What is the term for individuals who invest in start up companies with high growth potential in exchange for a share of ownership?

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• Tech startups need to set up a “clean” capital structure from the beginning to attract potential investors, who will seek certain criteria.
• Ensure you understand key relevant terms (e.g.,founders shares, initial equity issuance).
• When setting up or changing your tech startup’s capital structure, hire legal counsel experienced in setting up early-stage ventures and working on investment rounds.

Tech startup founders strive for and investors appreciate a “clean” capital structure for ventures that will eventually seek outside investment. There are a few terms you will hear when discussing the set-up of the capitalization structure for your business and here is what they mean:

Initial equity

The founders of a startup generally purchase shares at the time of incorporating the company at a nominal price per share, such as $0.0001 per share, paid in cash, since at that time the company will have no operating history, few assets and thus little value. These shares are referred to as founders’ shares.

Founders

Founders are the initial group of individuals who conceived the idea and/or the first individuals recruited to get the business off the ground. Founders are usually the one or two individuals who are the driving force behind the startup, but may be a larger group (usually less than six).

The founding group should objectively assess each individual’s expected contribution and allocate founders’ shares on that basis (rather than spread equally across the group).  You’ll want to consider whether an initial equity issuance or stock options represents the appropriate incentive for an individual.

Management

A founder may serve as a member of the tech startup’s management team; however, not all members of the management team are founders. Management will likely change over the life of the business and they are usually incented with a combination of cash compensation and stock options.

During start up, entrepreneurs should consider the number of founders’ shares and stock options to be issued in relationship to the current valuation of their business and/or the valuation they hope to achieve in the first round of investment from outside investors.

They need to determine how they wish to allocate the ownership of the business among the founders and to key employees, directors, advisors and contractors.

Consider the example below:

If the founders had simply issued 50, 30 and 20 shares for a total issued capital of 100 shares instead of 1,000,000, the ownership percentage for the company would remain the same among the founders; however, the company would have difficulty splitting the 17.65 shares available for stock options among option holders, since legally, partial shares are not permitted.

If you have incorporated your business with a smaller than desirable number of shares, you can modify your capital structure by “splitting” the current number of shares issued. You should consult legal counsel who will assist you to seek the necessary shareholder approvals to make the change and to file revised articles of amendment, legally documenting the change.

What does a clean capital structure look like for potential investors?

1. A limited number of classes of common shares are being used for equity issuances and stock option grants. Usually one voting common share class but sometimes a non-voting common share class may be established for stock option grants in addition to voting share class.
2. There are a manageable number of shareholders, excluding insiders holding stock options.
3. A stock option plan has been implemented, providing upside opportunity to all key employees who will continue to work with the business to build shareholder value.
4. There are no obstacles to obtaining necessary shareholder approval for the company to issue shares to the new investor in exchange for cash investment and to amend any existing legal documents or the capital structure accordingly. This is usually achieved through having a Shareholders’ Agreement in place, a voting trust or other legal documents to ensure that minority shareholders will follow suit with the majority.
5. Canadian investors generally prefer to invest in Canadian-Controlled Private Corporations (CCPCs). A CCPC is a Canadian-incorporated private corporation that is not controlled directly or indirectly by one or more non-residents of Canada or public corporations (or any combination thereof). CCPCs enjoy benefits including the right to claim refundable cash Investment Tax Credits under the Scientific Research & Experimental Development program as well as potential tax advantages for founders and employees on the sale of their shares or stock options. Companies should seek legal or tax advice as to how to maintain their CCPC status.  However, some US investors may require the company to reorganize itself on a cross-border basis for their own local tax or operational reasons.
   

Tech startup entrepreneurs should seek professional legal advice when setting up or making changes to their capitalization structure, choosing legal counsel with experience in setting up early-stage ventures and working on investment rounds for their clients.  Hiring a lawyer may seem like a big expense for your startup, but setting up your business incorrectly will cost you more in the long run.

Summary: Tech startups need to set up a “clean” capitalization structure from the beginning to attract potential investors, who will seek certain criteria.

Read next: Allocating stock options for an employee stock option plan (ESOP)

An investor is an individual or an organization that gives money to another person or organization hoping to see a future profit. Technically, anyone can be an investor: If you invest money into something, you are an investor. However, there is a difference between putting $20 in bitcoin and investing $5 million in a startup. 

In this guide, we’ll go over: 

What Do Investors Do?

Investors put money into something with the hope of getting more money back down the road. Investors can be individual people buying and selling stocks for their personal wealth-building plans. However, an investor can also be an organization, such as a private equity firm or a mutual fund. 

The goals of investors are as varied as their investments. For some personal investors, the goal may be to grow a retirement fund, while larger institutional investors may try to build wealth for future business ventures. 

Every investment has its own rate of return, or how much money you get back on top of the money you put in. Different types of investments also carry different levels of risk — not every investment will pay off, and not every investor will see returns on their investment. 

What Do Investors Invest In?

In both the public and private financial spaces, a variety of investment options are available for investors. Each investment type has its level of liquidity, or how easily it can be converted to cash. While some investors prefer more liquid investments, such as stocks, others like longer-term investments, like real estate. 

Some typical investment options include:

• Stocks (such as common stocks)
• Bonds
• Mutual funds
• Real estate
• Gold

Types of Investors

Every investor is different — some, like banks, may have high levels of capital at their disposal to invest in expensive, large-scale projects. Others, like personal investors, may not have the ability to take on high-risk investments. Some of the most common types of investors are:

An accredited investor is an organization or an individual that is granted special investment privileges by the U.S. Securities and Exchange Commission (SEC). Accredited investors are considered to be investment-savvy enough that they can trade securities (stocks, bonds, etc.) without all of the protections offered by the SEC. These securities they trade are often “unregistered” meaning they don’t have many of the normal disclosure requirements that registered securities have. 

Accredited investors must meet certain criteria to gain accreditation — high annual income (over $200K) or working as part of a company in the financial industry.  

>>MORE: What Is Financial Services?

Angel Investors

An angel investor is someone with a high net worth who uses their wealth to invest in entrepreneurs and start-up companies. Typically, angel investors invest in exchange for equity in the company, meaning they have partial ownership — if the company succeeds, the angel investor succeeds, too. 

Banks

Banks are the typical type of investor for most businesses — they offer both small business and personal loans to help fund entrepreneurs. Even big banks, like large investment banking companies, are investors on a larger scale, often funding expensive projects, buying and selling companies, and helping governments and organizations raise capital. 

Institutional Investor 

An institutional investor is any organization or company that invests money on someone else’s behalf. For example, a mutual fund is an institutional investor — mutual funds are invested in by individual investors and they use that capital to invest in bigger, higher-return investments to increase all individual investors’ capital. 

Peer-to-Peer Lenders

Peer-to-peer lenders are a special classification of individuals or groups that aid small businesses. An investment from a peer-to-peer lender is typically similar to a personal loan: The peer-to-peer individual or group gives money in exchange for payments with interest. 

Personal Investors

A personal investor can be basically anyone. Small businesses and entrepreneurs may use personal investors, like friends or family members, to help fund their goals. Personal investors can also be anyone investing in the stock market for personal financial goals. 

Venture Capitalists

Venture capitalists are similar to angel investors, but they specifically look for early-stage companies with high-growth potential. A venture capitalist may be part of a group of investors and together they offer guidance to the company they invest in to promote strategic growth. Venture capitalists typically receive equity in the company in exchange for their investment. 

>>MORE: Check out 20 popular careers in finance.

Investor Salaries

Ultimately, there is no set salary for an investor. People who work in the finance industry, like investment bankers or venture capitalists, may see salaries in the six figures. However, personal investors, or individuals who just casually invest in the stock market exchange, can have practically any level of income. An investor’s salary from investing depends entirely on how well they invest — smart investing choices can lead to high returns, while poor decision-making can lead to bankruptcy.  

>>MORE: See the best-paying careers in finance.

How Do You Become an Investor?

There is no single path to becoming an investor. For many types of investors, the key is just having a high net worth. But that isn’t even as necessary anymore. With the access to investing tools available online today, it is possible for almost anyone to become an investor. According to a recent study by Schwab, 15% of investors in the U.S. Stock Market began investing in 2020 — 16% of those were Generation Z and 51% were millenials. 

Some people may choose to become an investor after years of experience in one industry or another. For example, if you work in real estate for a few years and accrue enough capital to invest, it is possible to transition into real estate investing — buying and selling properties purely for profit. 

Working with investments themselves is a different story, though. To become a finance professional who works directly with investments typically means becoming an investment banker, personal finance advisor, or private equity professional. For careers like this, you often need a degree in finance and a strong interest in the financial field. 

Explore these investing-focused career paths:

Top Skills for Investors

The most important skill for investors to have is good money management. But, beyond that, being a successful investor requires strong people skills in addition to skills like: 

Start building your skills with Forage’s virtual experience programs. 

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