I noticed that I keep having the same conversation with people on fundraising. Understanding how ownership changes when a company raises money by issuing stock really is simple and straightforward. I think I’ve pinned down at least one issue that might make this stuff seem more complicated than it is.
The issue is that entrepreneurs are usually most interested in one number: percentage. As in, what percentage of the company will I own after raising money? This can confuse things because the way financing works, percentages aren’t treated as inputs; they’re treated as results of decisions on value. It was suggested that I lay this out in a blog post, so, here it is.
At its most basic, the important inputs to financing math are the pre-money valuation, and the amount raised. These numbers result in percentages. So let’s say for example that two founders decide to each own 50% of a company, and then they decide to raise $500k on a $1M pre-money valuation. That means that before the financing, the company is worth $1M, and right after the financing, the company is worth $1.5M (since it now has $500k in the bank). So, since the investors contributed $500k of the $1.5M post-money value, they now own 33% of the company. That means that the founders now own 33% each — they’ve been “diluted”.
This approach makes sense since the focus is on something that shouldn’t depend on how much money is raised: how much the company is worth right now. Then, depending on how much money is raised, the existing shareholders are diluted to lower percentages to make room for the investors.
Here’s a quick spreadsheet to play with that hopefully will make this all clear. The yellow bolded cells are the ones where you enter values; everything else then falls out from there. The number of shares per dollar of value is totally arbitrary; here it’s pegged at 10 cents a share.