Owning stock in a private company

**Chrisknight** · 07-27-2009 12:52 AM

I am thinking about investing in a private company. It's a tech company which hopes to be bought out someday. If I bought 1% of the companies stock then the company was "bought" by Ebay or whomever, would I then receive 1% of that sale price. For example, if Ebay bought the company for 1 million dollars, would I get a check for $10,000?
Let's assume it's preferred stock.
Obviously, it is different depending on what sort of deal I struck with my company, but what usually happens?
Thanks!

**ciaossu** · 07-27-2009 12:54 PM

Thats not how it works. Regular stock are not commonly set up legally to be sold outside of the company and as an investor, you must legally either be doing a bridge financing round that potentially could convert to stock OR be a series A investor that gains X number of shares of stocks. The actual % or number of shares is the negotiable part. You can't just flat out buy common stock in a company and preferred stock is only given out with an actual finance round. That said, there are key exceptions to this rule but hardly ever the right way to go about it.

**mikedahmongboy** · 07-27-2009 02:31 PM

I 2nd that.

**Chrisknight** · 07-28-2009 11:26 AM

Sorry, I guess I didn't make it clear that I work for the company. And, you're right, I will be buying common stock.
So, my question still stands, if I buy 1% of the company's stock, then that company gets bought out by Ebay (or whomever) then will I get 1% of the sale?
Thanks!

**ciaossu** · 07-28-2009 12:00 PM

Yes and no. The answer is quite complicated.

Common stock in any given company is considered allocated stock. There is also unallocated stock that has yet to be issued. Every company has a fixed number of stock they set (S Corps have limitation and C Corp has no limitation but there is a standard number most company set).

100% of the company ownership is dependent on the allocated stock, HOWEVER, the unallocated stock is taken into consideration during any merger, buy out, or change of control. That said, even if you invest in 1% of the company, and any experienced professional will tell you determining base on % is a flawed argument, there is the possibility of dilution between now (the time in which you buy stocks) and later (up to the point of buy out) if new shares are injected into the equation (i.e. someone else buying stocks which dilutes your shares).

To simplify this in a way you can easily understand this, lets assume that the company currently has 99 shares of stock allocated. If you buy 1 share, you now own 1% (like you wanted) and the company has a total of 100 shares of stock (hence 1 over 100 = 1%). Lets presume that the company hasn't sold in 3 months and someone else buys 1 share of stock. Now the total company shares is 101 and your 1 share is now worth less than 1% because of dilution.

Lets try to simplify this even further... Lets assume that between the time you invest and the time of the buy out that no one else has ever invested in common stock in the company, did the company raise funding for preferred stock, did it not. Preferred stock has a higher value than common stock and now you must determine the value of each stock after all the values of the preferred stocked is determined.

Then to complicate matters more, at the time of the buy out, the majority owners, the board, etc... will vote on how many multiplier they will allow the buyout to occur at. Depending on this decision of the buyover and the conversion of the current company stock to the new company stock, it may cause the common stock to be higher or lower in value.

Long story short, its actually more complicated than that and determining your stocks value isn't as simple as the question you proposed. Can it be 1% of the sale, yes. Will be it? More than likely not but again, it depends on the factors above and several I won't even bother listing here because this is literally a 50 page discussion to explain the whole process.

**awayoflife** · 07-30-2009 08:57 AM

Fantastic answer ciaossu!

**KaininConway** · 08-16-2009 12:05 AM

@ciaossu Nicely written. That was fantastic.

**StealYourDreams** · 08-19-2009 06:28 PM

Originally Posted by ciaossu

Thats not how it works. Regular stock are not commonly set up legally to be sold outside of the company and as an investor, you must legally either be doing a bridge financing round that potentially could convert to stock OR be a series A investor that gains X number of shares of stocks. The actual % or number of shares is the negotiable part. You can't just flat out buy common stock in a company and preferred stock is only given out with an actual finance round. That said, there are key exceptions to this rule but hardly ever the right way to go about it.

Sorry, that is wrong.

You are correct however on your discussion of dillution. You may want to use issued/authorized going forward. Otherwise good information.

**ciaossu** · 08-19-2009 07:15 PM

I'm not sure where that is wrong. It is very uncommon for a company to sell common stock outside of the company. Common stock is typically only issued within the company itself, with very rare exception as mentioned in the last line. One being Facebook itself. As for being an investor, where else when dealing with stocks do you see a potential other than bridge financing or Series A? Please clarify

**StealYourDreams** · 08-19-2009 07:47 PM

Originally Posted by ciaossu

I'm not sure where that is wrong. It is very uncommon for a company to sell common stock outside of the company. Common stock is typically only issued within the company itself, with very rare exception as mentioned in the last line. One being Facebook itself. As for being an investor, where else when dealing with stocks do you see a potential other than bridge financing or Series A? Please clarify

I dont know where you heard this. Sometimes when information, or advice, is passed from one person to another it is often taken as fact without any further inquiry.

In fact, it's actually quite common to sell to sell common stock outside of the company. This, of course, assumes the company is seeking financing.

Lets say you start a company and intend on an IPO / merger/ self filing as an exit. You tapped your personal funds and get your family, friends, and anyone who believes in you to invest seed capital. If you expect a later round of financing, especially if you plan of getting either angel or venture capital, they dont want to see any preferred issued. You're better off issuing common stock.

Also, I cant answer the latter part of your question because I'm not exactly sure what you're asking.

Save the preferred for an institutional level investor and issue common to everyone else.

Keep in mind there is more than one way to skin a cat and nothing is ever set in stone. Financing options are only limited by your imagination.

**StealYourDreams** · 08-19-2009 07:50 PM

Also, I cant answer the later part of your question because I'm not sure exactly what you're asking.

**ciaossu** · 08-19-2009 11:40 PM

You should reference bridge financing. Of course you can sell off stock prematurely as mentioned to family and friends, but there is a reason many upper VCs and Angels prefer that you don't and it may cause potential issues down the road. Hence why bridge financing exists.

If you sell off common stock in the company base on a value you deem fit, you prematurely create a valuation for your company regardless if this is from preferred or common stock. A professional would highly advise against this even if you can do it, you wouldn't want to. VCs would prefer that they set the valuation base on what they believe to be accurate. It could be damaging to a company to set the valuation too high or too low, which is why many prefer to do a bridge financing round pre-Series A. It not only does not place a self-made valuation but also allow the risk to be spread in the case a VC comes in because now there are other investors in the pot with the preset valuation they place. That said, typically a VC will add a board seat member if you do raise round, and while their risk is less with other investors due to the bridge, they don't give off any additional seats for the same valuation set. Its a win-win scenario.

You can do it your way too, but unfortunately for a very large scale company, it wouldn't be recommended. One valuable thing to also note, while you can still find people to invest if you did go that route, it typically also isn't advisable because most future investors would like to know that each share holder attributes to the value of the overall business. Bringing in family and friends that do not understand the business or help strategically grow the business other than blindly adding funds to keep it afloat may not be very ideal for investors looking into the business. They'll want to know beyond the monetary reasons why you choose to take capital from a certain investor, especially if they strongly belief there is a lot of room for growth. While I do agree it is on a case by case basis and there is always the possibility of doing things different, the standard says its not worth doing so if you plan on truly growing your business. The closer to the standard, the less questions there is down the road.

**StealYourDreams** · 08-24-2009 04:17 PM

Originally Posted by ciaossu

You should reference bridge financing. Of course you can sell off stock prematurely as mentioned to family and friends, but there is a reason many upper VCs and Angels prefer that you don't and it may cause potential issues down the road. Hence why bridge financing exists.

I dont think you quite understand what bridge financing means. Also, please provide me with examples of angels or VCs claiming that they prefer you NOT issue stock.

If you sell off common stock in the company base on a value you deem fit, you prematurely create a valuation for your company regardless if this is from preferred or common stock. A professional would highly advise against this even if you can do it, you wouldn't want to.

Again, please provide examples of where a "professional" would advise againt this.

I will tell you this: I set the valuation in any company I've financed or structured the financing for. Perhaps you prefer to be taken to the cleaners. Once you actually get involved in a transaction and gain some experience outside of what you've read somewhere, you'll change your tune.

The issuance of additional shares or the retirement of current shares takes care of any discrepancy in valuation.

You can do it your way too, but unfortunately for a very large scale company, it wouldn't be recommended. One valuable thing to also note, while you can still find people to invest if you did go that route, it typically also isn't advisable because most future investors would like to know that each share holder attributes to the value of the overall business.

Where do you get this from? I suggest you re-evaluate why investors invest. Are you familiar with PIPES at all? All they, with they being the institutions, care about is volume and being able to bleed out their stock.

Also, thank you for affirming I can do it my way. In fact I've been structuring deals for the last decade. I'll notify the SEC that they should look at my SB-2 with a fine tooth comb because I shouldnt do things the way I have.

Bringing in family and friends that do not understand the business or help strategically grow the business other than blindly adding funds to keep it afloat may not be very ideal for investors looking into the business. They'll want to know beyond the monetary reasons why you choose to take capital from a certain investor, especially if they strongly belief there is a lot of room for growth.

Again, I've never had this issue nor do I know anyone that has. I presume this comes from a textbook written by a professor with no real world experience.

Additionally, I generally try not to get family and friends involved unless it's real early. I'm talking about investors. Small investors, but still people that write $25,000 - $50,000 checks to me, a guy who doesnt do it your way. Maybe they're doing it because the last deal made them 625% and the one before that made them 500+ and is relisting on AMEX.

While I do agree it is on a case by case basis and there is always the possibility of doing things different, the standard says its not worth doing so if you plan on truly growing your business. The closer to the standard, the less questions there is down the road.

What standard? See, the problem with forums like this is a lot of misinformation goes around and it's taken as fact. The fact is, it's slim to none that you or anyone you know is going to deal with a VC. Yet, you take their requirements and attempt to apply them to every situation. Do you see the problem with doing that?

That's like approaching a VC and thinking you're going to be getting a 7 year ballon loan from the bank. Each financing option available has different criteria from the next.

I've had the opportunity to deal with both Angels and VC. I find it much easier to provide seed capital myself, get family & friends, or get outside investors.

VCs and Angels require huge exits, exits (IPOs) that most companies cant provide. For your small to medium sized businesses, or businesses that are outside of the VCs preferred sector. there are a ton of available options. One of which is selling common stock in a private company.