How is the % of equity given to an investor divided between partners?


2

When giving a percentage in equity to an investor, is the % taken equally from the existing members of a corporation (partners/shareholders)?

I'm asking this question, as I currently have the lowest % between four co-founders, and would like to bootstrap as much as possible.

If in a majority of vote, a investor is decided to be brought what measurements do I have to prevent reducing my ownership and involvement?

Co-Founder Investors Partnerships

asked Aug 28 '13 at 07:35
Blank
Daniel Johnson
11 points

2 Answers


1

The percentage held of the company depends on how many shares you have. If you have 100,000 shares and your other three co-founders have 900,000 shares then you own 10% of the company.

If an investor wants to put money into the company, the company has to create new shares that it sells to the investor, in return for the money. So maybe, the company will sell 1,000,000 shares to the investor in return for $500,000.

You still own 100,000 shares. The company now has 2,000,000 shares outstanding so your 100,000 shares are now 5% of the company, not 10%. Everyone is diluted proportionally by the fact you are dividing by 2M shares now, not 1M shares.

The only way to make sure you still own 10% is by buying new shares at the same price that the investor pays for them. Hypothetically, the company could issue you 100,000 extra shares 'for free'. This would count as taxable income for you, because that is the same as the company giving you a cash bonus that you used to pay for the shares.

answered Sep 12 '13 at 00:21
Blank
Kamal Hassan
1,285 points

1

It all depends on how you and the rest of the shareholders want to handle things. One thing to keep in mind (please do your research on this), is that a C corporation can have different classes of stock. By using different classes you can have an investor who owns 90% share of a company (entitled to 90% value of the company) but does not have any voting rights on the direction of the company. This is hard to find, because most seasoned investors know without good voting rights, they really cannot control or nurture their investment. But still smart to look at classes as they are useful for lower level investors (family, friends), and by not giving voting rights to future employees you bring on with stock options.

As for your initial question of how much an investor gets. Say you own 25% of the company, and I own 50% and another guy owns 25%. We assume the company is worth 100k. We want to raise another 100k through an investor (this actually can bring the company value to 200k, because the cash the investor brings to the table increases our value (could be more)).

So now the investor owns 50% of the company (worth 200k, his share is worth 100k). Now I own 25% (half) of the company. (25% x 200k = 50% of 100k).

The example above shows you that when an investor brings money to the table, the value of the company goes up and therefore your share % might go down, but your overall $$$$ value does not.

A couple side notes. As an investor I might put in 100k in your company that you valuate at 100k. You could assume based on the example above that the value would then be 200k, and i would get 50%. But as an investor if i know my money is what is going to make or break the company (critical to its success) then i might value my 100k investment as 900k worth of value for the company. My 100k might be what the company needs to get from beta to an actual profit producing company.

Because investors are smart. Few things you can do to protect yourself in these situations:

  1. Seperate your IP from the actual company. This sometimes involves creating two companies and leasing your IP back to the original company. Then raise investments in the original company only. This is an insurance policy for if an investor turns hostile and tries to bite your company. Your IP is protected.
  2. Get a good valuation for your company before you start. Pros who do this for a living exist, and will often find value in things you might take for granted. The higher your initial valuation is the better positioned you are for negotiating against investors. When doing a valuation I usually look at two numbers. Hard Value (what the company is worth if you were to fire sale it today), Soft Value (what the company is worth if operating at 80%). You always raise money based on the potential value of your company, but its important to realize the hard numbers in case the Shit hits the fan and you need to jump ship. That is when the knives and lawyers come out.
  3. Agreements, Agreements, Agreements. Dont cut corners when writing your agreements between partners, vendors, and investors. I know a few shark like investors who look for openings just to take advantage of startups.
  4. Raise as little as you need. Dont do the Silicicon valley dance and raise capital for what you really dont need. Raise as little capital as possible early on. THe earlier you raise capital, the more equity you are going to give away. Think about every spending decision. Does your company really need to lease office space? Or can you and a bunch of dudes just lease a cheaper apartment and setup 5 ikea desks to get to work. A lot of cost cutting in the onset can save you tons of equity if you are the next Google.
  5. Dont kiss investor ass. Dont be a dick either. THe main objective is to be honest and firm. If you beleive in your vision / product / team / and the market for what you are building, you will find people with capital who are just as excited about your company.
  6. Seek investors not just for their cash, but also for connections (to other investors) and knowledge. The best investors are those who have already been successful in similar ventures to yours. These guys sometimes call themselves angels (although these days Angels are really the lowest form of bottom feeders and opportunists and really few "Angels" exist). If you network you can find other entrepenuers who are successful, have a few extra bucks and want to put some of their eggs in your basket. These guys give you so much in valuable guidance and connections that their cash value is often overshadowed by the real value they bring to the table. In my opinion these are really the only type of investors you need, and beyond that you bootsrap until you can get traditional Bank financing.
  7. Invest your own capital first. Dont be a cheap ass and get others to buy your company before you are all in yourself. When I have been an investor, i always make sure that those I am giving money to are all in. Their survival instinct kicks in stronger if they have everything on the line. If i find out someone is using my capital as a hedge to protect themselves from loss, its usually a good sing that they dont really think their idea is a winner and nor should I. Also investing your own capital first, goes back to borrowing less from investors and not giving up capital. Last point on this. In a small team of guys building something, you can use your own capital to buy %% shares of your company, thus raising your equity.
answered Aug 28 '13 at 10:33
Blank
Frank
2,079 points

Your Answer

  • Bold
  • Italic
  • • Bullets
  • 1. Numbers
  • Quote
Not the answer you're looking for? Ask your own question or browse other questions in these topics:

Co-Founder Investors Partnerships