Financial Concepts for Young Tech CEOs

What I would have loved to have. Ps: This is just a dump. So it’s heavily unfiltered and all over the place. Forgive me. 🙏

EBITDA: Earnings before Interest, taxes, depreciation, and amortization.

How a company generates earnings from its primary businesses without the influence of how the company is financed. The focus is on the core operating profitability of the business.

• An asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit.

Current assets are short-term economic resources that are expected to be converted into cash or consumed within one year.

When looking at an asset definition, you’ll typically find that it is something that provides a current, future, or potential economic benefit for an individual or company

• An intangible asset is an asset that is not physical in nature, such as a patent, brand, trademark, or copyright.

A brand is an intangible asset because due to it, one can command customer loyalty, command premium prices and attract new customers.

When one company purchases another, the intangible assets associated with that transaction are considered goodwill. When a company acquires another business, any amount that exceeds the fair value of the target’s net assets represents its goodwill. If the amount is above the target’s book value, then it results in positive goodwill. Anything below book value is negative goodwill or badwill.

Importance of Goodwill:

1. Reflects Intangible Value: Goodwill captures the value of intangible assets that contribute to a company’s future earning potential.
2. Investment Justification: Positive goodwill justifies paying a premium for strategic advantages such as market position, brand strength, and synergies.
3. Financial Health Indicator: Negative goodwill may highlight underlying issues within the target company but can also present opportunities for turnaround and value creation.
4. The formula for calculating goodwill is:
5. Goodwill=Purchase Price−Fair Value of Net AssetsGoodwill=Purchase Price−Fair Value of Net Assets

Positive Goodwill:

• When it Occurs: Positive goodwill arises when the purchase price exceeds the fair value of the target’s net assets.
• Implications: It indicates that the acquiring company values the target’s intangible assets, such as brand reputation, customer relationships, intellectual property, and employee expertise, beyond the identifiable net assets.
• Example:
• Purchase Price: $10 million
• Fair Value of Net Assets: $8 million
• Goodwill: $2 million ($10 million — $8 million)

Negative Goodwill (Badwill):

• When it Occurs: Negative goodwill occurs when the purchase price is less than the fair value of the target’s net assets.
• Implications: This situation may indicate that the target company is undervalued due to financial distress, poor management, or other adverse conditions. The acquiring company may be getting a bargain purchase.
• Example:
• Purchase Price: $7 million
• Fair Value of Net Assets: $8 million
• Negative Goodwill: $1 million ($7 million — $8 million)

All the expenses of creating intangible assets are expensed. But intangible assets created by a company do not appear on the balance sheet and have no recorded book value. Because of this, when a company is purchased, often the purchase price is above the book value of assets on the balance sheet. The purchasing company records the premium paid as an intangible asset on its balance sheet.

Fixed assets are not easily liquidated. As a result, unlike current assets, fixed assets undergo depreciation.

Fixed assets are resources with an expected life of greater than a year, such as plants, equipment, and buildings.

While an asset is something with economic value that’s owned or controlled by a person or company, a liability is something that is owed by a person or company. A liability could be a loan, taxes payable, or accounts payable.

Amortization is an accounting technique used to periodically lower the book value of a loan or an intangible asset over a set period of time. Concerning a loan, amortization focuses on spreading out loan payments over time. When applied to an asset, amortization is similar to depreciation.

Accountants use amortization to spread out the costs of an asset over the useful lifetime of that asset.

Amortization vs. Depreciation

Amortization and depreciation are similar concepts, in that both attempt to capture the cost of holding an asset over time. The main difference between them, however, is that amortization refers to intangible assets, whereas depreciation refers to tangible assets.

Amortization is typically expensed on a straight-line basis. That means that the same amount is expensed in each period over the asset’s useful life

Depreciation

Depreciation is the expensing of a fixed asset over its useful life. Fixed assets are tangible objects acquired by a business. Some examples of fixed or tangible assets that are commonly depreciated include buildings, equipment, office furniture, vehicles, and machinery.4

Internal Revenue Service. “Publication 946, How To Depreciate Property.” Pages 3–4.

Unlike intangible assets, tangible assets may have some value when the business no longer has a use for them. For this reason, depreciation is calculated by subtracting the asset’s salvage value or resale value from its original cost.

Depreciation of some fixed assets can be done on an accelerated basis, meaning that a larger portion of the asset’s value is expensed in the early years of the asset’s life. Vehicles are typically depreciated on an accelerated basis. Salvage Value (also known as Residual Value or Scrap Value) is the estimated amount that an asset is expected to be worth at the end of its useful life. It represents the value that the company expects to recover from the sale of the asset after it has fully depreciated.

DEPRECATION METHODS

By definition, depreciation is only applicable to physical, tangible assets subject to having their costs allocated over their useful lives. Alternatively, amortization is only applicable to intangible assets.

The term depreciate means to diminish in value over time, while the term amortize means to gradually write off a cost over a period. Depreciation is recorded to reflect that an asset is no longer worth the previous carrying cost reflected on the financial statements.

Amortization, on the other hand, is recorded to allocate costs over a specific period. Both methods appear very similar but are philosophically different. Almost all intangible assets are amortized over their useful life using the straight-line method. This means the same amount of amortization expense is recognized each year. On the other hand, there are several depreciation methods a company can choose from.

Taxable income is the portion of your gross income used to calculate how much tax you owe in a given tax year.

Tax deductions are expenses or allowances that reduce a taxpayer’s taxable income, thereby lowering the amount of income subject to taxation. They can include various expenses such as mortgage interest, medical expenses, charitable contributions, and certain business expenses, either through itemized deductions or the standard deduction.

What Is Tax Liability?

Tax liability is the payment owed by an individual, business, or other entity to a federal, state, or local tax authority.

Generally, you have a tax liability when you earn income or generate profits by selling an investment or other asset. It is possible to have no income tax liability if you don’t meet the income requirements to file taxes.

When you sell an investment, real estate, or any other asset for a gain, you owe taxes on the gain. If you sell it for a loss, you can report it as a capital loss. Capital gains are taxed in two different ways: long-term capital gain and short-term capital gain. If you’ve held an asset for one year or less and sold it for a gain, it is a short-term capital gain included in your income.

Always be on the lookout for tax deductions, which can decrease your taxable income.

What Is Cash Flow?

Cash flow is the net cash and cash equivalents transferred in and out of a company. Cash received represents inflows, while money spent represents outflows. A company creates value for shareholders through its ability to generate positive cash flows and maximize long-term free cash flow (FCF). This is the cash from normal business operations after subtracting any money spent on capital expenditures (CapEx).

What Is a Balance Sheet?

The term balance sheet refers to a financial statement that reports a company’s assets, liabilities, and shareholder equity at a specific point in time. Balance sheets provide the basis for computing rates of return for investors and evaluating a company’s capital structure.

The balance sheet adheres to the following accounting equation, with assets on one side, and liabilities plus shareholder equity on the other, balance out:

Assets=Liabilities+Shareholders’ Equity

This formula is intuitive. That’s because a company has to pay for all the things it owns (assets) by either borrowing money (taking on liabilities) or taking it from investors (issuing shareholder equity).

A balance sheet explains the financial position of a company at a specific point in time. As opposed to an income statement which reports financial information over a period of time, a balance sheet is used to determine the health of a company on a specific day.

What Is a Hostile Takeover?

A hostile takeover happens when an entity takes control of a company without the knowledge and against the wishes of the company’s management. A hostile takeover is an acquisition strategy requiring that the entity acquire and control more than 50% of the voting shares issued by the company. It is considered bad business etiquette.

Common shareholders typically have one vote per share, while owners of preferred shares often do not have any voting rights at all.

What Is a Tender Offer?

A tender offer is a bid to purchase some or all of the shareholders’ stock in a corporation. Tender offers are typically made publicly and invite shareholders to sell their shares for a specified price and within a particular window of time. The price offered is usually at a premium to the market price and is often contingent upon a minimum or a maximum number of shares sold.

What Is Preferred Stock?

The term “stock” refers to ownership or equity in a firm. There are two types of equity: common stock and preferred stock. Preferred stockholders have a higher claim to dividends or asset distribution than common stockholders. Higher asset distribution means in the event of company liquidation, owners have a higher claim to assets as compared to the common stock. The details of each preferred stock depend on the issue

• Preferred stockholders usually have no or limited voting rights in corporate governance.1
• In the event of a liquidation, preferred stockholders’ claim on assets is greater than common stockholders but less than bondholders.

What Is the Downside of Preferred Stock?

Though preferred stock often have greater rights and claims to dividends, this type of investment often does not appreciate in value as much as common stock. In addition, preferred stockholders have little to no say in the operations of the company, as they often forgo voting capabilities.

Common stock is not just a piece of paper — or, these days, a digital entry — but a ticket to ownership in a company. When you hold common stock, you get to weigh in on corporate decisions by voting for the board of directors and corporate policies.

Initial Public Offerings

For a company to issue stock, it initiates an initial public offering (IPO). An IPO is a major way for a company seeking additional capital to expand the enterprise. To begin the IPO process, a company works with an underwriting investment bank to determine the type and price of the stock. Once the IPO is complete, the stock becomes available for purchase by the general public on the secondary market.

How Do I Use Common Stock to Vote at Company Meetings?

Most ordinary common shares come with one vote per share, granting shareholders the right to vote on corporate actions, often conducted at company shareholder meeting. If you cannot attend, you can cast your vote by proxy, where a third party will vote on your behalf.

Why Is Common Stock Called an Equity?

Common stock represents a residual ownership stake in a company, the right to claim any other corporate assets after all other financial obligations have been met. A company maintains a balance sheet composed of assets and liabilities. Assets include what the company owns or is owed, such as its property, equipment, cash reserves, and accounts receivable. On the other side of the ledger are liabilities, which are what the company owes. These include payables, debts, and other obligations. If a company is healthy, the total assets will be larger than the total liabilities. The residual amount left to the owners is known as shareholders’ equity and is represented by a company’s shares.

Google’s Share Class Structure

The multi-class share structure at Google came about as a result of the company’s restructuring into Alphabet Inc. in October 2015 (NASDAQ: GOOG).1 Founders Sergey Brin and Larry Page found themselves owning less than majority ownership of the company’s stock, but wished to maintain control over major business decisions. The company created three share classes of the company’s stock as a result. Class-A shares are held by regular investors and carry one vote per share. Class-B shares, held primarily by Brin and Page, have 10 votes per share. Class-C shares are typically held by employees and have no voting rights. The structure gives most voting control to the founders, although similar setups have proven unpopular with average shareholders in the past.2

Advisor shares typically vest monthly over a 1–2 year period on a schedule with no cliff and 100% single-trigger acceleration.

Shares are units of stocks.

How Shares are Issued and Regulated

Generally, a company’s board of directors is given a specific number of shares that can be issued. These are called authorized shares. Issued shares are the number of shares sold to shareholders and counted for ownership purposes. So, a corporation might have 10 million authorized shares but only issue 8 million.

Types of Shares

As mentioned, any company can issue shares, but publicly traded companies are more likely to divide their stock into different types of shares.

A share of stock represents equity ownership in that company. When a firm’s board of directors decides to take their company public, usually through an initial public offering (IPO), they authorize the number of shares that will be initially offered. This amount of outstanding stock is commonly referred to as the “float.” If that company later issues additional stock (often called secondary offerings) they have increased the float and therefore diluted their stock: the shareholders who bought the original IPO now have a smaller ownership stake in the company than they did prior to the new shares being issued.

Example of Shares Outstanding vs. Floating Stock

Here’s a hypothetical example to show how these two metrics work. Let’s consider the shareholders’ equity of a fictional company called XYZ, Corp. The company’s financials report its total outstanding shares and floating stock shares along with the authorized shares as follows:

• 24 billion authorized shares
• 7.5 billion shares outstanding
• Seven billion floating shares

The seven billion floating shares are the shares considered for the free float, market capitalization index weightings. In the case of XYZ, it has a relatively small float adjustment. This means it’s a high-float stock. That’s because the vast majority of its shares are available to the general investing public.

What Is a Stock’s Float?

A float refers to the number of issued shares available for trading of a particular stock — that is, they are available to be bought and sold on financial exchanges and stock markets. It excludes closely held or insider shares: those owned by corporate management and employees, certain large or institutional investors who have controlling stakes or seats on the board of directors, or company-owned foundations.

Proxy statements are documents that the Securities and Exchange Commission requires companies to give to shareholders so they can weigh in on important company issues. Proxy statements offer shareholders information about changes on the board and other important decisions the board needs to make.

Types of Cheques

• Based on transferability and encashment:
• Crossed Cheque: This type of cheque has two parallel transverse lines drawn across its face, with or without the words “& Co.” or “Account Payee” between the lines. It cannot be cashed over the counter and must be deposited into a bank account. You may have observed cheques with two sloping parallel lines with the words ‘a/c payee’ written on the top left. That is a crossed cheque. The lines ensure that irrespective of who presents the cheque, the payment will only be made to the individual whose name is written on the cheque, in other words, the a/c payee along with his/her account number. These cheques are relatively safe because they can be encashed only at the drawee’s bank.
• Open Cheque (Uncrossed Cheque): This cheque does not have any crossing lines and can be cashed over the counter or deposited into a bank account. An open cheque is basically an uncrossed cheque. This cheque can be encashed at any bank, and the payment can be made to the person bearing the cheque. This cheque is transferable from the original payee (the original recipient of the payment) to another payee too. The issuer needs to put his signature on both the front and back of the cheque.
• Based on who can cash the cheque:
• Bearer Cheque: This type of cheque is payable to whoever holds it, making it easily transferable. It can be cashed over the counter at the bank.
• Order Cheque: This cheque is payable to a specific person or entity named on the cheque. It can be endorsed and transferred to another person.

Hierarchy of a Company

• Position: Shareholders technically sit above the board of directors in the hierarchy. This is because they are the owners of the company, and the board of directors is elected or appointed to represent their interests.
• Power: Shareholders exercise their power through voting rights, which allow them to elect board members, approve major corporate decisions, and even remove directors in some cases.
• Visibility: While shareholders hold ultimate authority, they are not typically involved in the day-to-day management of the company. Their influence is primarily exerted through the board of directors.

[Questions pending]

• HOw do board directors come into play? Should you have that at conception? What are their roles?
• Seed, seed rounds, valuation, down round, valuation being low, etc?
• Stock dividend?
• Cash cow?
• Economies of scale?
• Vertical Integration?
• Network effects?