The Benefits and Drawbacks of Venture Capital

Though venture capital can provide you with the much needed capital to advance your company, you need to lay out all your options before partnering with a particular venture capitalist or venture capital firm.
As mentioned before, venture capitalists are equity investors. In short, when a venture capitalist or other equity investor invests in your company, they are actually buying part of your equity.

This basically means that when an investor invests in your equity, you will have to agree with that investor on particular terms of how much equity they will receive upon their exit from your company. In many cases, you and your cofounders need to divide up shares of the company.

This means that before the investor enters, you and your cofounders must agree on a certain amount of shares each.

For example, if your company has four cofounders, you can divide your company’s stock into 100 shares. Each share would then be 1% of the company stock. You and your other three cofounders would each own 25 shares and 25% of the company.

When an investor wants to invest, they too will want to have part of the equity. This means that you will have to redistribute the shares of the company and/or the shares will also need to be diluted to accommodate the investor’s conditions.

Now the company shares will need to be divided from 100 shares to 150 shares. This means that 150 shares equal 100% of the company stock. Here is where the math needs to be done. You and your cofounders will no longer own 25% of your company, yet you have more shares to be able to give the investor their desired portion.

your prospective investor will want to have 20% of company shares. This means that your shares will need to be laid out in such a way to make sure that you and your cofounders still own a majority of the company.

You might want to set up a system that allows you and your cofounders to hold 75% of the company shares and your investors 25% of the shares.

This all depends on the terms that you and your investor agree upon.