CORPORATE GOVERNANCE

Issuing Ownership to Outside Investors

Allowing outside investors is a great opportunity to gain additional funds for your company, as well as more individuals interested in helping your business grow.  With additional investors comes added focus on how your business is controlled/governed, because it is no longer just you owning the company.  When allowing additional investors, it is important to clearly define the relationship between you, your company, and these new investors.

If your business is a corporation (which is a requirement for businesses raising on Equivesto), it is a separate legal entity to you.  A corporation has its own rights and protections, which can in turn protect you.  When you were the sole owner of your business it wasn’t necessary to define this relationship in detail, because there was no one else involved.  With external investors, it is now time to document the details of that relationship. 

On Shares

Corporations are owned though shares (equity/stock).  Shares are the actual pieces of ownership of a business.  When a business is incorporated for the first time, the Articles of Incorporation dictate the number of shares being created, and those shares are issued directly to the founders of the business at that time.  Most businesses issue 100 shares at the time of incorporation.  When incorporating, a business must also choose at least one director.  A director is an individual who is responsible for the management and control of the organization (Find the section on Directors below for more information).  The founder is often the first and only director at the time of incorporation.  

Issuing Shares

Businesses are not limited to issuing only 100 shares.  Businesses, being separate legal entities, have considerable flexibility when it comes to how their ownership is organized.  At any time, the business can issue new shares, which they can give to employees as incentives for good work (employee stock options) or can be sold to individuals in exchange for money.  This exchange, shares for money, is how investing in a business takes place.  A business seeking investment issues new shares, which are bought by new investors.  It is important that the new investors buy new shares issued by the business, rather than the existing shares of the current owner.  If an investor buys the existing shares from the owner, they are giving the money to the individual, and the individual is selling their portionof the business, but the money is not going to the business itself.  

Imagine a small pie that represents the ownership of your company, divided between yourself and your original investors. When you get new investment for your company, you are making a new, bigger pie and selling a piece of it.  The pieces of the bigger pie held by you and any original investors equals the total size of the small pie.  If you simply sell your own shares to someone else, you are selling pieces of the small pie without it getting any bigger.  

Dilution

The act of issuing new shares of the corporation increases the total number of shares existing for that corporation, and as such, changes the ownership percentage of the shareholders.  When a business is incorporated with 100 shares, the founder owns all 100 shares and owns 100% of the business.  If an investor invests in the business (buying 20 shares for example), the business would issue 20 new shares, which would be sold to that investor.  There would now we 120 total shares in the business, 20 for the new investor and 100 for the founder.  The founder would now own 83.33% of the business.  This act dilutes the ownership of the founder but allows new money to flow into the business.  

Like our pie example, the size of the piece of pie you own has not changed, but the pie itself has gotten bigger, so the percentage of the total pie you have is now smaller.