I attended a venture finance event a while back in Palo Alto, which was put on DLA Piper. They had a nice segment on legal aspects of venture finance and law.
While this post is geared towards the investor, venture capitalist and angel, if you’re an entrepreneur, you will obviously gain value from understanding this overall concept.
Calculation of Number of Shares To Be Offered to Existing Investors Pursuant to Preemptive Rights:
To determine the number of shares to be offered to a current shareholder pursuant to preemptive rights to maintain ownership percentage, you must first determine the basis on which the calculation of the holder’s ownership is to be made {e.g., fully diluted including all options in pool, fully diluted excluding ungranted options, based on shares actually outstanding [on an as-converted basis], including warrants, etc.).
In a venture-backed company, these rights typically will be contractural rather than statutory {i.e., pursuant to the company’s charter or state incorporation laws). The calculation of statutory preemptive rights will vary depending on the law of the state of incorporation.
The actual number of shares to be offered to existing investors pursuant to preemptive rights is the difference between the aggregate offering size and the shares to be offered to new investors.
To calculate the aggregate offering size, use a standard “gross up” calculation by dividing the number of shares being offered to new investors other than the holder(s) with preemptive rights by a fraction which is (1 – [the holder's percentage ownership of the company after making the determination above]). For example, if the company proposes to offer 8,000,000 shares to new investors prior to the offering the existing investor with preemptive rights owns 5% (or .05) of the company then the existing investor would have the right to purchase the following number of shares:
Aggregate Offering:
8,000,000/(1 – 0.05) = 8,000,000/(0.95) = 8,421,053
Offering to Existing Investor: 8,421,053 – 8,000,000 = 421,053
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If you have 300 shares with 3 shareholders in the company and you want to bring in new investors. Do you calculate how much capital you need to raise, divide that by the value of the share and work out the number of shares?