Startup Funding and Equity

What is Equity in Startups?

Suppose 2 people started a company, initially they would need to create some number of shares for the company. for example, they choose to create 1000 shares for their company.

Now after some discussion, they agreed to have 500–500 shares each. that means they both will own 50% of the company. Equity represents how much stake does own by an individual in the company.

And based on some calculations it was finalized that the company valuation (worth) is 1000$, which means each share is worth 1$.

Let’s say they got an investor to invest 100$ in their company, which means the investor will get 100 shares of the company. Now, none of the founders will reduce their share count but instead, the company will issue 100 new shares (Share ownership rarely changes, when there is a need to have a new partnership, the company always issues new shares).

Initially, we had 1000 shares with a valuation of 1000$. After the investment, the company created 100 new shares. Now if we do the math, there are now 1100 shares for the company. and the valuation of the company now became 1100$.

Let’s see how much equity each of them has in the company. Founder 1 & 2 will have 500 shares each which now represents around 45.45% of the company and investor has around 9.09% of the company.

What are Convertible notes in Startups?

Your company is in a very early stage and when some investors invest money in your company, there should be some valuation for your company which will tell how much equity will that investor will get. and obviously, in a very early stage, this is very hard to estimate the valuation of the company, that’s where the Convertible notes come into the picture.

A convertible note is like a debt that gets paid back in Equity at a discount price with interest after some defined time. Suppose the Investor is investing some amount of money today for the convertible notes, Now when the company’s next round of funding happens, that time investor will get equity for the amount with discounted price with interest.

So during this round of funding, Investors will get Equity worth of Amount they invested + Interest on the amount at a discount price, this discount is usually around 15–20%.

Convertible notes are preferred when an early age startup doesn’t want to get involved in the big tax process and money waste without even making some profits.

What is angel investing

So lets say you have got some money and now you want to grow your money but also take some risks, well that's where angel investing comes into the picture. Angel investors are people who put their own money into companies which are at a very early age and this is called pre-seed or seed funding where angel investors only put a small amount of money.

Since angel investor is taking a risk in believing the company goals, they usually ask for more equity than normal VCs. in most cases angel investor will ask for 10-15% of your company.

So how do angel investors make money?

well, they put faith in the company's future, if the company that they have invested in gets more funding then the value of their share of the pie will increase and they can even sell the equity that they got after investing in the next round of company funding, but if angel investors really believe in the company for the long term, they will simply stay put and will definitely get bigger returns if the company go public in future.

Angel investing is a very risky investment but can be very profitable if you do your due diligence in choosing the company you are going to invest in because most startups fail even before getting any funding.

Originally published on my medium page. follow me on Medium to read more stories about startups and funding manojahi.medium.com