HOW MUCH EQUITY SHOULD INVESTORS GET
As a startup business owner, sourcing for funds to develop your business is at the top of your list, either if you want to develop a new product or expanding your business into new communities. Investors might be just the people you need to acquire capital, or might be the next big thing for your Startup. Seeking investors who would opt for equity requires you know the in and out of such investment.
Equity is the amount of money that would be returned to investors if the assets were liquidated and all of the company’s debt paid off. What investors do, is give equity in exchange for a share of ownership in the company. Most times, investors are not guaranteed a return on their investment, they expect certain benefits to offset the risk of their inv
estment. By way of illustration, an investment agreement may stipulate that the initial investment paid over a specific period followed by a share of profit after the investment is paid off. The terms of the agreement should be considered by both parties.
As a startup business owner, caution needs to be taken where equity is involved when you overvalue your business, hereby asking for more than what is needed from the investors – this implies that you would be handing over a greater part of your company to the investors, on the other hand, when you undervalue your business, it may affect its growth. Thus a delicate balance has to be reached.
To arrive at how much equity is enough for your investors, these two steps would help:
1. Decide on how much you need to raise: since we already know the idea behind equity is exchanging funding for a share of the company. Knowing the exact amount you need to raise is key. It is usually advised to raise enough to last twelve months or more just before you need to raise any more money, anything shorter would put pressure on you in terms of delivery and managing investor’s expectation. You should factor in your team members, cost of production and marketing, and also for unplanned expenses. Remember not to overvalue or undervalue, strike a balance. Also, operation cost is not going to reduce, neither are salaries going to go away. So when borrowing makes sure you do your math wells.
2. Establish how much of your company you are willing to offer the investor: the usual practice is giving up 10-20 % equity of the company, this is based on what the investor expects a return, they would be taking a risk by investing in your business hence would need a good return should the business not come through. If your investor is asking for more, there are high chances that your business is overvalued or you are trying to raise too much at an early stage. When plying the path of equity, be wary of investors who want to take the larger share of the company, what they might be offering might be tempting, one rule to follow is – you should only give up the share of your company if what you plan on trading it for improves your average outcome so much that what is left after equity, is worth more than the whole company was before.
“If this investment will take half of your pie, but makes the pie 4 times bigger, then you are left with a far bigger piece of the pie than you had without the investment.”
3. The Round of Investment plays a critical role: When you are receiving your first round of investment it might be tempting to give out more of your company equity out. This is so because your business is in its early stage and no matter how positive you are about your projection, there is likely chance that you will either make more profit or loss. It’s all about this, for this reason, your decision to give out equity to the investor should be critically evaluated and made based on the right data and not based on emotions. Aside from raising money from family and friends before now, be aware that even though they may not want a part of the business, you still have the responsibility to pay them back.
4. Your Investors Persona: Just like the way you create and design buyer persona, you will need time to create a detailed document of all your possible investors, where you can find them if they are individuals or corporate organisation. You can also approach accelerators or incubators in your local vicinity. However, be careful when you approach this incubator they sometimes require as high as 50% of the company’s equity. No bad feelings everyone wants their Business or investment to grow.
5. Building a tough skin: If you have not been used to rejection in the past, well now is the time to grow a tough skin. You may approach more than 100 investors or VC and may get only one positive response. This is the part of the journey of being an entrepreneur where resilience is needed, consider these rejections as nothing personal. Maybe they are just not the angels you need.
Until next time, enjoy your money sourcing journey.