Suppose your company is valued at $1M, and you own all of it. Your holding is worth $1M. Obviously.
Suppose now someone comes along to invest, and they put in $3M to the company. What percentage equity should you each now hold?
Simplistically, your holding should still be worth $1M, and their holding should be worth $3M. The company is now worth $4M, comprised of the $1M it was worth to begin with, plus another $3M in cash (or promises or whatever). You should have $1M of that, so now you own 25% of the company. The investor should have $3M of value, so they own 75% of that $4M total.
So on the surface, neither of you have gained. Except now the company has a shed-load of money, and so it can invest and trade more aggressively, thereby increasing its value. As a result, the company increases in value, and your 25% holding goes up in value.
Pretty much all trades and investments can be assessed like this, but with some refinements, in particular, factoring in the expectation of success.
Consider pitching for an investment. You value the company at $1M, you want $500K, so after the investment the company will be worth $1.5M and you will own 67% of that. Based on that assessment, you should be offering 33% equity for that $500K. But the investor will disagree with your assessment, saying that the company is now, currently, before investment, as not worth $1M. Perhaps they will say that without investment your company is only worth $500K. As a result, post-investment your company is worth $1M and you should each get half the equity. The gain for you both is that now, with the cash (and possibly expertise) of the investor, perhaps the company really is now worth $1.5M, so your 50% is now worth $750K, and the investor has immediately gained $250K (on paper).
The mis-match in the assessments of an owner and a potential investor is an area of considerable research and discussion, sometimes heated, but the above (very simplistic) analysis is a useful starting point. It largely matches the analysis he gives about selling to a competitor at $500K versus taking investment at $500K hoping to grow the company to $5M (giving him 50% of that, with a 20% chance of succeeding, making it worth an expected $500K)
Suppose now someone comes along to invest, and they put in $3M to the company. What percentage equity should you each now hold?
Simplistically, your holding should still be worth $1M, and their holding should be worth $3M. The company is now worth $4M, comprised of the $1M it was worth to begin with, plus another $3M in cash (or promises or whatever). You should have $1M of that, so now you own 25% of the company. The investor should have $3M of value, so they own 75% of that $4M total.
So on the surface, neither of you have gained. Except now the company has a shed-load of money, and so it can invest and trade more aggressively, thereby increasing its value. As a result, the company increases in value, and your 25% holding goes up in value.
Pretty much all trades and investments can be assessed like this, but with some refinements, in particular, factoring in the expectation of success.
Consider pitching for an investment. You value the company at $1M, you want $500K, so after the investment the company will be worth $1.5M and you will own 67% of that. Based on that assessment, you should be offering 33% equity for that $500K. But the investor will disagree with your assessment, saying that the company is now, currently, before investment, as not worth $1M. Perhaps they will say that without investment your company is only worth $500K. As a result, post-investment your company is worth $1M and you should each get half the equity. The gain for you both is that now, with the cash (and possibly expertise) of the investor, perhaps the company really is now worth $1.5M, so your 50% is now worth $750K, and the investor has immediately gained $250K (on paper).
The mis-match in the assessments of an owner and a potential investor is an area of considerable research and discussion, sometimes heated, but the above (very simplistic) analysis is a useful starting point. It largely matches the analysis he gives about selling to a competitor at $500K versus taking investment at $500K hoping to grow the company to $5M (giving him 50% of that, with a 20% chance of succeeding, making it worth an expected $500K)