I’ve been watching old episodes of shark tank/dragons den. I know that: ludicrous amount of money for <10% = laughable deal, but I don’t know what it means to have a percentage in the company. My understanding is it’s how much of a say you have in the company? Not even sure that’s right.
In: Economics
So this is a very nuanced topic, but essentially companies themselves have value apart from their profits, losses, assets, and debts. Those components are an important *part* of their value, but they aren’t everything. For example, a startup company might have no profits, losses, assets, or debts, but you think the founders might be able to build something which has those things in the future.
Owning a company usually means you have some control over it, and always means that you’re entitled to some percentage of the proceeds if control of the company is ever sold to some other entity.
For example, maybe you invest $1000 in an early stage company because you think that the founders have a really smart idea, and you end up with 10% of the company. This implies you think the whole company is worth right around $10,000. Now let’s say they go off and do smart things and then in five years they’re bought by Google. Google decides the company is worth about $5 million and so they allocate that much in terms of stock in GOOG to the people who control the company, including you. Since you control 10% of the company, you get $500,000. Not a bad return for $1000 over five years!
Doing the math in reverse… Since you valued the company at $10,000 at that initial investment, you were saying that there was at least an 0.2% chance that someone would eventually buy the company for $5M. Obviously, the math isn’t quite like that; in reality there’s a whole distribution of outcomes (down to and including $0), but this is essentially the idea. Higher valuation = higher expectation of greater success. The percentage of stake and seed capital is just a proxy to the valuation.
Of course, it almost never happens that way. Companies take additional investment over time, so your 10% maybe becomes 8% at some point, then 5%, then 4%, etc. You also might have the opportunity to sell your stake when the company takes on another investor, if you have decided you’ve had enough. Also most companies fail, so your $1000 is *probably* turning into $0.
Once a company gets big enough and stable enough that their future value is no longer growing at a significant rate (e.g. a company like Comcast), they often start offering a small amount of cash once per quarter to the ownership, in proportion to the percentage of the company they own (determined by shares). This in and of itself means the ownership has some intrinsic value, since you can buy a stake in the company and hold onto it for the dividend and sell it later and make a profit just by doing that. This doesn’t apply to startups though.
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