At what point selling equity of startup becomes personal money?

Question

Often company needs to sell portion of their equity to another VC investor to get money so it could scale. For instance startup A sells 10% of the equity for $100K. And then it uses that money to continue scaling and operation. So, that money has not left the company, (not sure is it taxed) but only way to get it personally would be through salary and dividends (for which investor would complain as badly invested money). And, this part is ok.After few months same VC decides to buy out the rest 90% for $500K, startup founder agrees and sells the company. Now at this point, does those $500K go to the founder pocket or the company? Does founder pays personal or corporate tax on that money? What is the difference between that one and the first case?What if founder sells 5 more times 10%, until company is not his anymore? As founder is not majority owner can he ever sell the rest to personally gain anything, as majority owners can decide to infinitely dilute and sell shares?I would really appreciate if someone can explain this.Somewhat I am confused with edge cases, for instance if investor asked to buy out 80% more for $450K, so founder is left with 10%, and then founder can be left with $50K of personal money with last sale. Where is an error in my thinking?

JamesVI · Accepted Answer

Rounds of investment and acquisition are both complex transactions. The simple way to think about it is that when a VC or other investor invests in a company the company creates new shares that are issued to the investor.
So a company might be incorporated with 10 shares that are all issued to the founder, then the company might take $10k investment and create another 5 shares that are issued to the investor.
The founder still owns her original 10 shares, but the total number of shares in the company are now 15, so she now owns 67% of the company, not 100%. The investor has 5 new shares (33% of the company) and the company is valued at 3x what the investor paid ($30k).
Later the investor decides to buy the whole company, so they offer $40k to the founder for her shares (the company has doubled in value). No new shares are created, it's just a change in ownership of existing shares.
So if the number of shares issued has increased the money goes to the company, if it's just shares changing hands then the money goes to the shareholder(s).
When you sell shares you pay personal income tax. In the US that means federal (long- or short-term capital gains depending on how long you owned the shares), state, and local taxes.
Often the company rules prohibit the sale of shares pre-IPO outside some kind of merger/acquisition approved by the board. There may be different classes of shares that have different voting rights. Shareholders don't control a company, the board of directors controls the company and decides when to issues more shares.
If the founder of the company either sells enough shares, or allows the board to issue enough shares, that they no longer hold a majority of the voting rights then the other shareholders can replace the board of directors who can do whatever they want to the company.
(edit: typos)

etothepii · Answer

The key point here is that a company can create shares.
If investor buys newly created shares that money goes to the company.
If investor buys existing shares that money goes to the person who previously owned the shares.
I think your confusion comes from thinking about the percentages rather than the number of shares.