When it comes to fundraising, startups always face the task of providing the company’s simulation of capital formation and shareholder’s structure to investors.

But what purposes do “capital formation” and “shareholders structure” serve and what is the difference between them?

“Capital formation”is the variation during fundraising of each stage. The elements of the variations include a total number of shares, types and classes of shares, prices for shares, forms of capital contribution, and other variables such as employee stock option plans.

On the other hand, “shareholders structure” is more about percentage ownership and the percentage of voting rights held by different shareholders, rights carried by different types or classes of shares, and how power is distributed among the various shareholders.

Why should startups simulate the capital formation and shareholders’ structure? It would be easier to understand if we break down and see from each stakeholder’s angle. From founder’s perspective, the shareholding ratio may involve or equal to controlling power. It is critical for the founders to know their shareholding proportion before and after each round’s financing, the controlling interest they will have over the actions of the company, and the profit  they may collect based on their equity shares.

The investors may also review the shareholding ratio of the founders and the operations team, as well as the holding ratio of other shareholders. The shareholders of a startup generally consist of founders, core technical personnel, board members, investors, and strategic partners within the supply chain. As an experienced investor, venture capitalists usually place their attention on the following facts: Does the previous issue prices seem reasonable comparing to the startup’s valuation? Are the rights carried by the common shares and preferred shares appropriate? What effects the capital variation may have on the startup’s future EPS? Whether the checks and balances are reinforced by the shareholding structure which is beneficial to the startups?

The arrangement and variation of capital formation and shareholding structure is a continuous and progressive development, it is closely related to corporate governance and can have positive or negative effects on the growth of the organization, the organization’s capital structure, decision-making process, operations management, supervision, profit-sharing mechanism and corporate image. For the startups who are seeking long-term development, we would suggest the team contemplate more comprehensively on mapping out the variation of capital formation and shareholding structure.

The Author :Aileen Chang / Lucille Chang

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