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tag: Research
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# Raise Blog Key Insights

## Understanding Shares in a Startup

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Shares are held by a stakeholder. A stakeholder is someone that owns a financial stake in the company that issued the shares.

Shares have two major ingredients in common:

- **Dilution:** shares are quantifiable — they increase and decrease based on specific calculations.
- **Rights:** all owners of shares will usually be able to participate in the company — through voting and attending important meetings.

### Dilution

As your startup grows and issues shares, existing stakeholders are diluted: their percentage ownership in the company decreases as time goes on.

It’s important always to understand share calculations and mechanics (there are some simple ones to know, we promise). If you don’t, you’re at risk of being diluted without knowing it.

### Rights

Shares are divided into classes. There are two common types of shares: (1) common; and (2) preferred. Those classes can also be divided into series (e.g. Series A, B and C preferred shares).

**Common shares** [...] form the foundation on which we add ingredients like rights, preferential calculations and convertibles. They’re what you’ll issue when you first incorporate the company — and are usually held by founders. These are the most important kinds of shares for the company, as they’ll determine the share price and value of the company. They come with some basic rights like voting and participating in meetings. Think of common shares as your company’s foundational share class.

**Preferred shares** [...] give special (or preferred) rights to investors. These are much more complicated types of shares that come with a lot of complex mechanics, rights and voting powers. *It’s always important to consult legal professionals whenever you’re creating or selling preferred shares.*

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## Understanding Employee Stock Options

Employee stock options are a great way of attracting and retaining talent for startups whose budgets are not yet big enough to support a full grown team.

#### Why?

In the venture capital space, startups with option pools are considered safer bets, because they will be able to attract and retain, talent. For this reason, you will be asked by most VC funds to show your company’s option pool.

#### What?

Employee stock options are a special kind of shares offered to employees and consultants. They are useful because they distribute ownership across the founders, investors, employees and contractors with one common goal. It encourages everyone to stay with the company longer and grow everything — the product, customer base and revenue.

#### How?

There aren’t clear rules and regulations for how employee stock options can work for private companies across the continent. In Kenya, for example, there is a pretty clear regime for how to create and maintain employee stock options for public companies listed on the Nairobi Stock Exchange. There is no transparent process for private companies (not listed on NSE).

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## Pre vs Post-Money SAFEs

A Simple Agreement for Future Equity (SAFE), is an agreement between an investor and you (the founder) to get money now in exchange for the promise that the investor will receive equity in your company at an undefined future date when your company raises a priced round (e.g. Series A).

> *Investors agree to make a cash payment to a company in exchange for a contractual right to convert that amount into shares when they raise equity round.*
>

A SAFE is neither debt nor equity, and there is no interest accruing or maturity date. They are simple, standardised documents, easy to use, fair for all parties, and have little to zero in transaction costs for you and your investors.

**Why raise using SAFEs?** For an early-stage startup, it's hard to accurately value your company because you might have minimal data points. That’s where a SAFE can be used as a form of financing.

> *With SAFEs, you can postpone your startup’s valuation until you have a good MVP(Minimum Viable Product).*
>

#### Pre-Money SAFEs

The Pre-Money SAFE is standardized on a pre-money valuation. The investors receive pro-rata rights (right for the SAFE investor to purchase more shares in the company if the company raises a subsequent round of financing). The advantage of this SAFE is it favours the companies because you can delay the valuation of your company.

More startups have been issuing Pre-Money SAFE and convertible rounds, this has made it difficult to keep track of both founders and investors’ relative ownership stakes as the companies keep adding investors in subsequent rounds.

#### Post-Money SAFEs

Post-Money SAFE round can be treated as a seed round, and the valuation cap is post-money, both startups and investors have clarity of ownership and future dilution. They also removed the pro-rata rights that existed in the original SAFE, unless the company approves to grant this to the investor. A significant disadvantage here is that the Post-Money SAFEs investors will not participate in any dilution of subsequent financing rounds until the Post-Money SAFE converts at a priced equity round. Post-Money SAFE investors are getting a better deal than Pre-Money SAFE holders on the cap table. The tradeoff is the increased clarity of ownership and future dilution (to incentivize more investor confidence, and thus more capital invested).

#### TLDR

Pre-Money SAFE is typically the better option for small, initial financing rounds. With Post-Money SAFE, you can accurately track ownership and dilution changes during that fundraising round and in future rounds. You can also negotiate pro-rata rights. Post-Money SAFE is often the SAFE of choice for companies that are confident their next round of fundraising will be equity round.

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## Raising Capital with Convertible Notes

You can’t sell shares without giving them a price, and you can’t set a price per share without a valuation for the company. You’ll usually set a price for those shares in your seed round, but to get to a seed round financing, you need tons of traction, the next best product and a great team.

> Convertible notes are an easy way for your startup to raise capital without having to create value for the shares.

Convertible notes (SAFEs/Debt) will magically "convert" into equity (shares) the next time your company raises funds. So, you’re issuing shares to both the convertible holders and the new investors of the round. However, founders need to be careful as there’s a high chance that you will have sold a much bigger percentage of your company than you thought.

#### Terms

The terms of a convertible note are used to determine something simple: the percentage ownership that the convertible-holding investor will get when the notes are triggered and turn into shares. Terms are usually buried in deep legal jargon and mathematical calculations. Be careful.

#### Triggers

Convertible notes are *triggered* — and turn into shares with equal percentage ownership in your company. It’s simple — on the day the trigger happens — the $300,000 you issued in SAFEs will become 20% of the company.

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## Building Strong Corporate Governance

Founders build an idea into a company. They grow that company with a community of stakeholders. Stakeholders hold a financial stake in the company.

Naturally, as the company grows in financial value, stakeholders will insist on creating rules and processes to protect their financial stake (written out and detailed throughout various agreements, contracts, policies, and resolutions). These are rules that set roles for the board of directors, relationships between shareholders and vesting schedules for the teams.

> This collection of rules and processes are what we call corporate governance. Their goal is simple: to maintain a transparent company that balances the financial interests of stakeholders’ share ownership.
>
***Strong corporate governance is fundamental to raising money.*** New investors will often require certain updates to your corporate structure. In order to do so, you will go through a due diligence process. This means looking closely at your corporate governance since day one of the company’s incorporation to understand the legal and financial health of your company.

Practice strong corporate governance now to become a more investable company.

#### Tips

Here are healthy practices you can start now:

- Review your share register (or capitalization “cap” table) to be sure it is compliant with local laws;
- Create an organizational chart for your existing company and stakeholders (build one in Google Docs here);
- Build a balanced relationship between board members who all have clear roles and terms;
- Create and sign company resolutions for important decisions like new investments or filing with your corporate registry;
- Use accounting software like Quickbooks or Accounteer to maintain clear financial records for any audits.

To make sure you’re on the right track, ***start with looking at your company’s by-laws (otherwise known as memorandum or articles of association).*** If you can’t find one, ask your corporate secretary (in countries like Kenya, Ghana, Mauritius, and Nigeria, your corporate secretary is responsible for maintaining your corporate governance and records).

***Corporate governance is about transparency.*** The stronger the corporate governance, the more ready you are for growth.

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