10% or just 1%?

73
00:03:44,720 --> 00:03:47,740
By knowing that the total pool is ten
million,

74
00:03:47,740 --> 00:03:52,100
we know that issuing 10,000 shares means
giving away less than 1%.

75
00:03:52,100 --> 00:03:55,860
Some of this initial authorized stock is
issued to founders,

76
00:03:55,860 --> 00:03:58,270
who pay a par value for it.

77
00:03:58,270 --> 00:04:01,600
Par value is a nominal value that you
arbitrarily assign to

78
00:04:01,600 --> 00:04:03,790
the share when authorizing it.

79
00:04:03,790 --> 00:04:05,980
You usually assign a low par value so

80
00:04:05,980 --> 00:04:09,800
that founders have to pay very little to
acquire their shares.

81
00:04:09,800 --> 00:04:15,325
At my company with ten million authorized
shares, if I issued myself

82
00:04:15,325 --> 00:04:21,270
four million founder shares, I could set
the par value to $0.001.

83
00:04:21,270 --> 00:04:24,701
This way I only pay 400 for my four
million shares.

84
00:04:25,760 --> 00:04:29,460
Do not confuse par values with market
values of a share.

85
00:04:29,460 --> 00:04:33,250
A par value is an arbitrarily assigned
nominal value.

86
00:04:33,250 --> 00:04:37,310
While the market value is established in
the market and changes over time,

87
00:04:37,310 --> 00:04:40,440
depending on the valuation of the company,
investor sentiment and

88
00:04:40,440 --> 00:04:41,310
a lot of other things.

89
00:04:42,420 --> 00:04:47,000
The portion of shares that you give to
other people is known as issued stock.

90
00:04:47,000 --> 00:04:51,080
Issued stock is the amount of authorized
stock that is currently in, or

91
00:04:51,080 --> 00:04:54,350
has been in the hands of founders or
investors.

92
00:04:54,350 --> 00:04:56,750
Once issued, stock is always issued,

93
00:04:56,750 --> 00:04:59,990
regardless of whether the company has
repurchased it.

94
00:04:59,990 --> 00:05:01,950
That leaves, outstanding stock.

95
00:05:01,950 --> 00:05:05,640
Shares that are currently owned, either by
founders or by investors.

96
00:05:06,680 --> 00:05:09,570
Let's use those terms in another example.

97
00:05:09,570 --> 00:05:14,010
At my company, I authorize ten million
shares at a par value of $0.001.

98
00:05:14,010 --> 00:05:19,340
I want to maintain majority control of the
company down the road, so

99
00:05:19,340 --> 00:05:23,350
I issue myself 50% of the shares, or five
million.

100
00:05:23,350 --> 00:05:29,740
To get those five million, I pay five
million times 0.001, or $5,000.

101
00:05:29,740 --> 00:05:33,680
While five million is half of the
authorized stock,

102
00:05:33,680 --> 00:05:36,040
it is 100% of issued stock.

103
00:05:36,040 --> 00:05:38,890
Which means, currently, I have complete
control.

104
00:05:38,890 --> 00:05:40,805
So we have ten million authorized stock,

105
00:05:40,805 --> 00:05:44,510
five million issued, and five million
outstanding, as well.

106
00:05:45,752 --> 00:05:49,690
It is now two years later, and I want to
raise $1 million to expand the company.

107
00:05:49,690 --> 00:05:53,960
The market value of the company stock is
around a dollar,

108
00:05:53,960 --> 00:05:59,080
which means that to raise $1 million, I
need to issue a further million shares.

109
00:05:59,080 --> 00:06:01,590
So, as always, our authorized stock rule
remains the same.

110
00:06:01,590 --> 00:06:03,370
There's ten million shares.

111
00:06:03,370 --> 00:06:07,350
Our issued, as well as our outstanding, go
up from five million to six million.

112
00:06:08,390 --> 00:06:12,954
Earlier I owned five million of the total
five million outstanding stock,

113
00:06:12,954 --> 00:06:15,750
which was 100% ownership.

114
00:06:15,750 --> 00:06:21,534
Now I own five million of a total of six
million outstanding stock, which is 83%.

115
00:06:22,640 --> 00:06:24,980
This highlights an important point.

116
00:06:24,980 --> 00:06:28,670
As more stock is issued to investors
through equity funding rounds,

117
00:06:28,670 --> 00:06:32,288
the founders' percentage of ownership is
diluted or decreased.

118
00:06:32,288 --> 00:06:37,730
From the investors' point of view, they
own 10% of the authorized shares and

119
00:06:37,730 --> 00:06:41,640
16.6% of the issued and outstanding
shares.

120
00:06:41,640 --> 00:06:44,770
Now that you have a good understanding of
the life of a stock,

121
00:06:44,770 --> 00:06:46,840
let's talk about some of the different
types of stocks.

122
00:06:48,240 --> 00:06:52,090
When people talk about stocks, whether
it's about privately held stock or stock

123
00:06:52,090 --> 00:06:57,770
in the financial markets, the most common
terms used are common and preferred stock.

124
00:06:57,770 --> 00:07:01,520
What do they mean though and do they apply
to all companies?

125
00:07:01,520 --> 00:07:05,050
When we talk about common and preferred
stock, we are referring to

126
00:07:05,050 --> 00:07:09,200
ownership structures and corporations in
the United States specifically.

127
00:07:09,200 --> 00:07:12,730
While the terminology may differ, common
stock in the U.S.

128
00:07:12,730 --> 00:07:16,610
or ordinary shares in the UK, the
underlying concepts are similar.

129
00:07:17,650 --> 00:07:19,470
Common stock is voting stock, and

130
00:07:19,470 --> 00:07:24,030
is issued to founders when the company
incorporates, to officers, directors, and

131
00:07:24,030 --> 00:07:27,640
consultants as incentives, and as stock
options.

132
00:07:27,640 --> 00:07:31,760
When the company goes public, common stock
is what is offered to the public as well.

133
00:07:32,780 --> 00:07:35,620
Holders of the common stock are typically
entitled to

134
00:07:35,620 --> 00:07:40,310
one vote per share on all matters that are
voted on by shareholders.

135
00:07:40,310 --> 00:07:43,200
Common stockholders are also entitled to a
share of

136
00:07:43,200 --> 00:07:46,130
the profits if the company decides to hand
some of it out.

137
00:07:47,530 --> 00:07:49,540
Then you have preferred stock.

138
00:07:49,540 --> 00:07:52,690
Preferred stock can be customized and
offers more rights and

139
00:07:52,690 --> 00:07:55,100
privileges than common stock.

140
00:07:55,100 --> 00:07:58,570
Preferred stockholders get to be at the
front of the line amongst equity

141
00:07:58,570 --> 00:08:02,960
holders when it comes to profit sharing
and that's why investors love it.

142
00:08:02,960 --> 00:08:06,640
With preferred stock, you can have all
sorts of rights, preferences, and

143
00:08:06,640 --> 00:08:10,540
privileges that allow investors
preferential treatment.

144
00:08:10,540 --> 00:08:14,000
In exchange for this treatment, they give
up their voting rights, however.

145
00:08:14,000 --> 00:08:15,350
So, they don't get everything they want.

146
00:08:16,465 --> 00:08:19,460
You're probably wondering why all this is
necessary.

147
00:08:19,460 --> 00:08:21,730
Well, now that you know how the moving
parts work,

148
00:08:21,730 --> 00:08:25,420
we can talk about how equity financing
works in a nutshell.

149
00:08:25,420 --> 00:08:29,440
When you raise an equity round, you're
essentially getting money in exchange for

150
00:08:29,440 --> 00:08:31,330
ownership in the company.

151
00:08:31,330 --> 00:08:35,020
You don't have to pay this money back, so
it seems like free money, but

152
00:08:35,020 --> 00:08:37,420
there are other consequences.

153
00:08:37,420 --> 00:08:41,110
Depending on how much money you raise and
how much of the company you exchange for

154
00:08:41,110 --> 00:08:45,650
it, you will be handing over a portion of
control through your preferred stock.

155
00:08:45,650 --> 00:08:50,430
So you may now have to run big decisions
by other people before you can execute.

156
00:08:50,430 --> 00:08:53,810
These investors may also dictate a minimum
rate of return.

157
00:08:53,810 --> 00:08:56,610
They want to see the money they gave put
to work.

158
00:08:56,610 --> 00:08:59,490
Which means you may have to take some
revenue generating actions that

159
00:08:59,490 --> 00:09:00,350
you weren't happy with.

160
00:09:01,600 --> 00:09:05,380
So how do you know whether you should take
on debt or raise an equity round?

161
00:09:05,380 --> 00:09:06,650
Let's go on to the next video.