Early Stage Funding With Ordinary Shares
Last updated: 2021-06-02 (originally published on 2019-12-03) — by Rae Steinbach
Startup founders have a lot to consider when it comes to raising funds. Taking on debt is one option, but making loan payments can be an issue during the early stages of a company.
As an alternative to taking on debt, many startup founders will look to equity financing. With ordinary shares, business owners have the potential to raise a considerable amount of funding without having to overburden the business with debt. With that being said, it is not the right option for every startup.
Ordinary shares give the investor an ownership share of the company. With this share of the company, the investor has the right to take part in the corporate governance of the business. This means the holder of the stock has the right to vote on things like appointing board members.
The shareholder will have voting rights that are directly proportional to the number of shares they hold. Typically, one share equals one vote. That means that a shareholder will have more control and more influence over the company if they own more shares.
Return on Investment
Every investor is looking to realise some return on their investment when they buy shares. One obvious way to see a return on investment with ordinary shares is to sell the shares for a higher price than you paid for them. Along with that, you also have the potential for dividends to be paid out of the company’s profits.
One of the reasons why ordinary shares can be an attractive option is that they have the potential to offer an almost unlimited return on investment. Beyond the potential to sell the shares or receive dividends, the holders of ordinary shares own a piece of the company’s profits as long as they hold the shares. If the company’s fortunes skyrocket, the shareholders will have a right to a piece of those profits no matter how high they go.
Advantages and Disadvantages
Ordinary shares can be a good way for some startups to acquire early-stage funding. One of the obvious advantages is that it is a way to raise capital without having to take on debt. While avoiding debt is positive, issuing ordinary stock does come with some obligations.
First and foremost, your investors are going to want to see a return on investment. This will have to come from growth in the price of the stock or through dividends. As an additional issue, every share of ordinary stock dilutes the ownership of the company. As you issue more stock to more investors, your share of ownership will decrease.
While issuing ordinary stock does mean sharing ownership with the shareholders, businesses usually do retain the right to buy back some or all of the outstanding shares in the business. If the company ever reaches a stage where it no longer needs equity financing, it can buy the shares back to consolidate ownership.
Another issue with ordinary stock is that it may be less attractive to some investors. Ordinary shares can work well if the investor believes in the vision of the company, but preferred shares tend to be more attractive to venture capital firms and angel investors.
Modern startups now have a wide array of options when it comes to obtaining early-stage financing. Equity financing does offer a way to raise capital while avoiding debt, but it does come with some concessions. Before you decide to issue shares, you should consider all of your funding options and think carefully about whether equity funding with ordinary shares is right for your business.
This article does not constitute legal advice.
The opinions expressed in the column above represent the author’s own.