When starting a company, it may be difficult to properly determine the number of shares to allocate to investors. However, various experts and venture capitalists have highlighted a rule of thumb to follow in order to properly allocate shares in the early stages.
When splitting the shareholding "pie", or diluting (i.e. issuing additional shares), the pie will increase in size as you get more investments. This is beneficial for your company as it allows for greater growth at a faster rate. However, with each additional investment, you lose control of your company little by little. That is why it is advisable to accept investments only when needed, from trusted and respected individuals.
Generally, investors, or a group of investors, will want to own 25-33% of the company. That number can climb to 40% if, for example, you have two venture capitalist who both want 20% of the pie. If you are giving away 40% of your company, you should seek a greater amount of money from investors.
It is generally not advisable to give out small portions of equity stake in the company (e.g. 1 to 5%) to family, professional advisors, and the like, because the return is often minimal and the investors may interfere with your company’s growth prospects, which are normally fuelled by professional investors. It is also important to keep an option pool, so as to reward employees in the future when they contribute to growth and success. It is recommended to reserve approximately 10-15% of the company’s stock for future employees, but this is not at all mandatory and varies between companies.
When proceeding with issuing equity stake for investments, you need to have a proper valuation of your company so that the investor knows his stake in your company and the amount to invest. Pre-money valuation is the valuation of the company prior to the investment, whereas post-money valuation is the valuation of your company after the investment, equal to the combined total of the pre-money valuation and the amount of new equity.
When it comes to dilution of your ownership in the company, there are various degrees of dilution at each stage of investment. In the seed round, where most investments are from angel investors and family, it is usual to see 10-25%. When in Series A, it is expected that the dilution will range from 25% to 50%. In Series B, 33% is typical. You need to remember that investment in each round is to allow the company to attain a particular milestone, enabling the company to raise greater amounts at each stage, thereby increasing its valuation.
These figures are guidelines; your actual strategy may differ. The owner of a company may decide to allot shares in different ratios and to accept investments from particular individuals rather than others. It all comes down to preference and personal strategy. For further information, please visit the links below: