LexGyaan Series on ESOPs – Part 1: How do Employee Stock Options Plan (ESOPs) work?

CREATING AN ESOP POLICY

In our experience of having assisted several entrepreneurs with execution of ESOPs for their startups, we have observed that most entrepreneurs are under the impression that by just mentioning the number of ESOPs on their cap table, or in offer letters to their employees, the startup has fulfilled its obligation to grant ESOPs to its employees. This is actually incorrect.

Mentioning ESOP pool on your cap table actually just makes your investors happy. Why? Well when an investor invests in your startup, they want to ensure that they do not get diluted for any reason except in case of future rounds of fundraising by your startup (even for that they have the right to maintain valuation aka pre-emptive right). It is important for investors that their shareholding does not get diluted in order to give shares to your employees, mentors or all those well-wishers of yours, whose help and guidance you took in the initial days of starting up and promised equity to. Only you the founder should get diluted to give these promised equity shares to your mentors and advisors, not the investors. This is the reason why investors require a startup to create an ESOP pool/advisory stock option pool, as a condition precedent to their investment in a startup. This is also the reason why investors require you to convert all loans from friends and family, and conversion of convertible notes, if any.

Related reading: Understand how valuations work and how a founder’s shareholding gets diluted when an investor invests in a startup in our blog titled ” The Valuation Game.. What Does It Mean Exactly? , by our co-founder, Karthik Chandrasekar.  

Therefore, all you have achieved by mentioning a “ESOP Pool” on your cap table and inserting a number against it is (a) carving out the maximum number / percentage up to which your investors won’t get diluted, and (b) demonstrating to your investors, your intention to give ESOPs some day to your employees.

At this stage, where your startup’s ESOPs are only on the cap table, your ESOPs are only a virtual pool. How do you convert the ESOPs in to reality? Well, that’s easy, you will just have to create an actual ESOP pool. In order to do that, you will have to take the following steps:

Step 1

Draft an ESOP Policy in compliance with the Indian Companies Act, 2013. The ESOP Policy will have to set out in detail the terms of ESOPs, cliff period, vesting schedule, exercise price/strike price, exercise period, consequences of employee leaving the startup, consequences of the startup getting acquired, etc.

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Step 2

Once the draft ESOP policy has been finalized and if you have investors in your startup, then check your Shareholders’ Agreement and Articles of Association, to verify if the approval of investors for a ESOP policy will be required. Lost? Well, just look for a clause that is titled either as “reserved matter right” or “affirmative voting matter” or  “affirmative voting right” or “investor protection matter”. Once you find this clause, then look through the several items and check if creating a stock option, ESOP etc is listed therein. If it is, then you would have to send an email to your investor alongwith copy of the ESOP policy for your startup, requesting the investor for its approval to the ESOP policy.

LexGyaan: Most VCs get their respective legal team to also review the ESOP policy. Therefore, be prepared for few iterations and discussions.

 Step 3

Where you don’t have any investors in your startup, you can skip step 2 and directly proceed with step 3, i.e., convene a Board Meeting for approval of the ESOP Policy. How to convene a board meeting properly under Companies Act, 2013?

Step 4

Convene a meeting of Shareholders (aka EGM) of your startup, for approval of the ESOP Policy.

Now you have an ESOP policy and can formally start granting ESOPs. Click here to download a free template of a ESOP grant letter!

Click here to read FAQs on ESOPs.

LexStart makes ESOP creation a breeze. Click here to learn more. Request a Demo.

 

LexStart’s LexGyaan Series: Can I grant ESOPs to a Co-Founder?

Granting ESOPs to Promoters/Co-Founders

I often get asked this question – “Can I grant ESOPs to a Co-Founder who I recently brought on board my Startup?”. Well the answer is both yes and no!

The Companies Act, 2013 prohibits grant of ESOPs to the Promoter of a company. The term “Promoter” does not necessarily refer to only a person who is named as a Promoter at the time of incorporation of the company. A Promoter is defined broadly and includes, the following:

  • Any person who has been named as such in a prospectus or is identified by the company in its annual return; or
  • Any person who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise; or
  • Any person in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act. Provided that such person is not someone who is acting merely in a professional capacity.

Therefore, typically a Co-Founder who you bring on board at a later stage, may not be a Promoter as stated in the Charter Documents (Memorandum and Articles of Association of your Startup) but still can be considered a “Promoter”, thus restricting him from receiving ESOPs in the company.

ESOPs to Promoters/Co-Founders of recognized Startups

The Companies Act, 2013 has made an exception to the above rule, by allowing Startups that are recognized by Govt. of India to grant ESOPs to founders, as long as the grant of such ESOPs is within 5 years from their incorporation. This means if your Startup has a Certificate of Recognition from DPIT, Govt. of India, then you can grant ESOPs to Promoters/Co-founders.

Related Readings : How to Get Startup India Registration

FAQs on ESOPs

 

Issue of Shares with Differential Voting Rights

What is Differential Voting Rights?

Shares with Differential Voting Rights (DVRs) means shares that give the holder differential rights as to voting (either more or less voting right) as against the Ordinary shareholders of the company.

Types of DVR    

  • Shares that have superior voting rights
  • Shares that have inferior voting rights

Eligibility/Condition for issue of shares with DVR*

  • AOA of the Company should authorize issue of DVR;
  • Consistent track record of distributable profits for the last three years;
  • No default in filing annual return for last 3 Financial Years;
  • No default in payment of declared dividend or repayment of deposit or loan borrowed;
  • the shares with differential rights shall not exceed twenty-six percent of the total post-issue paid up equity share capital;
  • No penalty by court or tribunal for any offense for the last 3 Financial Years; and
  • The shares issued with DVR cannot be changed later.

*This provisions shall not apply to private companies in case MOA and AOA of the company provide otherwise.

Procedure for issue of shares with differential voting rights

  • Check AOA of the Company;
  • Obtain valuation certificate from registered valuer;
  • Open a separate bank account;
  • The terms of issue of shares should be finalized;
  • Conduct board meeting for issue of shares with DVR;
  • In case issue of DVR affects the rights of existing class of shares then obtain consent from 3/4th of the shareholders of that class;
  • Filing form MGT-14 with ROC within 30 days of EGM;
  • Circulate offer letter along with the share application form to the investors;
  • Receive share application money along with the application form ;
  • Conduct board meeting for allotment of shares;
  • File form PAS-3 within 15 days of allotment of shares;
  • Pay stamp duty and issue share certificates; and
  • Make entry in register of members.

Difference between DVR shares and Ordinary Shares

DVR shares
  • Provide few or higher voting right to shareholders.
  • Rate of dividend is low or higher.
  • DVR shares are ideal for small shareholders or promoters.
  • Issued at a discount in comparison with ordinary shares.
Ordinary Shares
  • One share One Vote.
  • Rate of dividend is fixed for class of shareholders.
  • Ideal for large shareholders.
  • Issue at FMV.

Advantages of Issuing shares with DVR

From Issuer Perspective
  • To raise more capital without diluting its ownership structure.
  • Get control in decision making process.
  • A tool to avoid hostile take over.
  • To fund large Project.
From Investor Perspective
  • Benefit to investors since share are issued at discount & also for incremental dividend.
  • Better for investors who are looking for good quick return rather than voting rights.
  • Institutional Investors can invest in private companies without any limit and making it a subsidiary.

Dis-advantages of DVR

From companies Perspective
  • Lack of investor awareness about such issue of shares.
  • Issue shares at discount.
  • Minority shareholders can lose faith in the Company.
From investor Perspective
  • Lack of investor awareness about such issue of shares.
  • Possible misuse of voting power
  • by the promoters & hence act
  • against the interest of the shareholders.
  • Lack of liquidity may hamper return.
  • Not beneficial for Institutional
  • Investors as they are
  • interested in voting rights and long term capital gains both.

Case of Tata Motors

  • In 2008, issued DVR shares.
  • It was the first company in India to issue DVR shares and amongst the very few in Asia.
  • Issued at Rs 305 a share which was about 10% lower than the issue of normal rights at Rs.340.
  • Will offer 5% of more dividends.
  • Gives an additional 10.3% discount.
  • But carry one-tenth the voting rights of ordinary shares. This means 10 DVR shares = 1 ordinary share as far as voting rights is concerned.

Amazon caps voting rights in Witzig Advisory Services at 17%

  • Amazon has bought 17% stake in the company through Class A shares and the rest 32% through Class B shares having differential voting rights (DVR).
  • Each Class A share shall have one vote, while the Class B shares shall not carry any voting rights. This effectively caps Amazon’s voting rights in Witzig at 17%.
  • Amazon appears to have made use of DVR shares to comply with the new ecommerce FDI norms that came into force from February 1, and also to ensure that More can continue selling on its Indian marketplace.
  • The new ecommerce FDI guidelines had forced Amazon to reduce its stake from 49% to 24% in Cloudtail and Appario, the two top sellers on its marketplace. The American etailer had also evaluated the idea of limiting its holding in Witzig to less than 26%, and not acquiring 49% in the company as was originally planned.
  • By capping its voting rights in Witzig at less than 17%, Amazon will be able to continue with More as a seller. Samara Capital will hold 51% in Witzig, making the latter an Indian owned-and-controlled company.

Conclusion

  • For an investor, who wants to be in the company’s decision processes, DVR  shares is not an attractive proposition due to limited voting rights.
  • But if an investor isn’t concerned much with voting rights, then investing in the DVR would certainly be an attractive option.

Convertible Note – Cheat Sheet !

Planning for fundraising and considering a Convertible Note? Here is a cheat sheet for you:

  1. Check if Convertible Note is the right instrument for you. Click Here to do a quick check!
  2. Well, if you are convinced that Convertible Note is the right instrument for fundraising for your startup, continue reading:
  3. Register with Startup India from DPIT.  Read more here
  4. Draft a Convertible Note Agreement. Purchase LexStart’s Convertible Note Primer to get a template. Purchase Now
  5. Draft a Convertible Note certificate.
  6. If the Articles of Association do not allow the Board to borrow money, amend the Articles of Association to give the Board the power to borrow by passing board and shareholders resolution.
  7. Draft a board resolution for approving Convertible Note.
  8. Draft a shareholders’ resolution for approving Convertible Note.
  9. Convene a Board Meeting for approving issuance of Convertible Note.
  10. Convene a Shareholders’ Meeting for approving issuance of Convertible Note.
  11. Stamp the Convertible Note Agreement.
  12. Procure signature of all Parties concerned on the Convertible Note Agreement.
  13. Upon receipt of investment amount, issue Convertible Note Certificate, duly stamped and executed.
  14. File Form MGT-14 within 30 days of Shareholders’ Meeting.
  15. File Form DPT-3 by 30th June of every year.

New requirement for Foreign Direct Investment

The Reserve Bank of India (RBI) has announced that with a view to integrating the reporting structures of various types of foreign investments in India, it will introduce a single master form (SMF) which is to be filed online.  

The SMF will provide for reporting to the Reserve Bank of India (RBI) of (i) total foreign investment in an Indian entity, and (ii) investment by a person resident outside India in an investment vehicle in India. As a pre-requisite to implementing the SMF and to receive foreign investments in India, Indian entities will be required to provide data on total foreign investments received by them in a format specified by Reserve Bank of India (RBI). The format for providing information on foreign investment is yet to be issued by the Reserve Bank of India (RBI) and will be made available on the website of Reserve Bank of India (RBI) between June 28, 2018 to July 12, 2018.  

What happens if you skip filing the information with the Reserve Bank of India (RBI) within the timeline prescribed by the Reserve Bank of India (RBI)? Indian entities not complying with this pre-requisite will be considered non-compliant with Foreign Exchange Management Act, 1999 and regulations made thereunder and will not be able to receive foreign investment (including indirect foreign investment) in India.

In order to enable Indian entities to start collating the information in advance, the Reserve Bank of India (RBI) has provided the list of information that will be required to be filled in the form. These details can be found in Annex 1.  The format of the SMF currently contemplated by the Reserve Bank of India (RBI) is Annex 2.  The final forms will be available in the Master Direction on Reporting under the Foreign Exchange Management Act, 1999 to be issued by the Reserve Bank of India (RBI).

Fundraised from Foreign Investors? Ensure You Don’t miss this Filing with RBI!

Which companies are eligible to file the Form FLA?

Every Indian company and Limited Liability Partnership (LLP) which have received Foreign Direct Investment (FDI) and/or made Overseas Direct Investments (ODI) in the previous year(s), including the current year are required to file Annual Return on Foreign Liabilities and Assets (“Form FLA”) with RBI on or before July 15th every year.

The Form FLA has to be also filed in a case where a company/LLP has not received any fresh FDI and/or ODI in the current year but has outstanding FDI and/or ODI from previous years.

In case where the company/LLPs financial statements are unaudited before the due date of submission of Form FLA, the return is required to be submitted on the basis of such unaudited (provisional) financial statements. Once the accounts get audited and there are revisions from the provisional information submitted, the company/LLP’s will be required to submit a revised return by September 30th.

The following companies are excluded from submitting FLA return:

  1. Where Indian company/LLP does not have any outstanding investment in respect of inward and outward FDI as on the end of March of the reporting year, the company/LLP is not required to submit the Form FLA.
  2. If a company/LLP has received only share application money and does not have any foreign direct investment or overseas direct investment outstanding as on the end of March of the reporting year, the company/LLP is not required to submit the Form FLA.
  3. If all non-resident shareholders of a company/LLP has transferred their shares to the residents during the reporting period and the company/LLP does not have any outstanding investment in respect of inward and outward FDI as on the end of March of reporting year, the company/LLP is not required to submit the Form FLA.
  4. If shares are issued by reporting company to non-resident on Non-Repatriable basis, then it should not be considered as a foreign investment; therefore, companies which have issued the shares to non-resident only on Non-Repatriable basis, are not required to submit the Form FLA.

How does one submit the Form FLA?

The format of Form FLA can be found here. The filled form along with any attachment has to be mailed to [email protected] by the due date. The email has to be sent from the official email id of any authorized person in the company/LLP, such as CFO, Director, Company Secretary, etc.  Acknowledgment will be received from RBI on the same email id from which the form is sent.

P2P Lending Regulations – Important Provisions You Should Know

The Reserve Bank of India, in its recent notification, has brought in platforms carrying out the business of P2P lending under the purview of NBFC. Below are the key provisions:  

  1. Any business proposing to carry out business of Peer to Peer (“P2P”) Lending will be required to register with the Reserve Bank of India (“RBI”).
  2. Existing entities carrying out the P2P business will have to register within 3 months of the notification
  3. Dos and Don’ts
    1. What can a registered P2P entity do?
      • Act as an intermediary providing an online marketplace or platform for P2P lending.
      • Ensure adherence to legal requirements applicable to the participants.
      • Store and process all data relating to its activities and participants on hardware located within India.
      • Undertake due diligence on the participants and undertake credit assessment and risk profiling of the borrowers and disclose the same to their prospective lenders.
    2. What are the restrictions on a registered P2P entity?
      • Cannot raise deposits.
      • Cannot lend on its own.
      • Cannot provide or arrange any credit enhancement/credit guarantee.
      • Cannot facilitate or permit any secured lending linked to its platform.
      • Cannot hold, on its own balance sheet, funds received from lenders for lending, or funds received from borrowers for servicing loans.
      • Cannot cross sell any product except for loan specific insurance products.
      • Cannot permit international flow of funds.
  4. Prudential Norms
    • A P2P entity shall maintain a Leverage Ratio not exceeding 2.
    • The aggregate exposure of a lender to all borrowers at any point of time, across all P2Ps, shall be subject to a cap of INR 10,00,000/-.
    • The aggregate loans taken by a borrower at any point of time, across all P2Ps, shall be subject to a cap of INR 10,00,000/-.
    • The exposure of a single lender to the same borrower, across all P2Ps, shall not exceed INR 50,000/-.
    • The maturity of the loans shall not exceed 36 months.
    • P2Ps shall obtain a certificate from the borrower or lender, as applicable, that the limits prescribed above are being adhered to.
  5. Mode of Transfer of Funds
    • Fund transfer between the participants on the P2P lending platform shall be through escrow account mechanism, which will be operated by a trustee.
    • The P2P entity needs to set up at least 2 escrow accounts – 1 for funds received from lenders and pending disbursal, and the other for collections from borrowers.
    • The trustee shall mandatorily be promoted by the bank maintaining the escrow accounts.
  6. Prior written permission of the Bank shall be required for:
    • Any allotment of shares which will take the aggregate holding of an individual or group to equivalent of 26% and more of the paid up capital of the P2P entity.
    • Any takeover or acquisition of control of a P2P entity, which may or may not result in change of management.
    • Any change in the shareholding of a P2P entity, including progressive increases over time, which would result in acquisition by/ transfer of shareholding to, any entity, of 26% or more of the paid up equity capital of the P2P entity.
    • Any change in the management of the P2P entity which would result in change in more than 30% of the Directors, excluding Independent Directors.
    • Any change in shareholding that will give the acquirer a right to nominate a Director.
  7. Public Notice about Change in Control/ Management
    • A public notice of at least 30 days shall be given before effecting the sale of, or transfer of the ownership by sale of shares, or transfer of control, whether with or without sale of shares. Such public notice shall be given by the P2P entity and also by the other party or jointly by the parties concerned, after obtaining the prior permission of the Bank.
  8. Intimation Requirements – Change of address, directors, auditors, etc. RBI needs to be intimated about any of the following changes, within 30 days from the change:
    • The complete postal address, telephone number/s and fax number/s of the registered / corporate office.
    • The residential addresses of the Directors of the company.
    • The names and office address of the auditors of the company.
    • The specimen signatures of the officers authorised to sign on behalf of the NBFC-P2P to the Regional Office of the Department of Non-Banking Supervision of the Bank within whose jurisdiction the Registered Office of the P2P entity is located.
  9. Reporting Requirements 

The following quarterly statements are required to be submitted to the RBI within 15 days of the end of each quarter:

  • A statement, showing the number and amount in respect of loans (quarterly).
  • The amount of funds held in the Escrow Account.
  • Number of complaints outstanding at beginning and at end of quarter, and disposed of during the quarter.
  • The Leverage Ratio, with details of its numerator and denominator.

Are you a recognized Startup?

If you haven’t heard about the Startup India Initiative, then you’ve definitely been living under a rock! The initiative was launched last year with much fanfare to encourage entrepreneurship and promote sustainable growth within the Indian startup ecosystem. In fact, it was only in 2016 that “startup” was defined as a separate term[1] by the Department of Industrial Promotion and Policy (“DIPP”). But despite many incentives for startups such as tax benefits, credit availability etc. it wasn’t very well received by the startup community. After taking feedback and suggestions from various stakeholders within the startup ecosystem, the government reassessed its Action Plan and in May 2017 and the DIPP[2] notified a broadened definition of the term “startup” (discussed below), relaxed the norms for eligibility and made the process for recognition of startups much simpler. As a result of this much needed amendment as of now 3160[3] startups have been recognized and 67 out of those have already received funding support from the government!

[1] DIPP Notification No. G.S.R. 180(E) dated February 17, 2016

[2] DIPP Notification No. G.S.R 501(E) dated May 23, 2017

[3] http://startupindia.gov.in/ (last visited August 30, 2017)

The eligibility criteria for “Startup” recognition is now broader!

Having assisted multiple startups with their application for recognition, over a period of time we felt there was dearth of information regarding the relevant documents and the process of application. In this blog post we would like discuss the relevant details and information that an applicant must furnish as well as keep in mind the key parameters for the eligibility criteria for recognition of a startup. We hope to bring clarity and help many applicants realize their dream of being recognized as a startup.

But before we delve any further, it is imperative to understand the revised definition of a startup which will help in understanding the process of application and the key parameters that applicants must keep in mind. The broadened definition of startup is:

  1. It has to be an entity, i.e., a private limited company or an LLP or a registered partnership firm
  2. It should be less than 7 years’ old. In case of a biotechnology company, this limit is 10 years.
  3. The entity must not be formed by splitting up, or reconstruction of an existing business.
  4. It should not have annual turnover exceeding INR 25 crore in any preceding financial year.
  5. It should be working towards innovation, development or improvement of products or processes or services, with a scalable business model and can generate employment opportunities or wealth creation.

If an applicant fulfills the above mentioned criteria, then it may be eligible to apply for recognition as a startup.

Certificate from Incubator not mandatory anymore!

Let us now proceed to understand the application process, necessary documents and other relevant information that an applicant must furnish with its application:

  1. The application can be made online either through the DIPP web portal[1] or via their mobile app.
  2. Following documents are required to be submitted:
  • KYC (Know Your Customer) details, i.e., certificate of incorporation, registered office address, details about the directors or partners, authorized representatives of the company, number of employees etc.
  • Details of all or any intellectual property rights that the applicant may have registered or applied for. This includes the entire gamut of IPRs such as trademarks, patents, copyrights, design and plant varieties.
  • Identify the industry, sector and category.
  • To facilitate ease of doing business in India, the government has introduced self certification of the application. That means that it has eliminated regulatory and bureaucratic hurdles of obtaining recommendation and support letters from incubators and industry associations.

Once all the basic details regarding the entity are filled in, we come to the section that we believe can make or break the chances of receiving the recognition. Every applicant must keep in mind the revised definition a startup that is, an entity that is working towards innovation, improvement (existing product/service/process) and scalability. Applicants are required to submit a brief note highlighting how their startup is supporting these 3 key parameters in about 250 words. This section also requires the applicant to indicate the current stage of development of its product that is, whether it is in ideation, validation, early traction, or scaling stage. Apart from this, applicants may submit links to their website, any videos and press coverage of their entity. The application also requires applicants to submit a pitch deck, however, in our experience, essentially, the applicant has to submit an overview of their business and their business plan. Any document whether it is a brief profile of the startup, or an executive summary or a pitch deck that elucidates this would suffice

This sums up the application process for recognition of a startup. Unless there are issues, a certificate of recognition is granted within 3-4 days (sometimes even 1) of making an application.

Startup recognition can be obtained in less than 7 days!

It goes without saying that the Government has taken steps to simplify the application and kudos to the government for that. For instance, it comes as a huge relief that the self certification has been introduced and that the age limit for startups have been extended. But like all things new there are teething issues and of course, there are areas of concern that need to be looked at; for instance, we believe that at present the list of industries is not exhaustive. The Indian startup ecosystem is young and extremely dynamic. However, the list of industries is very limited and in our experience, a number of industries are missing from the list. This poses a huge problem for applicants. Kudos to the government for relaxing the age limit for startups, but we feel that there are many startups that have a longer gestation period and age limit of 7 years may be unfair to quite a few. Further, we also feel that a lot of startups may not be able to meet the criteria of employability and wealth creation in their early stages. Having said that, we also believe that the government has taken steps in the right direction. Over the next few years we hope to see favorable amendments that will benefit the entire startup ecosystem and give the Indian entrepreneurial spirit the impetus that it truly deserves!

The Valuation Game…What Does It Mean Exactly?

In this blog, we will be explaining the concepts of investment amount and valuations. The most basic of all concepts in an investment process – if you get these basics right then the rest of the process may become relatively easier (not necessarily painless!)

Most investors / VCs and entrepreneurs start the investment game / conversation with a statement that goes something like this:

Entrepreneur: “I am seeking a $1m investment in exchange for a 20% equity stake in my company.”

Or you will hear VC say: “We typically invest $2m (or our “sweet spot” is $2m) and we take a minority stake in the startup – typically in the mid to high-teens”

The Investment Game

Let us break down the terms in the figure:

  1. The investment or Investment Amount is the actual cash amount the investor will put into your company – so it is also called “New Money
  2. The Pre-Money Valuation is the value of the company before the investment happens
  3. The Post-Money Valuation is valuation of the company immediately after the investment happens

The Ownership % is the Investment Amount over the Post-Money Valuation, also referred to as dilution, i.e. we don’t want to give away more than 20% of our company…

Dilution

So, what comes first? Pre-Money, New Money, Post Money or Ownership %?

It is the New Money!

  1. The New Money is the exact investment amount / the actual cash amount the investor will put into your company; it is also the basis for your business plan.
  2. The valuation of the company is calculated based on a funded business plan – different amount of funding means different plan – so, it comes after the New Money coming in, so, it is called Post-Money or Post-Money Valuation.
  3. So, the pre-money valuation – the value of the company before the New Money came in – is the Post Money Valuation less the New Money – it is a derived number and comes last
  4. Here you can see that the promoter ownership got diluted from 100% to 80%, or by 20%. Remember the promoters did not sell any shares, the company issued new shares which diluted the promoters’ ownership

Once the money is in – it is old money, so, now when a new investment comes in the old investor’s shares get the same dilution as the promoter shares. Take a few minutes and work through this next round of investment – $5M new-money for a $25M Post-Money.

  1. Ownership the new investor or New Money gets is 5/25 or 20%
  2. So the older ownership stakes gets diluted by 20% – i.e. reduced by a multiple of 80% or .8 – so, 80% becomes 64% and 20% becomes 16%
  3. Pre-Money is $20M – so with the new round the value of the holders of the old shares went from $10M to $20M – i.e. the value doubled
  4. The Value of the company went from $10M to $25M or 2.5x

That jump in valuation is what each investor is looking for when they invest into their company with an expectation of what the eventual return would be for them and when. All the investment terms that go alongside the valuation and ownership are linked to the differences in yours and their expectations or around the risks or ensuring some minimum returns.

So, how much equity should an investor get for funding a business?

Exactly what his Investment Amount will buy him over the Post-Money Valuation that you can agree that you will create using the funding (Investment Amount)!