corporate share structure

In the 1987 film “Wall Street”, Michael Douglas in playing the lead role of Gordon Gekko proclaimed “Greed, for lack of a better word, is good. Greed is right. Greed works. Greed clarifies, cuts through, and captures, the essence of the evolutionary spirit….”

Well what does greed have to do with share dilution and the entrepreneur?

Simply, in order to get capital an entrepreneur has to give up a portion of his or her company. Many entrepreneurs do not have deep pockets to delve into to feed their cash starved ventures – so they must ask investors for cash. For some entrepreneurs this becomes a tremendously agonizing and emotional decision since the thought of giving up a percentage of the company and thus potentially control of the company is untenable. The problem – the entrepreneur’s unbridled ego and an unabated view of fear and, yes, greed of giving up something of higher value than the utility that cash can bring. This can blur vision of getting the capital needed to get a company to the next stage of important development.

However, let’s take a step back. In the beginning a start-up company entrepreneur owns a 100% of the company. Sounds impressive, but a 100% of a high risk venture, with no revenues just expenses and a great deal of hope is really 100% of nothing. When cash is needed an entrepreneur has to raise money and it’s the issuance of shares that triggers ownership dilution. This is good dilution because when investors see value they expect a favorable return which means the company must have some accretive promised value.  So all things being equal, if an investor acquires 40% of the company for $500,000 and this $500,000 can create even more enterprise value, then the entrepreneurs 60% is worth more than the 100% initial ownership. Good dilution means a share unit has increased in price and when multiplied by the number of shares held by the entrepreneur it means an overall appreciated value of his holdings. (more…)