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I have an Invention ... Now What?
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   Starting New Company?
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Gattaca
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Starting New Company?
« on: Dec 3rd, 2004, 3:57pm »
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Hey guys I have a few questions that I have about this whole process.
 
1) If all the money comes from investors does that mean you have 0% of the ownership? Or does the % vary from contract to contract? If it does what is the normal % that the investor usually gets?
 
2) If a company fails, do you owe the investors anything?
 
Thanks
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JSonnabend
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Re: Starting New Company?
« Reply #1 on: Dec 6th, 2004, 7:25am »
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on Dec 3rd, 2004, 3:57pm, Gattaca wrote:
Hey guys I have a few questions that I have about this whole process.
 
1) If all the money comes from investors does that mean you have 0% of the ownership? Or does the % vary from contract to contract? If it does what is the normal % that the investor usually gets?
 
2) If a company fails, do you owe the investors anything?
 
Thanks

 
1) It depends on the structure of the transaction.
 
2) It depends on whether certain formalities (e.g., Reg-D) were followed, as well as the structure of the transaction.
 
- Jeff
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JimIvey
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Re: Starting New Company?
« Reply #2 on: Dec 6th, 2004, 6:10pm »
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Okay, let's see if I can even begin to answer this question....  First, I barely understand the startup model of the late 1990s.  Second, I'm not sure it applies anymore.  Since I barely understand an obsolete model, don't hold me to any details -- especially the numbers.
 
You should never be left with 0% ownership, unless you're selling your idea(s) and business model outright.  
 
Typically, there are 2 or 3 rounds of financing.  In each round, you promise to raise a certain amount of money.  Once you do, all investors are bound.  If you fail to reach that amount in committed investments, the round "falls through" and each investor takes their money back -- no deal.  And, you promise to do something with the invested amount -- build a prototype, bring something to market, become profitable, etc.
 
In the first round, you try to raise enough money to build a proof-of-concept prototype.  You try to sell no more than about 10-25% of your company.  The typical numbers here are a couple hundred thousand to just a few million.  The investors at this stage are generally referred to as "Angels" and are most often wealthy individuals.
 
Once you have the prototype, you try to raise enough money to go to market and start earning revenue -- maybe even become profitable.  You try to sell another 20-30% of your company.  The investors at this stage are generally referred to as "Venture Capitalists" (VCs) and they tend to represent funds -- accumulated money of wealthy individuals and perhaps arbitrage divisions of companies.  Most VCs won't even look at your idea if you can't justify spending at least $3million with a good change at a ten-bagger -- 10x return on investment.
 
One you're making money and are perhaps profitable, you may try to raise money to expand to other markets.  I don't know much about this phase.  Sorry.  At this stage, even banks will get into it.
 
When you're hunting for an IPO (initial public offering) or some other exit strategy (where everybody gets paid), a good distribution is about 25% for the initial founders, 50% or so for investors, and 25% as a pool for key employees (stock options for officers such as CEO, COO, CFO, CTO, VPs, etc.).   For an individual officer/VP, 1% is good and 3% is great.  
 
Then, you go public, cash out, and buy the Dallas Mavericks and produce your own reality show staring yourself and a bunch of young, desparate wannabes who all try to really impress you and film yourself being impressed, sort of.
 
See?  I told you my model was obsolete.
 
For many smaller businesses not aiming to catch the fiscal "big surf", you might be able to get buy with just a single round of smaller investors.  Just do the math.  Think about how much money you want to make and how much profit your idea will generate (will, not could).  Make that the percentage you'll own when your "in business."  Map out how you'll get from "here" to "there" selling off no more than that percentage.
 
Of course, the further you go with less investors' money, the better off you are.  You can go further without selling off more of your company and you can ask for more money in exchange for less of your company the closer you are to turning a profit (and the more uncertainty you've eliminated).
 
In case it's not entirely clear, I am by no means an expert in this area.  I've only scratched the surface here and probably didn't scratch it in the right places.  This question is merely a distant cousin of patent law, so there's not much more I can say about that.
 
I hope that helps, nonetheless.
 
P.S.  Since the dot-gone phenom, I read somewhere that angels are acting like VCs (requiring revenues) and VCs are acting like banks (requiring a showing of profits).  There has been a bit of investor cannibalism out there.  For what it's worth, my unofficial observation is that things are slowly getting better -- less desparate.
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