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L42 Founder Warrant

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George Morgan
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Page no: L42
Question / Problem
Solution
2.

Explain the basic mechanics of a capital increase. Write a couple of paragraphs explaining working capital, where shares are coming from, dilution and preferred vs. common stock. (2 hours)

 A capital increase is one form of equity increase.
When you or another shareholder invests cash in your corporation, you will issue additional shares.
This will reduce the value of the existing shares.
Example:
Existing situation 100’000 CHF working capital with 10’000 shares at (nominal value) 10 CHF.Liquidity Event: Ordinary Capital increase of 200’000 CHF; for example because an investor wants to provide funds.In an capital increase , the company will issue new shares.
The price and quantity of the shares depends on which stake the investor wants to obtain in the company. Let’s imagine 10%.
If the investor obtains 2000 new shares, then the original shareholder(s) should possess 18000 shares, 9 times more.
Hence they obtain 8000 new shares.
Share price after capital increase: 15 CHFDilution:
If there is another capital increase with the emission of new shares, then the value of the 2000 shares of the first investor might change/fall. Investors often provide clauses to protect them from such dilution.Common stock: They have voting rights.
Preferred stocks: Owners of preferred stocks obtain their “preferred dividends” before common stock holders and are often also preferred vs. common stock holders (but not versus bond holders) when the company files for bankruptcy.
Call Option
  

An call option is a contract giving the buyer the right, but not the obligation, to buy the underlying asset at a specific price on or before a certain date.
Underlying: In the case of a company (e.g. a startup), the underlying are the shares of the company.
Moreover the option must specify the quantity of shares that the option buyer will obtain when he executes the call option and when this event occurs.

Quantity:
There are some possibilities:
1) Either as a number of shares at a pre-determined price for the share (the strike price).
2) or as a percentage of the total owners’ equity
Event:
For traded options the buyer can freely exercise the option in several ways.

European Style Options: can be exercised only at expiration.

American Style Options: can be exercised at any time prior to expiration.

Options can be exercised also in other, free definable ways. More below under the FI warrant.
4.

Watch the following short video: https://fndri.com/2QIpwdB. Next, read and understand the FI warrant. Write a few paragraphs explaining how and when the warrant can be executed, the basic mechanics of such execution, and how executing the warrant results in cash. (2 hours)

 Please see previous question:
Warrant = Option to buy shares from my company at a predetermined price (the strike price).
Event:  when my company receives its first equity investment of $100’000 or more.
The investors will set the price of the shares including the shares that go to the Founders’ Institute.Using the example from above:
Ordinary Capital increase of 200’000 CHF thanks to a new investor. The new investor wants 10% stake in the company. Instead of 90%, the original shareholders will only obtain 86% of the shares and 4% of the shares go to the Founders’ Institute.Hence new investors: 2000 shares
Old investors: total 18000 shares (90%) – 800 (4%) = 17200 shares (86%)
Founders’ Institute = 800 shares (4%). Important to state the FI does not need to buy the shares at this moment, but it only about setting the strike price.Strike price: 300’000 CHF / 20’000 shares = 15 CHF per shareThe Founders Institute usually waits until a later stage, e.g. when the company goes public or finds more investors or when selling the company. Then FI executes the warrant / call option at the strike price.
There is usually a difference between the share price at the moment of execution and the strike price.
This difference results in cash/proceeds that are distributed the FI bonus pool, i.e. to mentors, local directors, to the fgraduates (distributed equally) and to the FI headquarters. Therefore anybody in the FI network has a financial interest that the startups are successful and they are ready to support the new founders.
Equity Pool

 

The Shared Liquidity Pool, or Bonus Pool, works in the following way.

1. Graduates contribute 3.5% (2010) of their company in the form of Warrants or Options to the Founder Institute.

2. The Founder Institute contractually allocates the financial returns that comes in from this ownership to four groups:

2.1. 30% goes to the Founders equally, so if there are 15 Founders with 15 companies, each would receive 2%.
2.2. 30% goes to the Mentors based on the number of sessions that they lead and their rating for help by the Founders.
2.3. 25% goes to the team of local Directors that runs the chapter.
2.4. 15% goes to the Founder Institute as a long-term management fee.
Answer to Epic Sprint about the warrant and company creation

#2 (Epic Sprint)

Post the work from your Epic Sprint here, including accessible links to any documents. It is very important to complete the Epic Sprint on time and to produce the highest quality work possible. Follow the exact instructions provided to the best of your ability. Any Founder with partially incomplete or poor work on the Epic Sprint will be invited to re-enroll. (20+ Hours)

 Answers Epic Sprint Equity Warrant PDF

 

Link to Epic Sprint on Company Creation and Founders Warrant

 

 

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