When you look at business equity like a pie, then you are looking at the business as a Limited Liability Company. This type of company is created as a partnership and is usually split into percentages where the partners hold certain percentages and so getting outsiders into the business is often difficult and selling equity to those companies are almost impossible but when you see startup companies selling rounds, they are C corporations.
To explain how a startup that wants to sell rounds look like, I will use a company where 2 people are partners, trying to build a business. They both get 50/50 percent of the company an this could be any amount of shares available for instance, 100 shares each. When they decide to sell a round to an investor, the company will create more shares. They will not remove from the share number the owners hold, rather new shares will be created but this time around, lesser than the amount of the founders, and it will be sold based on percentage. So if the percentage of the shares would change but the amount of shares the investor will hold is dependent on the business valuation.
Company valuation can be very confusing. A startup company could be having only expenses and no income and while you think it will not be valued at any amount, it would be valued at billions so it is not often based on the current situation of the country but the future in some cases, and so if investors want to invest in a startup, they are looking at how much they can risk for a particular amount of shares if the founders are right.
When trying to sell equity to investors, the founders need to ensure that the share amount is looking promising for investors in the future to invest because it is likely that more investors will come in the future. An investor who decides to invest $500k for 10% of the company is directly saying that the company is worth $5 million. This meant that before the investor's fund, the company was valued at $4.5 million. If the company was worth $4.5 million before the money, then it means each one of the 200 shares is worth $22,500. So the company will create an additional 22 shares for the investor making it 222 shares for $5 million valuation.
With this, the shares of the founders are diluted as they are no longer 50% although they are still the same amount. A shares cannot be divided so they are sold in whole numbers. and the founders now have 45%of the company. Asides investors, startup companies also give stock options to key members of staff that are important to the growth of the company since the company doesn't have enough money to pay them what they deserve for their job.
The company when it list on a stock exchange market now have common shares and preferred shares where the common shares is a normal share that makes a person entitled to one vote out of the total number of shares as well as a share of the profit of the business. When a share is sold to investors with clauses such as no voting right, or higher claim to the company's assets and dividends. Depending on the clauses tied to a preferred share, it can either be better or worse than a common share.
Unlike the thought you have that shares are sold from one person to another, new shares are created and sold to investors who want to buy them and when it comes to valuation, investors are just weighing in risks to rewards.