While raising funds, I was asked these questions countless times:
1) Will you raise more money and dilute my stake in the company?
2) You said you wanted to raise £150k and now have raised £200k. You have already diluted my stake …..
It is IRRELEVANT.
The questions that you, as an investor, should be concerned with are:
1) What is the value of my shareholding now?
2) Do I believe this value will increase over time?
These are the fundamental principles underlying all investment decisions.
A high-level simple test is to ask yourself this: Which investment has a higher value, owning 10% of £1m business or 1% of a £10m business? The answer is obvious – they are both worth exactly the same (£100k). Also, when you buy shares of a public company, e.g. Apple, do you care about the % stake in the company? No, you are only interested in what you are paying for the shares now and what you think they may be worth in the future.
Let’s break this down to understand different scenarios that angel investors face. Some of these concepts may be difficult for the less finance savvy people, but for an entrepreneur or an investor, I can’t reiterate how important these concepts are.
Scenario 1 – Assume that a company is raising £100k at a pre-money valuation of £1m
If you didn’t understand the table above, here are the detailed workings:
PRE-MONEY
Valuation: £1m
Original number of shares: 10,000
Price per share: £100
NEW INVESTMENT
Money: £100k
Additional shares issued: 1,000
Price per share: £100
POST-MONEY
Valuation: £1.1m
Total number of shares: 11,000
Price per share: £100
YOUR INVESTMENT
Money: £10k
Number of shares allotted: 100
Price per share: £100
Stake in the business: 0.91% (100 shares / 11,000 shares)
Value of your shareholding: £10k (100 shares x £100 per share)
Scenario 2 – Company raises £200k instead of the planned £100k
NEW INVESTMENT
Money: £200k
Additional shares issued: 2,000
Price per share: £100
POST-MONEY
Valuation: £1.2m
Number of shares: 12,000
Price per share: £100
YOUR INVESTMENT
Money: £10k
Number of shares allotted: 100
Price per share: £100
Stake in the business: 0.83% (100 shares / 12,000 shares)
Value of shareholding: £10k (100 shares x £100 per share)
As you can see, even though your stake in the company has decreased from 0.91% to 0.83% the value of your shareholding remains constant at £10k.
After a year, the company raises £1.2m at a £3.6m pre-money valuation
PRE-MONEY
Valuation: £3.6m
Original number of shares: 12,000
Price per share: £300
NEW INVESTMENT
Money: £1.2m
Additional shares issued: 4,000
Price per share: £300
POST-MONEY
Valuation: £4.8m
Number of shares: 16,000
Price per share: £300
YOUR INVESTMENT
Number of shares: 100
Stake in the business: 0.63% (100 shares / 16,000 shares)
Price per share: £300
Initial invested money: £10K
Current value of your holdings: £30K
Even though your stake in the company has decreased from 0.83% to 0.63%, the price per share has increased from £100 to £300 and your £10k investment is now worth £30k!
In Summary
Based on the above analysis, in scenario 2, your investment was worth 0.83% of the business. After the £1.2m raise, although the proportion of your investment has decreased to 0.63%, the value of your £10k initial investment has tripled to £30k. Therefore, the percentage of your stake in the business doesn’t matter, the value and the share price of the business are your main concerns.
Of course, you want the entrepreneur to raise the right amount of capital for the business, but that’s a conversation for another time…
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