EQUITY

The principle underlying equity distribution is simple. If you and two friends each put a dollar into a joint bank account, you would each own one-third of the bank account. After many years of accumulated interest payment, the money the money will double to six dollars, and you still own one third of the account, which is two dollars. If you agree to let a fourth person deposit four dollars in the account, there will be ten dollars in the account, but you and your two friends will each only own 20% instead of 33% of the account. This is referred to as dilution of equity. When the account grows to $20 from accumulated interest, you will still own 20% and will be entitled to $4. Just because you used to own 33% of the account and were later diluted to 20% does not change the value of your original investment; your money would have increased from $1 to $2 to $4 even if the fourth person hadn't invested his $4.

Unlike a bank account, a company has some intrinsic value even before any money is invested. The value comes from the idea, the people, and investment of time and energy that went into putting everything together. This value is referred to as sweat equity or founders' equity; it belongs to the founders of the company. This intrinsic value is also equal to the pre-money valuation of the company prior to its first financing. The pre-money value of the average biotechnology startup is rarely more than $2M - $3M. If an investor gives the company $3M based on a pre-money valuation of $3M, the total valuation of the company after financing will be $6M and the investor will own 50% of the company.