Startup to IPO How the Founders Shareholding Changes

In this video I’ll discuss how the shareholding of a company evolves from a start-up all the way through to a public listing on a stock exchange, which is also known as an Initial Public Offering or IPO. I’ll explain what some of the jargon means and hopefully demystify some of the concepts, so let’s enjoy the video together.
To illustrate this journey, I have used the data of over 700 IPOs in my charts. Our journey begins with two partners starting a software company, who have equal shareholding and self-fund the business. However, after a few months they run out of money and need a cash investment to employ more coders in order to grow the business. They apply for a loan from a bank which is rejected as the business is a fledgling start up with no positive cashflow.
The only option left is to approach a wealthy individual, known as an angel investor, to invest in their business. One of the key benefits of an angel investor is that the founders are not required to repay the investment amount AND there are no interest payments either. They are required, however, to give away a portion of the shareholding which essentially amounts to future profits. A typical shareholders breakdown for the Angel Investor stage looks like this.
Experienced angel investors know what the optimum shareholding allocation should be in order to keep the co-founders motivated while covering their own risk.
Around 10% of the shares are usually set aside to entice key employees to join the company. A small percentage, usually 5% it set aside for advisors, typically influential individuals, who lend it credibility and help open doors to key decision makers.
To ensure that the employees remain committed to the business, their shares are vested. This means they earn the ownership of their shares over time. A typical vesting schedule looks like this. In this example a million shares are vested over four years with a one-year cliff. This means that if the employee leaves the business within a year, they do not receive any shares and if they leave after one year but before 2 years, they only receive a quarter of their shares, which in this case it will be 250000 shares. The employee will only receive the full balance of their shares after 4 completed years of employment with the company.
In our example, a further year has passed, and the business now requires another big cash injection to maintain its growth trajectory. The investment amount required is too big for the Angel Investor, so we enter the world of Venture Capital. These are firms which invest other people’s money in promising new businesses. Venture Capital Firms usually invest in stages known as rounds. For example, round A round B, C D etc. with each round requiring a larger investment.
This chart is a typical ownership breakdown for Round A Venture Capital. In my example some of the money was used to buy out the angel investor, while the balance was spent on growing the business. It is unusual for a Venture Capital firms to buy out existing shareholders as they would prefer to spend the money on growing the business. To do this they authorised new capital and issue these new shares to the VC firm. In practical terms this means the money flows directly from the VC firm into the business. This is different from buying out the Angel Investor as the money is paid directly to the Angel Investor who exits the business with his share of the money with no benefit to the company.
Let’s fast forward to round C and you can see that the VC firm now owns the lions share of the company. The VC shares are almost exclusively preferential shares which means they get priority pay-out in the case of liquidation as well as dividend pay-outs and automatically convert to ordinary shares at the time of the IPO. The founders have ordinary shares which means they have the voting rights to control the company.
This line graph illustrates the change in ownership for each VC investment round, you can clearly see how the founder’s shareholding in orange reduces.
The final stage in the evolution of our company is the IPO which is when usually around 30% extra new shares are created to sell to the public. These shares are underwritten by an investment bank, which guarantees the sales of the shares at a set price. This safety net comes at a price as the investment banks charge between 3.5 and 7% per share which can be very expensive for the company.
It also means that that the founders shares are further diluted as well as their voting power. To counter this companies like Facebook and Google created Class B non-listed shares which has 10 votes for every one share and this allows the founders to keep the voting control of their company.
The following graph does show that despite the dilution of the founders’ shareholding, the overall value increases exponentially from inception through the funding rounds all the way to the IPO.

[@morgankaye8888]

Super interesting Douglas. Thanks for this. Interesting to see the employee portion gets smaller and smaller with each round.

[@swiftreg]

Glad you enjoyed it

[@juliusmubajje7510]

Hi Douglas great content once again.
I have an idea I would like to present to you. It’s in the area of company registration and compliance. Since you are in the same field, I thought you might find it interesting.
How can I have a short meeting with you to evaluate. Even 30mins will be fine.
Thanks

[@swiftreg]

Hi Julius, thank you for the compliment, sure I am happy to chat. Please send me a Zoom or Teams meeting to [e-mail]

[@juliusmubajje7510]

@@swiftreg Alright then, what time slot can schedule please?

[@swiftreg]

@@juliusmubajje7510 I can do 11h00 tomorrow.

[@juliusmubajje7510]

@@swiftreg Alright. I’ve sent the G-meet invite please. Thanks.