How does the founder of a company get paid when they give equity to investors?

Question

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

Answer 1

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.