Audio/Video post answering the question of how to calcultate shares for a new business partner. Looks into Authorized vs. Outsanding shares.
A consultant has offered to find an investment of $1 million for my startup. As a reward he is asking for an option expiring in five years to subscribe at par value for ordinary shares representing 5% of the capital of the company. What does this mean? Should this option be exercised, how much will I receive for 5% of the company considering that post money valuation would be $4 million. However, current issued shere capital is 100 shares at $1 each.
It's unclear to me whether he is asking for 5% of the company, or if he is asking for 5% of the shares that are received from the $1 million investment. I hope, and suspect, it's the latter. It would be a typical arrangement for someone acting in this capactity to receive a commission on the money they helped to secure, and 5% is a pretty typical ask for the size of the investment you are looking for.
Sometimes they want to be paid in cash from the proceedes of the financing, meaning that if you raise $1 million, you would pay the finder 5%, or $50,000 when the financing is complete. In your case, and in the case of many startups, that $50,000 is a lot of money that you were hoping to have put into the business, and so rather than pay $50,000 cash, I would rather you conver that to additional equity. I believe this is what he is suggesting.
However, there may be no reason to structure this an an option. More on that below. I suggest you structure as follows:
The new investor(s) will purchase $1M worth of your stock at a price you mutually agree to. It sounds like you are looking for $4M post-money which means they will be buying stock at price equal to $3M divided by the number of shares you currently have. This gives you a price per share, indicating that your company is worth $3M today, then they will add $1M in cash, thus you will be worth $4M "post money" or after the investment. I will point out that the $3M pre-money valuation is up for negotiation, but lets assume for now that this is the price.
Also lets assume that you have 1 million shares of stock today. This means your current price-per-share is ($3M pre-money valuation) / (1 million shares) = $3 per share.
The new investors will invest $1M, and they will be issued newly created shares. Thus, their $1M dollars buys them 333,333 shares at a price of $3 per share. Once issued, your company will now have 1,333,333 shares issued and outstanding, at a price of $3 per share, giving you a post money valuation of $4M.
What I suggest is that the agent who finds you the money be issued shares at this time, equal to 5% of the amount of money they helped to raise. Issuing an exipring stock option seems compeletely unnecessary to me. Thus, the agent should receive (5% * $1M) = $50,000 worth of shares at $3 per share = 16,667 shares.
This then would give your company a total of 1,350,000 shares of stock, valued at $3 each, for a total post money of $4.05M. You will receive $1M in capital to grow your business, the new investors bought 24.7% of the company, the agent would receive $50,000 worth of stock as valued at the price set by the investors.
I suspect that the reason the agent is looking for an option has to do with taxes. The detail here depends on the tax structure wherever you live, and they don't want to pay taxes on the $50,000. There are a number of options likely available to you, and you should have your attorneys draw up the right arrangement. It could be that you pay some of that $50,000 in cash, such that they can pay the tax bill, or it could be that his shares are valued as common stock like yours (and thus have a market value far less than the preferred stock purchased by the investors), or it could be that the stock option is the best way to go.
Again, the suggestion of the option is likely around taxes and there could be different paths available to deal with that. In the end I would prefer that there be no lingering option because the cleaner you can keep your capitalization table, the better. Work with your attorneys to find the best answer here, or at least reach an agreement with your agent that as a part of the closing of the financing, your attorneys will draw up language that makes everyone happy.
I have a newly started honey farm that has very good prospects... It will take 3-6 months to realize our first profits because honey is seasonal, but we have lines of outlets agreed to buy our unique jamaican honey. Can I issue some shares now and collect a pool of funds from their sale, even though I have yet to make a sale? How freely can I use the funds?
Hi Marco. Absolutely you can. There have been thousands of companies which raised money and never got their products to market at all. Obviously that's not your goal, but investing is risky and early stage investing is particularly risky. Any investor putting money into your company should be well aware of this and it's expected.
As far as how you can use the funds, this will be determined by the investment agreement between you and your investors. Generally these agreements will be very open and you can use the funds for any business purpose, but again, it's all in the specifics of that agreement. You will want to consult with a lawyer on drawing up these agreements and complying with any securities laws in your area.
For your pariticular business, it may be possible to get a line of credit from a bank based on committed sales. If you have customers committed to buying, then those commitments can sometimes be leveraged into bank financing especially with seasonal businesses. If you do talk to a bank, be sure you have spent the time to put together a solid business plan, pitch, and financial projections. Looking professional and prepared will go a long way.
I'm trying to start a company with no funds of my own to speak of. My idea is sound and planned out for success but I have no money to my name... I have looked into government grants and it seems more likely to get money to put internet through the Congo than to receive funds to start a new business venture. I’m at a loss for where to go next and how to provide the early funding to get an investor or a loan to start my business.
Hi Paul. Unfortuantely there is no straight-forward answer to this because it depends on many factors unique to the business. If you need money to buy inventory, equipment, facilities -- things with capital value -- then you could potentially get a bank loan, perhaps an SBA loan. If you need money for operating capital, advertising, payroll, etc, then you need to look at getting equity financing (and sure, if you find a grant proposal you'd be a fit for, give it a shot, but you are correct in thinking that you need to look elsewhere).
Assuming that your capital need is not bank-fundable, then it depends on how much you are looking to raise and what the business model is. If you needs millions, and you have a business model that supports it, you might look to venture capital. If you need less, then you might look to angel financing -- or put another way, look to wealthy individuals.
To find a list of wealthy individuals you need to network, ask around, make calls, get referrals, etc. There's a lot of legwork invovled and it will take some time. But this is the only way to do it -- don't expect to make any meaningful progress poking around on the interent for a list of angel investors. Go to your local chamber of commerce meetings, see if there are any startup groups in your area, and just keep checking and asking, checking and asking. Great investors might come from successful people in a related area to your business. Asking doctors to be funders for a new medical device or medically oriented software/website business, for example.
When you do compile a list, you need to be prepared to take them through your vision and pitch. There's a lot of content written about this on this site already, and if you are serious you should look at the 8 slide investor pitch book I published earlier this year. Those who invest will invest in you and your passion and your story. The only way to convey that to them is to get out there, track them down, and ask them to listen.
Best of luck to you.