Is money invested in a company owned by the company?

Question

If someone sells 20% of their company for a $500,000 investment, I assume that means that the investor has a right to 20% of the profits.

Would this $500,000 then be owned by the company or by the person who sold their 20% of the company?

Can the person who sold their 20% spend that money however they like (to buy personal property etc for themself) or must that $500,000 be spent by the company for company purchases and expenses?

I heard a case where the owner of a tech startup sold 20% of their company for $500,000, saying they needed the money to hire a developer to complete the project, and then after getting the investment he paid the money to his friend who paid most of it back to him, and then they presented the project which had been completed long before. So I wonder why they would do that rather than just offer 20% of the company with the completed project.

Answer 1

If X initially has full ownership and control of the company, then it is X's choice what is done with the company's stock and assets. There may be tax and accounting rules and consequences, but fundamentally X is allowed to move personal funds into the company (investing their own savings) or take funds out of the company (paying themselves salary or dividends), because the company belongs to X.

To sell 20% of the company, X likewise has a choice -- to directly sell part of their ownership, or to have the company sell 20% of itself. (The investor must of course agree to whatever is being proposed.) In the first case, X ends up owning 80% of the company and having $500k in their personal bank account. (Say X is a late-stage entrepreneur who wants money to retire.) In the second case, X likewise ends up owning 80% of the company, but it is a bigger, more valuable company because it has $500k in its corporate bank account. (Say X is an early-stage entrepreneur who wants money to continue growing the company.)

Also note that a 20% investor generally does not have a right to 20% of the profits, at least not as a distribution in cash. The investor has the right to a 20% vote in corporate decisions (which may be worthless) and, more importantly, the right to resell their shares to another investor (e.g., one who may be accumulating a controlling stake in the company). This works out so that shares are generally valued as if they were an entitlement to profits, because in the long run this is the basis of their value.

Answer 2

If someone sells 20% of their company for a $500,000 investment, I assume that means that the investor has a right to 20% of the profits.

Well, 20% of any profits distributed to the owners as dividends. The company's management can also decide to re-invest.

Would this $500,000 then be owned by the company or by the person who sold their 20% of the company?

It would be owned by whoever sold the 20% of the company. That might be a person or it might be the company.

Can the person who sold their 20% spend that money however they like (to buy personal property etc for themself) or must that $500,000 be spent by the company for company purchases and expenses?

If the seller was a person, they can do whatever they like with the money. The company is not significantly affected -- before person A owned 20% of it, now person B owns 20% of it.

If the seller was the company itself, then the company now has $500,000 more money but every previous owner now owns a smaller percentage of the company. These should be roughly equal in value. Presumably, the company only agreed to sell 20% of itself for $500,000 if it needed the money for some reason, so all the owners should be better off.

Say Alice and Bob each own 50% of a company and the company is worth $2 million. Alice and Bob each have $1 million in equity. Say the company needs some cash, so the company sells 20% of itself for $500,000.

The company now has $500,000 more than it did before, so should be worth $2.5 million. Alice and Bob each now own 40% of the company, worth $1 million (40% of $2.5 million equals 50% of $2 million). The buyer owns 20% of a company now worth $2.5 million, which is worth $500,000 (20% of $2.5 million is $500,000) -- the amount he paid.

Alice, Bob and the buyer now all have fair shares in the company, but the company has $500,000 more in cash. Presumably, Alice and Bob agreed to have their company do this because the company needed more cash for some reason.

Alice and Bob see no change in the value of their stock, it's still worth $1 million. But from now on, Alice and Bob will only get 40% of any future dividends instead of 50%, but presumably they felt this was a fair trade to get the company the cash it needed.

Alice or Bob, assuming the company allows such transfers, can each sell 20% of the company (now half their holdings) if they wish. They can do whatever they want with that money. The company's value and holdings are not affected.

So the short answer to your question, "Is money invested in a company owned by the company" is "Sometimes".

Answer 3

It all depends on what the investment contract said.

You can't assume anything, which seems to be all of your mistakes here.

Answer 4

If you invest $500k in a company for a 20% stake, assuming no subsequent investment by anyone, you are entitled to 20% of distributed dividends and 20% of the profit on the sale of the company. This ignores special arrangements and complications which may be more or less usual.

The money becomes the company's to do with whatever it wants, subject to applicable laws and regulations. In particular, the investor does not get to decide how the money is used. Most likely it would not be in the company's interest to spend the money for the benefit of a single shareholder alone, so conspiring to do so could create legal and regulatory problems and is therefore not advisable.

Not a lawyer or accountant. YMMV