Funding works by spitting the equity pie with Investors. The opposite of funding is 'bootstrapping', the process of funding a startup through your own savings. Every time you get funding, you give up a piece of your company. The more funding you get; the more company you give up. That 'piece of company' is 'equity'. Everyone you give it to becomes a co-owner of your company. Splitting the Pie
The basic idea behind equity is the splitting of a pie. When you start something, your pie is really small. You have a 100% of a really small, bite-size pie. When you take outside investment and your company grows, your pie becomes bigger. Your slice of the bigger pie will be bigger than your initial bite-size pie. When Google went public, Larry and Sergey had about 15% of the pie, each. But that 15% was a small slice of a really big pie. Funding Stages We can consider a hypothetical startup and will see how it gets funding. Idea stage At first it is just you. You are pretty brilliant, and out of the many ideas you have had, you finally decide that this is the one. You start working on it. The moment you started working, you started creating value. That value will translate into equity later, but since you own 100% of it now, and you are the only person in your still unregistered company, you are not even thinking about equity yet. Co-Founder Stage As you start to transform your idea into a physical prototype you realize that it is taking you longer (it almost always does.) You know you can really use another person’s skills. So you look for a co-founder. You find someone who is both enthusiastic and smart. You work together for a couple of days on your idea, and you see that she is adding a lot of value. So you offer her to become a co-founder. But you can’t pay her any money (and if you could, she would become an employee, not a co-founder), so you offer equity in exchange for work. But how much should you give? 20% – too little? 40%? After all it is YOUR idea that even made this startup happen. But then you realize that your startup is worth practically nothing at this point, and your co-founder is taking a huge risk on it. You also realize that since she will do half of the work, she should get the same as you – 50%. Otherwise, she might be less motivated than you. A true partnership is based on respect. Respect is based on fairness. Anything less than fairness will fall apart eventually. And you want this thing to last. So you give your co-founder 50%. Soon you realize that the two of you have been eating Domino’s Pizza every time you meet. You need funding. You would prefer to go straight to a VC, but so far you don’t think you have enough of a working product to show, so you start looking at other options. The Family and Friends Round: You think of putting an ad in the newspaper saying, “Startup investment opportunity.” But your lawyer friend tells you that would violate securities laws. Now you are a “private company,” and asking for money from “the public,” that is people you don’t know would be a “public solicitation,” which is illegal for private companies. So who can you take money from? 1. Accredited investors – People who either have Rs.10 Crore in the bank or make Rs.2 Crore annually. They are the “sophisticated investors” – that is people who the government thinks are smart enough to decide whether to invest in an ultra-risky company, like yours. What if you don’t know anyone with Rs.10 Crore? You are in luck, because there is an exception – friends and family. 2. Family and Friends – Even if your family and friends are not as rich as an investor, you can still accept their cash. That is what you decide to do, since your co-founder has a rich uncle. You give him 5% of the company in exchange for Rs.1,50,000, cash. Now you can afford planning expenses and Dominos for another 6 months while building your prototype. Registering the Company To give uncle the 5%, you registered the company, either through an online service like LegalZoom, or through a lawyer friend. You issued some common stock, gave 5% to uncle and set aside 20% for your future employees – that is the ‘option pool.’ (You did this because 1. Future investors will want an option pool, 2. That stock is safe from you and your co-founders doing anything with it.) This post will be updated soon |
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