Company Shares or Equity:
For a proprietary/ one person company, you own everything. For a partnership, you may have one or more partners, and they can divide the investments in equal/unequal proportions. For registered companies, this differs regarding shares of a company. Assuming the total investment is divided into 100 parts, and you own ten parts of it, you have 10% equity in the Company.
We won’t go into the complexities of different types of shares and assume that every stakeholder/investor has the same type of basic shares. The shareholding means you own that % of company’s income and assets and you have the same % of voting rights for decision making. Look for more freelance tips in this area to understand complexity in shares.
You understood the share but how to decide the valuation of a Startup for the first time? Generally, for the first time; you have to decide the valuation based on your entity’s ‘Market Value.’ The amount someone is willing to pay for your company is its market value. So, based on similar company’s valuations and your unique selling points, you can come to a figure as the valuation of your company. Once the valuation is known, it is easy to divide it by 100 and decide the share price. At least one investor should agree with your valuation and willing to pay that amount for your Startup.
You won’t like to sell off the entire Startup (though you can!) and would like to take investors and partners for growing the Startup. In that case, the shares are going to help you to decide how much portion of your company you can sell and at what cost?
Investment is offering shares for money. So if your company is worth $100, if someone pays you $10, you will give 10% share of your company to this person.
The investor is not giving money to the owner; the investor is investing the money in the Startup and getting shares in return. In this process, the shareholding of the owner will go down / dilute on the total number of shares.
The growth factor is very important here and one the Startup starts growing, your diluted share % in the Startup will be of more value than the 100% ownership of a small Startup always struggling for cash flow.
Startup Investment Stages:
The initial stage is the idea stage, and with your innovative/brilliant idea, you may be the only one who believes that and all investment will also be your own. You are an unregistered firm, and you have entire responsibility of the profit/loss of your business entity. It also involves some cash borrowed from friends and relatives. At this stage, you may be doing only freelance work.
At the second stage, you may think of bringing in more people as co-founders. You need more hands, more skills, and more cash. The best way to get everything together is to get a business partner/co-founder within your business. Based on work, value addition, skills, and investment; you can decide the co-founder’s stake and can go up to 50% also.
Accelerator/ Angel Investor:
The accelerators can provide space (incubation centre), funding and guidance the investment may not be very high but is it for you to go to the next stage. With Each investment, you are going to dilute your ownership. Some advisors can give you a great advice and direction to your Startup to make a lot of difference than the cash they invest.
The Angel investors are known to consider your valuation much less than the market valuation to reduce their risk. They don’t provide working space, but they invest and guide only. They have their say in the Startup decisions.
Venture Capital Investments:
There are many VC funds available all over the World; you invest in a Startup, guide it and fund it to make it a big Company and they sell off their stake and move to the next Startup. They can invest large amounts, and they also expect a large chunk of your shares. They are investment experts, and you have to clear their interview rounds with solid data and convince them about the valuation of your Startup. From this stage, Startups become a big company, and they either require more funding or they decide to go Public, meaning they become a public limited (listed on a stock exchange) company.
Every time, with additional investments, the valuation of the company goes on increasing, and more shares get added. The value of the share also goes on increasing if the Startup is doing well and making profits.
Dilution of Equity:
As we have seen, dilution is lowering the owner’s shares and distributing shares to the investors instead of funding. The initial shares and their value remain same, but when additional investment is accepted, you have additional shares; meaning percentage of your shares related to the total shares of the Company has changed (reduced). The post-investment valuation is an important concept, and the investor’s percentage of equity depends on this valuation.
There are much more complexities to work with investors, and then you have a sign up a contract with them and conduct several meetings to finalise the deal. The freelance websites are best sources to know more details about this. Understand more complexities and discuss with your financial advisors and stakeholders/co-founders before you take further steps towards getting investment as in most cases, it is difficult to go back to earlier stages.
Let us understand that your Startups value is simply the value of each share multiplied by the number of shares. The valuation at the initial stage is not having a standard formula and it the value of the Startup, which someone is ready to pay. The investment happens in a business entity and not with a person. Dilution changes your percentage of shares but doesn’t change the number of shares. Company valuation is ultimately determined by what someone is willing to pay. Keeping the basic in mind is important apart from suggestions from your Chartered Accountant/ Lawyer while getting into the formal contract.