From Sole Proprietorship to a Corporation

Suppose you decide to start a business from your personal savings of $1 million to produce some goods. You hired some work force for this purpose and start the business. In other words, you have created a sole proprietorship. You soon realize that the business would be more beneficial if it be carried out at a larger scale and by more people. You ask your friend, a rich person, for investment and partnership. Your friend was impressed with your business and invested $1.2 million into the business and became owner of the 50% of your business. In other words, you are your friend have created a partnership. Fortunately, this partnership was successful and you can spend your business to very large extent. And for this, your partnership needs continuous investment into the business. You and your friend (the two partners) divide the value of the firm into 1 million shares and register your business as a corporation (also called company or firm). So,

Total value of the firm = 1 million shares

So, in this newly created firm there are two members in the board of directors (you and your friend), a few managers (including you both) and dozens of workers. Now, your company can raise more capital either by:

  1. Angel Investors, or
  2. Venture Capital Firms

A. Angel Investors
Angel investors are wealthy individuals who invest in adolescent firms.
Suppose your company decide to raise capital from angel investor. The investor purchased 200,000 new shares for $10 each and became the third member in the board of directors. So, it was the first market price of the company's shares ($10). Now, company's number of shares are

1,000,000 (1 million) + 200,000 = 1,200,000

And, the value of the company is

1,200,000 x 10 = $12,000,000


Venture Capital Firms
These firms invest in adolescent firms, and then work with them to increase the value of the firm.
Suppose your company decide to raise capital from a venture capital firm. The firm purchased half of million new shares for $11 each, posted some of its specialist managers and got seat of the board of directors in your company. Now, company's number of shares are

1,000,000 (1 million) + 500,000 = 1,500,000

And, the value of the company is

1,500,000 x 11 = $16,500,000

RELATED PAGES
- Definition: Corporate Finance
- An Overview of Corporate Finance


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