In popular media when a startup receives funding it’s hugely celebrated, and most people think it to be a sign of success. However, people and founders do not understand what’s really happening behind the scenes. Who’s losing control and who’s gaining control, and what happens to a company’s valuation.
When a startup receives investment from an external firm, the ownership and structure of the company changes. Here’s how it typically works:
- Pre-investment structure:
- Let’s assume there are two founders, and each owns 50% of the startup.
- Issuing new shares:
- When the investment firm buys a stake in the company, it usually does this by purchasing newly issued shares from the company rather than from the founders’ personal shares.
- The company issues new shares that dilute the ownership of the existing shareholders (founders). So, after the investment, each founder will own less than 50%.
- Who receives the money?
- In most cases, the company itself receives the money from the investment firm. This money is added to the company’s balance sheet and used for growth, expansion, or other business activities.
- The founders do not personally receive money unless they are selling a portion of their shares, which is less common in early-stage investments.
- Post-investment structure:
- The new ownership percentage will depend on the amount invested and the valuation agreed upon during the investment round.
- For example, if an investment firm invests Rs 1 Crore for 25% ownership, the company is valued at Rs 4 Crore post-investment. The two founders’ combined ownership will drop from 100% to 75% (37.5% each if equal).
Example Breakdown:
- Before Investment:
- Founder A: 50%
- Founder B: 50%
- Total company value: Rs 2 Crore (hypothetical pre-money valuation)
- Investment:
- An investment firm invests Rs 1 Crore for a 25% stake.
- After Investment:
- Founder A: 37.5%
- Founder B: 37.5%
- Investment firm: 25%
- Total company value: Rs 4 Crore (post-money valuation)
- The company now has Rs 1 Crore in funds to operate, expand, or invest in its growth.
The key point is that the company gets the money from the investment, while the founders’ percentage of ownership is reduced but they retain their shares unless they also sell a portion directly.
Abhishek is a computer science graduate. He was too scared of programming so he pursued MBA. He then joined a management consulting firm but soon realised that without any real world and technical experience, consulting wasn’t real.
So he joined a bicycle manufacturing company as a marketing manager. There he got into the nitty-gritties of cycling and learned all about manufacturing, sales & distribution. But soon, things got too easy, so he quit and joined a media conglomerate, which would later give him and his wife the idea for SAM, their digital media business. His heart was still in cycling, so he rejoined the cycling company as product manager, which he truly aspired for. He got selected for a company sponsored executive MBA program at IIM-A, only to realise that it would make everybody around him jealous.
That sent him working in other business areas like corporate strategy, precision steel tube, exports, etc. After COVID-19 and becoming a father of twin children, he was made to quit. So he finally got the guts to leave the job-life once and for all, and run the media business he helped start.
Today he’s the co-founder of a media business along with his pretty wife and also runs his investment fund. He is interested in writing about topics that no one wants to touch or discuss. Over the years Abhishek has come to realise how lucky and immature he has been and wants to repay the world with good karma.
He’s used to be passionate cyclist and participated in several competitive events, as of now he’s procrastinating to get back on to his bike’s saddle again. He also has interests are in behavioral psychology, economics, stock valuations and chess.