Weighted Average Calculations
Basic Principle. In general, a weight is assigned to individual quantities to ensure an accurate average is calculated. As a simple, descriptive example of weighted average calculations, consider the different stock series below. Each has a different share value and associated number of shares that was issued:
Series A: $5/share (3 million shares)
Series B: $3/share (3 million shares)
Series C: $2/share (4 million shares)
Each value would be multiplied by its weight. The totals are then added together:
Series A (5 x 3) + Series B (3 x 3) + Series C (2 x 4) = Total Shares
$15 million + $9 million + $8 million = $32 million
Next, add together the number of occurrences (i.e., number of shares associated with each issuance):
Series A occurrences + Series B occurrences + Series C occurrences
3 million shares + 3 million shares + 4 million shares = 10 million shares
Finally divide the total value by the number of occurrences to obtain the weighting average factor (i.e. the adjusted conversion price):
Total Shares ÷ Occurrences = Adjusted Conversion Price
$32 million ÷ 10 million shares = $3.2/share
Venture Capital Specific. The following calculation is a formula from the National Venture Capital Association (NVCA). Here, to take into account preferred stock, the formula treats preferred stock as converted to common. In this manner you can come up with a “new conversion price” without actually issuing more preferred shares for the previous round.
CP2 = CP1 x (A+B) ÷ (A+C), where:
CP2 = New Series “A” Conversion Price
CP1 = Series “A” Conversion Price (prior to new Series being issued)
A = Amount of common stock (shares) outstanding (prior to new Series being issued)
B = Amount to be received by your company (as part of subsequent Series) divided by CP1
C = Shares issued in new transaction
Investor A wants to invest $300,000 for 30% of your company. You own 700,000 shares in your company. Therefore, Investor A would require you to issue another 300,000 shares for Series A (at a value of $1.00 each)..
Investor A’s share price: $300K ÷ 300K shares = $1/share
Your company’s pre-money valuation: $1/share x 700K shares = $700K
Your company’s post-money valuation: $300K + $700K = $1M
Investor B wants to invest $400,000 for 50% of your company. If you accept the offer, then your company’s overall valuation must be adjusted down to $800,000. With 1 million shares outstanding (yours + Investor A’s), another 1 million shares must be issued to Investor B (for the new investor to reach 50% ownership).
Investor B’s share price: $400K ÷ 1 million shares = $0.40/share
New value of Investor A’s total stock: 300K shares x $0.40 = $120,000
New ownership stake for Investor A: (300K shares ÷ 2 million) x 100 = 15%
Your new ownership stake: (700K shares ÷ 2 million) x 100 = 35%
If Investor B wants to make his/her investment by including the shares associated with anti-dilution protection, then use the following formula to obtain the weighted average conversion price. If Investor B does not include those “anti-dilution” protected shares, then you will need to make multiple adjustments (as if performing a full-ratchet anti-dilution calculation) and use a spreadsheet with an “iteration” function to automate the calculations.
CP2 = CP1 x (A+B) ÷ (A+C), where:
CP1 = $1/share
A = 1 million shares outstanding
B = $400,000 ÷ $1/share = 400K shares
C = 1 million shares (initial number to be issued)
CP2 = $1/share x (1 million shares + 400K shares) ÷ (1 million shares + 1 million shares)
CP2 = $0.70/share
Investor A’s conversion for Series A shares: 300K ÷ $0.70 = ~430K
Therefore Investor A’s 300,000 shares must be increased by ~130,000 shares to compensate for the new, lower value issue (Series B).
You can also calculate the number of new shares required for the anti-dilution by:
Number of New Shares = New Conversion Price ÷ Liquidation Preference
Liquidation Preference = Multiple (e.g. 2X or 3X) of Share Price for “Converted” Preferred Stock
Let your lawyers do the math and have them explain to you what percentage of the company you will own after each round of financing.
This document is an integral part of a Will-it-Fly?® DKTS module.
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