Let us imagine a budding entrepreneur with a brilliant business idea – to manufacture highly fashionable, organic cotton t-shirts. The designs are unique, has attractive price points and the best quality cotton is used to make these t-shirts. He is confident that the business will be successful, and is all enthusiastic to launch the idea into a business.
As a typical entrepreneur he is likely to be hit by the typical problem – where would he get the money to fund the idea? Assuming the entrepreneur has no business background he will not attract any serious investor at the initial stage. Chances are, he would approach his family and friends to pitch the idea and raise some money. He could approach the bank for a loan as well but this would not be the best option.
Let us assume that he pools in his own money and also convinces two of his good friends to invest in his business. Because these two friends are investing at the pre revenue stage and taking a blind bet on the entrepreneur they would be called the Angel investors. Please note, the money from the angels is not a loan, it is actually an investment made by them.
So let us imagine that the promoter along with the angels raise INR 5 Crore in capital. This initial money that he gets to kick start his business is called ‘The Seed Fund’. It is important to note that the seed fund will not sit in the entrepreneur’s (also called the promoter) personal bank account but instead sits in the company’s bank account. Once the seed capital hits the company’s bank account, the money will be referred to as the initial share capital of the company.
In return of the initial seed investment, the original three (promoter plus 2 angels) will be issued share certificates of the company which entitles them an ownership in the company.
The only asset that the company has at this stage is cash of INR 5 Crs, hence the value of the company is also INR 5 Crs. This is called the company’s valuation.
Issuing shares is quite simple, the company assumes that each share is worth Rs.10 and because there is Rs.5 crore as share capital, there has to be 50 lakh shares with each share worth Rs.10. In this context, Rs.10 is called the ‘Face value’ (FV) of the share. The face value could be any number. If the FV is Rs.5, then the number of shares would be 1 crore, so on and so forth.
The total of 50 lakh shares is called the Authorized shares of the company. These shares have to be allotted amongst the promoter and two angels plus the company has to retain some amount of shares with itself to be issued in the future.
So let us assume the promoter retains 40% of the shares and the two angels get 5% each and the company retains 50% of the shares. Since the promoter and two angels own 50% of the shares, this allotted portion is called Issued shares.
The share holding pattern of this company would look something like this..
Please note the balance 50% of the shares totaling 2,500,000 equity shares are retained by the company. These shares are authorized but not allotted.
Now backed by a good company structure and a healthy seed fund the promoter kick starts his business operations. He wants to move cautiously, hence he decides to open just one small manufacturing unit and one store to retail his product.
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