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Posted on January 17, 2013 @ 10:12:00 AM by Paul Meagher
You don't have to be listed on the stock market to think about your company as consisting of so many shares valued at x dollars a share. If
you think your company is worth $100,000 dollars, then you can also think about that value in terms of 10,000 shares at $100 per share or
1000 shares at $1000 per share. This is just simple math and you are free to choose whatever breakdown you like.
If at some point you decide you are looking for a business investor, then this game of representing your company as consisting of so many
shares valued at x dollars a share is no longer a game. This is one way to write up the purchase agreement with investors where they
get so many shares in your company valued at y dollars in exchange for a comparable amount of financing. How much financing they provide can determine the number of shares in your company they might acquire.
If you go this route, then an important distinction that you need to keep in mind is the distinction between common shares and preferred shares.
An angel investor generally purchases common stock in a company where their voting rights, dividend payments, share of the revenues is
comparable to the owners of the company; they get voting rights, share of dividend payments, share of revenues, etc... in proportion to the
number of shares they have purchased in the company.
A venture capital organization may come in at a later around of funding and supply more capital on that round then was supplied during the
seed round by an angel investor. One of the differences you might expect in this round, is that the Venture Capital or Private Equity
firm will be asking for preferred shares in your company. What that means can vary from deal to deal, but one aspect of what it might mean
to have preferred shares is that the investor has priority in terms of being paid whenever there are dividends, profits, or assets to be distributed.
If there is a "liquidity event" the investor with preferred shares in your company will be first in line to recoup their investment.
The cost of shares in your company vary over time just as the needs of your company do. The cost of preferential shares are generally higher
than the cost of common stock in a company which is why you would agree to offer preferential shares in the first place. This is not
always the case, and you will sometimes hear of "flat rounds" and "down rounds" of investment that can occur in a struggling ecomony when a company is strapped for cash.
The rule of thumb is that if an angel investor is investing smaller amounts in your company you can offer them common shares; if a large venture capital firm is offering you larger amounts of money, then they will likely be looking for preferred shares in your company. Not all shares are created equal and the distinction between common and preferred shares is one mechanism used by larger investors to better protect their investments.
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