The VC World: Fund-raising & its implications

During the fund-raising process, it is important to understand the implications of raising money and how it affects the valuation of your company. In my previous post, I explained how the pre-money and post-money evaluations are calculated.  The following will highlight what occurs after additional money is invested into the company based on percentage of ownership (i.e.- how many shares each party own).

Percentage of Ownership
For instance, Paul and Dan start a company and therefore consider each other as co-founders; they invest $60 and $40, respectively. Paul would own 60 percent of the company and Dan would own 40 percent based on a $100 dollar total value and 100 shares. To clarify, Paul will own 60 out of 100 shares, valued at a dollar each, equaling 60 percent of the company. Dan will then own 40 out of 100 shares, valued at a dollar each, equaling 40 percent of the company. Additionally since Paul has majority ownership of the company – owning more than 51 percent of the firm – he can control the decisions that are made by the firm.

Price per Share before an Investment
In order to determine the price per share of a company you will need to divide the pre-money valuation by the total number of shares (prior to financing).  The pre-money valuation in this calculation is $100, which is then divided by 100 shares, giving you a value of one dollar per share. The following illustrates the dollar contribution, percentage of ownerships and number of shares per co-founder.

 
Price per Share after an Investment
 If an outside investor decides to put in $200 into Dan & Paul’s company then 200 new shares are created.  This results in 300 total shares each valued at a $1 per share (for a new $300 valuation).

Therefore: Pre Money + Investment = Post Money

$100 (Founders Investment) + $200(New Investor) = $300 (Total Investment)

Based on the new money invested, the following illustrates the new capitalization table (the percentage and money invested into a company by each shareholder and their shares):

  
 

Now even though both Paul and Dan still own the same amount of shares, their percentage ownership has been diluted down to 20 and 13 percent, respectively ( as opposed to their initial 60 and 40 percent).  This is a prime example of new investors such as Venture Capitalist entering the firm and shrinking down initial ownership stake.
Valuation of Shareholder

Although both co-founders have been diluted down based on ownership percentage, from a dollar per dollar standpoint they have not lost their value; Paul owns 20 percent (60 shares) of $300 equaling $60 and Dan owns 13 percent (40 shares) of $300 equaling $40 based on a dollar value per share.

Paul and Dan will use the investor’s money to grow their firm. Due to their success, the value of their company increases to $600. Since they own 20 and 13 percent of the company respectively, Paul’s shares are now worth $120 and Dan’s shares are worth $80. With a new valuation of $600 and 300 shares, the price per share is now equal $2, a 2x increase.

This is why people are willing to give up significant portions of their companies for outside investment; in the end both the investor and the founders win, as added value has been created for all parties involved.

If you have any comments/questions, be sure to shoot me an email or post a comment.

Best,

Ashkan