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I am a bit confused on this topic. You hear a lot of stories now on how startup X received X million dollar from X VC firm. But I'm unsure whether the owners of the startup are actually 'making money' of these deals.

For example, A startup has 1 owner/founder who has 100% of the ownership, then a VC invests and gives him/the company 1 million for 10% of the company.

Does the founder actually get to do anything with this money? or is it for business purposes only. So is the founder actually 'the owner' of the million (or 90% of it). If not, then the founder is only giving away % ownership for the 'potential' of growth with the newly received money, since he cannot actually spend it besides business costs.

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There are different ways to determine the value of a company:

  • Fair Market value is the value that a willing buyer would pay for the company.
  • Investment value is the value that an owner has invested into his or her company.
  • Intrinsic value is the value that an investor believes that the company has, based on the company's future potential to make money.
  • Asset value is the value of the company's assets, if the company shut down immediately and sold off its assets.

When an entrepreneur starts a new company himself and owns 100% of the company, the Fair Market value is unknown. He has put his own money into the company, so it has a high Investment value to him, meaning he has a lot at stake in the company. The Asset value is probably less than the Investment value, meaning if he closed the company, he would lose some of the money he invested.

Now, using your example, a Venture Capitalist comes along and takes a look at the company. She believes that the company has a great future potential to make money, which means that she believes that the Intrinsic value is very high. She decides to invest $1 Million in the company for a 10% stake, and the founder agrees. The Fair Market value of the company at that moment is $10 Million. The VC believes that the Intrinsic value of the company is more than $10 Million and that she is making a good investment. The Asset value of the company just went up by $1 Million.

To answer your question, the $1 Million is not the founder's to spend on a new house. It is the company's money. However, the founder owns 90% of the company. The new capital will allow the company to buy whatever assets the company needs to meet the potential that the founder and the VC see in it, and make the company grow and earn money for the two investors.

A crooked founder could, theoretically, close down the company immediately and pocket 90% of the new cash, but there are certainly legal protections in the contract they signed when the investment was made that prevent him from doing that.

  • could the founder us it to pay himself a living wage? – Lyndon White Nov 16 '14 at 10:27
  • @oxinabox In most cases, he'd be required to pay himself a wage, for tax purposes. – Ben Miller Nov 16 '14 at 12:34

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