contracts, project-management, managementI think an answer to the following simplified question should help me. If you would like to help me with my more specific scenario, then you can read the detailed question at the end. Thanks.
–
Simplified version:
If Person-A is the sole owner of a limited liability private company. Then one day he gets an investor, Person-B, and sells him 20% of the company for his investment. Then, later, Person-A agrees to sell a further 10% of the company to another investor, Person-C…
Do both Person-A and Person-B proportionally share a loss of their shares when Person-C gets their shares, or are Person-B’s shares fixed and secured to him, and therefore only Person-A bears the affects of the transfer to Person-C?
I hope that is clear and succinct enough. Thank you.
–
My specific scenario question is:
I have recently begun a new startup. It is basically just me and a friend as partners. But we both acknowledge that I should be entitled to a larger portion of the company, so we have agreed to an 80-20 split. His 20% is broken up as: 5% for being a co-founder; another 5% as reward for his ongoing role as an advisor; and 10% which he has bought.
The company is officially only in my name alone. When it comes time to give my partner his share of the profits, the accountant will officially incorporate him then to give him his share. (This is for a tax benefit to all, which we both agreed to.)
We are trying to understand though… If we sell a share of the company to an investor, then do I solely bear the ‘loss’ of shares, or do we share it proportionally. And if proportionally, then does the friend ‘suffer his loss’ from all his 20% or just 5%, 10%, or 15%?
Thanks!
Myer
.
If we sell a share of the company to an investor, then do I solely bear the ‘loss’ of shares, or do we share it proportionally. And if proportionally, then does the friend ‘suffer his loss’ from all his 20% or just 5%, 10%, or 15%?
I have considered two cases, first investor invests in the company and second investor buys share from existing owners.
Whenever you have new investor on board, equity of existing owners will dilute (I would not use word loss for reasons below)
First of all, before the deal with new investor you need to know (or just assume some figures) for :
From above 3 values you can easily calculate, ownership after new investor joins in.
In you case:
You = 80 %
Friend = 20 % (details do not matter)
If you think your company is worth $1 million and new investor is willing to invest $1 million more money (lucky you !) then:
Pre-Money valuation = $1 million
Post-Money valuation = $2 million
(with new investor's share = 50 %)
So now your ownership is said to be diluted by 50 %
New pattern is
You = 80 % * 50 % = 40 %
Friend = 20 % * 50 % = 10 %
New investor = 50 %
You can also think this as new investor asking for 50% share in the company and paying $1 million for it. In any case this is transaction between company and new investor.
Other possibility is that one of you “selling” your share to the new investor. In that case, it is personal decision and simple to calculate. Support you decide sell 20 % and your friends 10 %. From current pre-money valuation $1 Million, deal will be for 200,000 and 100,000 respectively).
New pattern
You = 80 % - 20 % = 60 %
Friend = 20 % - 10 % = 10 %
New investor = 30 %
But in above case, company’s valuation has not changed, because money changed hands of private investors. This is more of partial exit for you and your friend.
Hope now you know the difference between: loss, exit and dilution.
For more details, see : http://techcrunch.com/2011/10/13/understanding-how-dilution-affects-you-at-a-startup/
If you have 80% and your mate has 20% then there are no more shares left. 100% of the company is sold.
If someone comes in and wants to buy an additional 10%, then its up to either of you to decide who sells a piece from their holding. Thus, your mate might decide to sell half his holding, reducing his ownership from 20% to 10%. This also means he would profit, not the company, from the sale.
What you need do is talk to an accountant. You have forgotten there are three entities, not two. There is 1) you, 2) your mate, and 3) the company.
You two could decide to dilute your ownership - thus, bring your 80% down to 40%, and your friends from 20% to 10%. This means that the company has two shareholders, and combined, they hold 50% of the company (your 40%, your mates 10%). This therefore implies the company still has 50% of shares to sell.
It halves the number of shares you own, but that does not imply that you have halved your investment. The value of the company changes daily - it means nothing until one of you want to buy or sell and a price agreed between a potential buyer, and the seller.
You two still own all sold shares in the company.
Prior to the business selling the outstanding 50%, the two of you (best with an accountant) need to agree on the value value of the business. This will help you place a value on your shares, your mates shares, and the cost of the outstanding shares. The valuation can include everything from physical value of assets, to the goodwill that you bring and can bring to the company. It will help set your expectations on what a third share holder need pay for their investment. The third share holder might agree with your valuation, he might not. That is a different subject. Some could argue that Uber which is not on any stock market but has rumored $50billion value is accurate or inaccurate. They substantially less revenue than someone like Procter & Gamble yet their intrinsic value by some places it far above P&G. New investors will pay what they perceive to be the value based on the value today plus a forward expectation on business and return on investment.
The value of shares only materialize when someone wants to buy or sell more. Until then, you can be talking trading match sticks, straws or chips.
All content is licensed under CC BY-SA 3.0.