Understanding Equity, Dilution, and Shares in Startups
1.Equity Basics
Equity is a term used in business to describe the value of a company. It is calculated by subtracting the company's liabilities from its assets. Equity can be divided into two categories: common equity and preferred equity. Common equity is what the majority of shareholders own and is usually the most risky type of equity. Preferred equity is a higher-priority type of equity that usually has certain guarantees, such as a fixed dividend payment.
2. What is Dilution?
Dilution occurs when a company issues new shares of stock or when existing shareholders sell shares. This reduces the percentage of ownership that each shareholder has in the company and reduces their proportional ownership in the company's assets and profits. Dilution can also occur when a company issues warrants or options to purchase shares.
3. Types of Dilution
There are three types of dilution: economic, voting, and liquidation. Economic dilution occurs when a company issues new shares and the proceeds are used to invest in new projects. This reduces the earnings per share (EPS) and the value of the company's stock. Voting dilution occurs when a company issues new shares and the proceeds are used to finance an acquisition. This increases the number of shares outstanding and dilutes the voting power of existing shareholders. Liquidation dilution occurs when a company issues new shares and the proceeds are used to repay debt. This reduces the amount of money available to repay creditors in the event of a liquidation.
4. How to Calculate Dilution
To calculate dilution, you need to know the number of shares outstanding, the price per share, and the amount of money raised by the new issue. The formula for calculating dilution is:
Dilution = (Number of Shares Outstanding
- New Shares Issued) / Number of Shares Outstanding
For example, if a company issues 1,000 new shares at a price of $10 per share, dilution would be calculated as follows:
Dilution = (1,000
- 1,000) / 1,000
Dilution = 0%
5. Effects of Dilution
Dilution can have several negative effects on a company. It can reduce earnings per share (EPS), which can reduce the value of the company's stock. It can also reduce the voting power of existing shareholders and make it more difficult for them to oppose proposals or take control of the company. Dilution can also increase the risk that a company will go bankrupt, since it will have more liabilities relative to its assets.
6. Determining Shares in a Startup
When a startup first incorporates, it will issue a certain number of shares to its founders, employees, and investors. How these shares are allocated will determine how much ownership each person has in the company. There are two main ways to allocate shares in a startup: proportional allocation and par value allocation. Proportional allocation gives each person a percentage ownership based on their contribution to the company. For example, if a startup has
10 founders who each own 10% of the company, then each founder would own 1% of the company's assets and profits. Par value allocation gives each person a set number of shares regardless of their contribution to the company. For example, if a startup has
10 founders who each own 1,000 shares, then each founder would own 10% of the company's assets and profits.
7. How to Issue Shares in a Startup
Shares in a startup can be issued in two ways: through an initial public offering (IPO) or through private placements. An IPO is when a company sells its shares to the public for the first time. A private placement is when a company sells its shares to specific investors such as venture capitalists or angel investors.
8. Types of Shareholders
There are four types of shareholders in a startup: founders, employees, investors, and creditors. Founders are the people who started the company and typically own a majority of the common equity. Employees are people who work for the company and typically own stock options rather than common equity. Investors are people who have invested money in the company in exchange for shares. Creditors are people who have lent money to the company and expect to be repaid in case of bankruptcy.
9. How to Convert Shares into Cash
Shares in a startup can be converted into cash in two ways: through an initial public offering (IPO) or through private placements. An IPO is when a company sells its shares to the public for the first time. A private placement is when a company sells its shares to specific investors such as venture capitalists or angel investors.
10. Conclusion
Equity is a term used in business to describe the value of a company. It is calculated by subtracting the company's liabilities from its assets. Equity can be divided into two categories: common equity and preferred equity .Common equity is what most shareholders own and it is usually more risky than preferred equity . Preferred equity is higher-priority than common equity and usually has certain guarantees , such as fixed dividend payment .
Dilution occurs when a company issues new shares of stock or when existing shareholders sell shares . This reduces each shareholder's percentage ownership in th ecompany and their proportional ownership in th ecompany's assets and profits . Dilution can also occur when warrants or options to purchase shares are issued .
There are three types o fdilution: economic , voting , and liquidation . Economic dilution occurs when new shares are issued an dthe proceeds are used t oinvest in new projects . This reduces EPS an dthe value o fthe com pany's stock . Voting dilution occurs when new shares are issued an dthe proceeds are used t ofinance an acquisition . This increases th e number o fshares outstanding an ddilutes th e voting power o fexisting shareholders . Liquidation dilution occurs when new shares are issued an dthe proceeds are used t orepay debt . This reduces th e amount o fmoney available t orepay creditors in th eevent o fliquidation .
To calculate dilutation , you need t oknow th e number o fshares outstanding , th e price per share , an dth e amount o fmoney raised by th e new issue . The formula for calculating dilution is:
Dilution = (Number o fShares Outstanding
- New Shares Issued) / Number o fShares Outstanding