Hey folks. Without going into all the how’s and whys, I need to get a good answer to a simple question: What is “founder’s” stock?
I have looked at all kinds of glossarys for financial terms, checked the Fool, Etrade, Yahoo finance, etc. It appears nowhere. But my attorney mentioned it to me in an important context. He sort of explained it, but I like to educate myself thoroughly before I make a move.
Can anyone point me in the direction of some information about this?
This site: http://www.emergecorp.com/research/glossary.html says:
It’s just a type of ‘preferred’ stock. That is, the shares are special in that they have extra privileges.
Preferred stock may have benefits such as “If the company is bought, preferred stock holders get money before common stock holders”, or whatever.
I’d imagine that the stock would be issued in such a way that if they founders sold a portion of it, that portion would become common stock.
Any CPAs or CFOs out there?
Stoidela, founders shares are not associated with special voting privileges.
Here’s how it works: Suppose you and I start a business in our garage. We borrow some money from Aunt Martha, we get an idea, maybe a prototype together, then we need real money. So we form a corporation. We set an initial price for the stock at a very cheap price, say $0.0001 (1/100 of a penny). Now, we each throw in $100 and buy 1M shares each. These are the initial pool of common stock, known as founders stock. At this point, we each own 50%.
At this point, we go to investors. Let’s say we’re looking for $1M. Between us (the founders) and the investors, we set a value that the company is worth at this point. Let’s say we come up with $4M, a typical number at this stage. Now, our company is worth $4M, and the investors give us $1M, meaning the company is now worth $5M. The $4M is known as the pre-money valuation and the $5M as the post-money valuation. By putting in $1M, the investors have bought 20% of the company ($1M divided by $5M). To do this, we print up another 500K shares and sell them to the investors at $0.50 each for a total of $1M. This measns there is now a total of 2.5M shares outstanding. The additional 500K shares is known as the Series A round.
At this point, you and I still own our original 1M shares each. And since shares have crossed hands for $0.50 each, it implies that our shares are each worth that value, so though you now have seen your equity drop from 50% of the company to 40%, your value has risen from $100 to $500K. Of course, that’s only on paper. We have to go liquid to actually see anything.
Each additional funding round goes through the same process. You lose a percentage of the company, but hopefully each share has gone up in value, so that your piece of the pie goes up in value.
Now, to the original point about voting rights. Common shares, which is what the founders have are the real shares. The preferred shares that the investors have will have the option to be converted into common shares if the company goes anywhere. And they will typically not have any voting rights. So, it’s not that the common shares are special in that they have voting rights, it’s that the preferred shares are special in that they don’t.
Are you starting something up? Are you in the high-tech world? If so, you’re welcome to e-mail me. I’ve been through this a few times.
Er, there’s a math error in there: Series A goes out at $2/sh, not $0.50. As a result, your post-money 1M shares are worth $2M, not $500K.