Let’s say Jane creates a company and owns 100% of it. Jane then decides to give John 25% of the company in exchange for $100,000. Does this $100,000 go into the bank account of the *company* ? Or does it go to Jane, the *individual*, for giving up a portion of her company?
On shows like Shark Tank, the sharks frequently ask the contestants what they plan to do with the shark’s money if they invest, implying that the money will go into the bank account of the *company*. If that is the case, how does Jane, the *individual* who worked hard to create the company, get compensated for the portion of the company she used to own that has been transfered to this new investor?
In: Economics
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If the investor and the owner agree to sell 25% of the company for $100,000 that means that they are valuing the current company and its assets at $300,000. Before the sale, the owner owns 100% of a $300,000 company. After the sale, the company has an additional $100,000 so it’s worth $400,000. The investor owns 25% of a $400,000 company (worth $100,000) and the owner owns 75% of a $400,000 company (worth $300,000). Both the owner and the investor have the same value before and after the sale, but the company now has cash to use to create more value.
If jane owns a company and sells 25% then she would pocket the money. If the company was a corporation and was selling stock then John could buy 25% control of the company and that money would go in the company pocket to be used by the corporation.
The Sharks will offer 200k for 20% of the company . That money goes into the owners pocket. In most situations those folks use that money to grow the business to a point where they can make a larger profit. The sharks are choosing people whom they are fairly sure can get the product to market and make them a profit.
When an investor like in Shark Tank “invests” in the company, new shares are created for them and they buy those shares from the company.
So the founder will still retain the total number of shares they originally had, they will just own a smaller % of the company as the company now has issued more shares.
Other than a salary, the founder gets paid at the time of an exit when some other company buys out their own personal shareholding in order to get control over the company.
A couple ways:
1. Founders typically pay themselves a salary once there’s enough money in the company to do so, but until there’s external funding this would be largely pointless, as the founder would be paying themselves out of their own pocket.
2. It’s common, especially in later funding rounds where there’s competition among investors, for founders and early investors to cash out some of their own shares as part of the transaction. It’s generally a fraction of the total investment, but it’s tolerated as table stakes for the opportunity to invest in a growing company.
Usually, the purpose of the investment is that it goes into growing the company. The idea is that the $100k investment will turn a $400k business into a $2m or $4m business or whatever by allowing the money to further growth. Perhaps outside investment might allow for the founder to start taking a salary as one of the expenses it funds.
There may be points where earlier investors do sell personal stakes for money that goes into their pocket, but that’s usually later rounds of private investment or during the IPO.
The short answer is she doesnt get compensated for that. Her compensation is that her company can keep operating because someone else out money in. In your scenario, there’s maybe 3 ways Jane gets paid:
1. In addition to her equity, if she’s actively running the company as CEO or something equivalent, she probably receives a salary + bonus structure for that.
2. If cash dividends are paid to equity holders, Jane will receive whatever her portion is based on her % of ownership.
3. If the company ever becomes large or profitable enough to sell, Jane will receive some of the purchase price based on the amount of the company she still owns.
The problem you’re pointing out is a tough one for many founders. When a new company is started, it’s often losing money but is considered too risky for a bank loan. The founder has to sell some piece of the ownership to get funds in to keep running the business. However, it reduces their eventual payday if the company ever is able to sell. So the founder will want the most money while giving away the least amount of ownership. An investor like John of course wants the opposite, more ownership for less money. That’s why in Shark Tank they haggle over ownership as well as cash invested.
Work in investing so can try to give a simple example here. What you’re asking about is whether the investment is “primary” vs “secondary” capital.
In a primary capital investment, the investor gives the company money to put on the company’s balance sheet (typically to fund growth) and in exchange is granted new shares in the company. This is more common in venture capital. Example: you own 100% of a company worth $100,000 and there are 100,000 shares so $1.00 per share. I invest $50,000 at $1.00 per share and there are now 150,000 shares and you own 66% and I own 33%. You didn’t get any money in your pocket but now your business has cash on hand to fund operations and is worth more by the amount of the cash invested (worth $100k “pre-money” and $150k “post money”.
In secondary capital, you sell me your shares in the company so that you can get liquidity (i.e. take cash out of the business). The business doesn’t get anything but you trade your ownership for cash. This type of transaction is more common in private equity where the businesses are mature and don’t need cash to fund growth. Using same example as above, if I invest $50k (you sell me 50k), now there are still 100k shares in the business and we both own 50%.
In primary capital new shares are created that “dilute” existing investors but give the business cash to do things that should make it more valuable for everyone. In secondary capital existing shares just change hands amongst individuals or organizations.
It depends.
Let’s say Jane owns 100% if the company and there are 100 shares.
Jane could sell 25 shares to an investor, in which case Jane gets the money, and the company recieved nothing. She owns those shares, it’s her stuff she is selling.
But maybeJane’s company is young and Jane doesn’t need the money for herself but rather wants to hire someone for the company, or buy some inventory to sell.
The company could issue shares, let’s say 25 new shares and sell those 25 to an investor.
The money from that sale would go to the company. Jane would no longer own 100% of the company, but rather 80%. The new investor would own 25/125 shares or 20% of the company.
Jane would still have control, but would probably have to share 20% of profits going forward. She’d also have to look out for the interests of the new investor to some degree. And the company could make it’s hire, or buy it’s new inventory.
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