Founders Lounge

What's your knowledge of valuations? Learn more about the concept and check your knowledge as part of our Equity 101 course. Here's a simple way to break it down: 

When a company raises money, the investor will typically give them a legal document called a term sheet. And what this document does is lay out all the terms and conditions under which the investor will give money to the company. One of those terms is the valuation. This is where the investor says, in plain English, here's how much money I believe the company is worth right now. The reason this matters is because it affects the fair market value of the shares of the company.

So let's say a company has 10 million shares in total. An investor comes in who wants to give the company money at a $10 million valuation. So that means the entirety of the whole company's issued stock is being valued at 10 million, in total. And since there are 10 million shares, this means the value of each share is $1. So let's say this investor wants to give the company a million bucks. That means they're buying one million shares, which is 10% of the company. Easy enough, right?

But now let's switch it up. Let's say that instead of $10 million, the valuation lands somewhere higher, like $20 million. So the company's total shares are now worth $20 million divided by the number of shares, which is 10 million shares. Meaning, in this second scenario, the value of each share is actually $2. Again, the investor is putting in a million bucks. At $2 per share, they're getting 500,000 shares, which is 5% of the company.

So in scenario one, it was 10% of the company, but in scenario two it's 5%. The only thing that changed was the valuation, but it affected how many shares were being given, how much each share was worth, and what percentage of the company the recipient ultimately owned.

The big thing to know here is: If you own shares, the valuation of your company affects how much each of your shares is actually worth.