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Ownership Structure

The Meaning of Ownership

There are five possible meanings of ownership:

  1. financial return,
  2. participation in local/operational decisions,
  3. influence in global/strategic decisions,
  4. a sense of community, and
  5. fairness. 

The least popular of them is influence in global/strategic decisions.

From the perspective of perception gaps, the low discrepancy between managers and non-managers about the importance of these items is a positive sign. Managers and non-managers choose roughly the same importance rating for each item, and they tend to rank order the five aspects in almost the same way.

Within some companies, however, there are sharp differences. At one client, managers feel that financial return was the least important aspect of ownership; non-managers feel that it is the most important one. But on the whole, managers and non-managers seem to be starting from roughly the same place when they think about ownership in the abstract.

The business is owned jointly by the founder members, investors and by the employees. However, the extent to which they own the same differs from company to company. But generally 30 to 35% of the company is held by the founder members, another 25 to 30% is held by the investors (angel investors as well as venture capitalists) and the rest is owned by the employees other than the founder members.

Rights of the Investors

The extent of ownership is not fixed for all the companies. How much stock the founders keep depends largely on how much money they need to raise, how they plan to structure that financing, the intrinsic value of the business and what the long-term opportunities and upside are. Initially, no passive investor should want to own a majority of the business. The initial investment round should never exceed 35 percent to 40 percent ownership of the company.

When it raises additional sums, it's a reasonable goal to double or triple the valuation for each round -- as long as it has been successful in meeting benchmarks and the company is making significant progress. To demonstrate the importance of increasing the valuation over time, as it raises additional capital, for an example: If you raise $2 million for 25 percent of the company on the first round and you are successful at doubling your valuation on the second round, you will only have to give 11 percent of the company for the second $2 million.

Here is the calculation:

  Value of the company   Ownership   
    Pre-series A Post-series A  Post-series B
Series A Pre-money valued 6 100% 75%  
Series A investment   25%   
Total 8   100%  
Series B Pre-money 16     89%
Series B investment 2     11%
Total 18     100%

No matter what valuation one gets, keeping a controlling ownership interest in one's company, over the long term, should not be one's goal. Maximizing the value of the entrepreneur's ownership is much more important. Typically, after the second round of outside investment, the founders will have given up voting control of the ownership. At the time of a public offering, one should consider oneself highly successful if the founders have retained 20 percent of the company, 20 percent is in the hands of management, and 60 percent are in the hands of outside investors.

Investors' Required Share of Ownership

Various investors will require different rates of return (IRR) for investments in different stages of investment and will expect holding periods of various lengths.

The investor's required share of return is calculated as follows:

                                                     Future value of investment
Share of ownership required = --------------------------------------------
                                                    Future value of the company

The summary of the ranges of the annual rates of return that venture capital investors seek on investments in firms by stages of developments and how long they expect to hold the investment is given below.

Rates of Return Sought by Venture Capital Investors

Stage 

Annual ROR %

Typical Exp Holding Period

Seed and start
First stage
Second stage
Expansion
Bridge and mezzanine 
LBOs
Turnarounds

50-100%
40-60% 
30-40
20-30
20-30 
30-50
50+

more than 10 (yrs)
5-10
4-7
3-5
1-3
3-5
3-5

The extent to which properties and cash will be used is decided by the board members. This varies from one company to another.

There can exist various incentives like ESOP for the employees to remain in the company. Employees can be offered ESOP and in turn they become owners of the organization. This involves them in various decision-making programs of the company and also they feel like the owners of the company. Managers in employee-ownership companies tend to feel more like owners than non-managers do, and the difference is substantial. Managers exercise more of the rights of ownership, and they often own a larger portion of the company stock.

The founder members cannot leave the organization until either it reaches the IPO level or is sold out. Even if the founder is forced out of the company, the company is subject to pay the share held by him in the company.

Source: IndiaCo

 

 
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