Equity: The distribution of ownership of a company. Equity is the value after subtracting the company’s debt and liabilities.
Shares: A single unit of equity ownership in a company. Shares are owned by the business owner and investors and may also be owned by employees. The value of each share changes as the equity of the company changes.
Types of shares differ in factors like the type of company, whether the shares will be redeemed by the company later, and whether or not the share owner can vote, redeem shares for money, or have preferential rights. The main types of shares are. . .
- Ordinary, common shares: Most shares are of this type. These are equity shares the company has. Shareholders have one vote per share in decisions about the company and are entitled to equal dividends.
- Non-voting shares: Shareholders of this type have no voting rights regarding decisions about the company and cannot attend shareholder meetings. These shares are often used to reward employees with dividend payments and offer tax efficiency advantages.
- Preferred shares: Owners of these shares are paid dividends before common shares. Preferred shares pay a fixed dividend that is often a percentage of their value when issued.
- Redeemable shares: The company will buy back this type of share and often gives them to employees. Shareholders usually cannot vote.
Initial Public Offering (IPO): The first time a company sells shares to the public. It allows the company to raise money from public investors.
Valuation: Determination of a company’s worth or value based on several measures, including its assets, liabilities, and prospect for future earnings.
Resource: Glossary: Startup and Venture Capital Terms You Should Know – By Techrepublic.
FAQ: How do shares work in a biotechnology startup?
Answer: As the business owner, you and your original partners start with all the business’s shares (all the equity). Later, you may sell some shares to raise money, which gives the new shareowners some of your equity.
Angel investors typically are the next group to invest in helping you develop the concept. This is the point with the highest risk, so they get more shares for their investment. You have to give them enough shares to make it worth them taking the risk. The effect that giving or selling shares to others has on your ownership of the company is called dilution.
Venture capitalists invest after the concept is developed and provide funds to support further research and development and clinical development. Their investment further dilutes the shares.
Tip: Creating and Giving Shares
Follow this advice to avoid the common pitfall of not having enough shares to offer future investors:
- Be careful not to overvalue past work.
- Give specific numbers of shares as equity rather than a percentage.
- Use vesting whereby someone must wait to get their shares. Avoid overusing acceleration of vesting as an incentive.
- Comply with federal and state securities laws.
- Look into the pros and cons of filing a Section 83b election with the IRS early as it may save tax money later.
Resources on Financial Management and Shares
Alzheimer’s Drug Discovery Foundation. Financing 101 for Biotech Startups.
Anderson A. Startups and Stock Options. Hopkins Biotech Network. March 15, 2014.
DeGroot, C. A., and Hwang, A. What Is an 83b Election and Why Should Startup Founders Care? Startup Law Blog. Davis Wright Tremaine, LLP.