General Counsel
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There has been quite a bit of chatter over the last couple years about a tech bubble -- increasing hype which drives increasing valuations and increasing funding rounds beyond what the companies are actually worth. This article is a natural reaction to that. In it, the author questions whether funding announcements are actually a mark of success or of failure:
"I'm concerned a little bit with the culture of celebrating the fundraise," he said. "My dad taught me that when you borrow money it's the worst day of your life. We didn't clap for Red Rover [who spent time raising revenue instead of funds] because they didn't raise $6 trillion, but I was sitting here like, 'Good stuff!'"
Clearly, building revenue is the goal of any startup. But we mustn't overlook the fact that funding in this environment matters for two reasons: validation and expertise. To a certain extent, receiving a funding round from either an investor or a syndicate of investors gives some credibility and visibility to a startup by saying, "Hey, we like your business model and think it has a chance to succeed." As they say, success begets success; scoring a financing round from serious investors is like a badge of honor that can be used to grow and raise additional funds. It is not a guarantee of success, but it certainly helps.
But even more important, investors will take an active role in the company to protect their investment, which can be both good and bad for founders. The bad side is giving up a chunk of equity ownership and control of the company, but the good side is that you now have an experienced partner to add to your team.
That being said, it can certainly be a two-edged sword. The effectiveness of your relationship and the quality of that guidance is only as good as your new investor partner. I know of horror stories of investor relationships that sour and cause headaches (or worse) for founders. But under the right circumstances, investor funding is an infusion of credibility and guidance, in addition to the capital, and that, indeed, can be something to celebrate.
Here are two questions that I get often. Should the founders of a startup company divvy up all of the stock? If not, how do I calculate ownership percentage? In order to answer these, we have to review the difference between authorized shares and outstanding shares. At formation, a company must state the number of total shares that are authorized under its charter document (the name of the charter will vary by state but will be called Articles of Organization, Certificate of Formation, or something similar). This is the "bank account" of stock for the company and represents the maximum number of shares that stockholders can own. Once you give out this stock, you need to amend the charter before you can issue any more. However, the authorized shares do not represent ownership in the company (see below).
The authorized number is different from the issued stock. The issued (or "outstanding") shares have actually been given to stockholders.
The ownership percentage of a company is calculated entirely by the issued shares. Say, for example, your company authorized 10,000,000 shares and issued 1,000,000 shares to each of two founders (a total of 2,000,000 outstanding shares). That means that the two founders each own half of the outstanding shares or 50% of the company, and there are still 8,000,000 shares to issue.
If the company then issues 500,000 shares to third founder, then the ownership percentages change based on the new outstanding number (2,500,000). Therefore each 1,000,000 to the first two founders now represents 40% of the company and the third founder now owns 20%.
Generally, a company wants the number of issued shares to be fewer than the number of authorized shares because a company will want to leave some shares in the "bank account" to issue at a later time without having to update its charter. However, the number of authorized shares and the number of issued shares is arbitrary; in the above examples you could cut all of the numbers in half or by a third and the percentages would work out the same.
This gets a bit more complicated when you add in stock options, which are contracts given to holders for the right in the future to buy shares at a certain price. Even though the stock option shares are not issued until the option is exercised, the company still needs to reserve that number of shares so it doesn't go over the total authorized number. So before the options are exercised, the actual ownership percentages stay the same (because the shares have yet not been issued). But the company may then refer to its "fully diluted" ownership, which means the ownership percentages as they would be adjusted assuming that all of the options get exercised.
Even as Washington gridlock becomes the norm, ideas continue to circulate about kickstarting the sputtering U.S. economy. Everyone seems to agree that startups and other small businesses will lead a renewed hiring boom and increase demand, but not everyone is in agreement about how to get there. There are some ideas, however, that continue to move forward. Jeff Bussgang of Boston's Flybridge Capital Partners has highlighted some of them recently in an article that is worth reading, and points out this remarkable stat:
The Kauffman Foundation's research on this matter is clear: From 1997 to 2005, job growth in the US was driven entirely by start-ups.
The Startup Visa and government investment in innovation were also topics of this blog in that past in addition some other ideas like the green card visa. The U.S. needs to make it easier for businesses to start here, and then make sure that we attract as many of the world's leading scientists and entrepreneurs to make it happen.
As Congress dithers over process and campaign year politics, it is hard to understand why there is not more urgency on this vital area of economic development.
Startups often struggle because of how they are set up. Too often founders will treat a new company like a budding relationship: you get all excited about your idea, you seem to agree on everything, and then you move in together. Relationships built on that kind of whirlwind courtship often end up in failure, and startups are no different. It is critically important for co-founders to have the detailed conversations about their business, their working relationship, and many other topics that they will have to deal with as the company grows. In fact, we have discussed this here on a few occasions (see Founders Series Parts I, II, and III.
One of the people who knows this best is Dharmesh Shah, successful entrepreneur and c0-founder of HubSpot. He recently published a list of the most important questions that co-founders need to resolve as soon as possible when starting a new business. If you are in the process of starting a business, stop what you are doing and read it.
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