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.