How much equity to offer to investor


0

I am fully aware that this is asked frequently, but it will differ a lot depending on the type of business:

I am just about to start looking for an investor for a startup in the UK, i dont want to release too many details but i'll geve you the basics.

I am looking to start up a business that should grow quickly into a franchisable brand (its a sports venue type venture) the brand-building pre franchise part should take 1-2 years.
It is currently at the planning stage, and has no value as such.

I am looking to raise £150,000 and expect no help other than that from the investor(s)

Theoretically the business could turn over up to £500k in the first year, offering around £200k net profit.
2nd year up to £800k turnover, 400k proffit
and after that fairly linear depending on how the franchise works out.

This is the deal that i am hoping to advertise:
The investor gets 40% of the company until the point where they have received their investment back + 20% (so a 30k profit for them) hopefully this should take under 2 years. at which point they will retain 20% of the business for the forseeable future.

Does this sound reasonable? too good? or not good enough?

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asked Jun 15 '12 at 21:02
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Darkcat Studios
190 points
  • 150K seems like a small amount: if you borrow the money, you won't have to give up any equity. – Frenchie 7 years ago

3 Answers


2

A couple points:

  1. If they purchase 40% of the company they own 40% of the company. Not 20% of the company. If their percentage drops from 40 to 20 then the company or you purchased it from them. When you purchased it form them there was a determined value and they need to be compensated for that!
  2. If they lend you the money it is a note with terms. They don't get stock and repayment of "their investment." People get a return on a note. A return on their investment comes from the profits (dividends) and the sale of the stock (as per your buy-sell agreement)
  3. If there is a mixed investment with a guaranteed distributing based on profit with part of the money coming in as stock and the remainder as a note or something like that -- well, that will have to be laid out a lot more clear than the above for my simple brain to understand it.

My understanding of what you propose rolls these things into one jumpled heap. Perhaps they are getting 40% of the company, with preferred distribution, and a buy-sell that allows the company to purchase back 50% of their shares at a predetermined value in the future?

Stockholders get paid from the profits of the company proportional to their percentage of ownership in accordance with their stock class. If they own 40% of the company, they get 40% of the profit that the board agrees to distribute to shareholders.

Either way, you are selling a portion of your company, and that is a security, and that is a regulated industry so it is highly advised to involve a lawyer to represent your interests.

Going a step further:

If you are proposing that for L150 they get 40% of the business, then you are determining that the business is currently worth L225,000. (225K + 150K = 375K of which 150K is 40%) Since based on what you said above you have no product, no customers and no revenue I would be interested in how you make the case to the investor that the company is currently worth that amount, and that their contribution is worth 40% after they invest hard cash of L150,000.

Not saying you couldn't -- I just am proposing that you should be prepared to address this point.

If my understanding is correct, from my perspective this isn't a very good deal for the investor. Great deal for the business. And overall, doesn't sound reasonable.

answered Jun 16 '12 at 07:41
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Joseph Barisonzi
12,141 points
  • I think i probably wasnt clear enough: without complicating it with "legal talk" the investor gets a 40% proffit share until the point where they have received their initial investment + 20%. from that point on, they receive a 20% profit share. however you want to work that on paper / technically, i dont know until i have gone through the details with a lawyer / accountant. as for the value - you cannot value a startup in that way - it has no value at all. i am not valueing the company at anything, i simply need a £150k investment to get it off the ground. – Darkcat Studios 7 years ago
  • The point Joseph is making is that you sell them 40% of your business for 150k. That means they get 40% of your dividends for as long as they own it. To change this you must have a agreement in place that you can buy back 20% (50% of their holding) at a given point at a set price (180k). – Wolf5370 7 years ago
  • That makes more sense Wolf5370. obviously the detail will need to be bashed out with the investor as contracts are drawn up. – Darkcat Studios 7 years ago
  • I hope that you are able to close the investor. It sounds like a great opportunity. I hope that Wolf5370's comments and mine will provide you some insight as you get into the weeds of the specifics with the lawyer. – Joseph Barisonzi 7 years ago

1

The real problem is convincing investors that your company is worth the value you place on it (bear in mind that you have no assets, no orders and no sales). This means it is all potential. Most investors will want a large piece of the pie for their risk - this is how they make money.

Say it takes you 5 years to recoup the money to but the 20% back from the investor - in 5 years the invest paid you 150k for 40% - 5 years later he gets 180k for half his holdings (it is unlikely if you are saving to pay him off and the rest of the costs he got much in dividends up to that point - even if he did he does not count that as part of the risk factor coverage, only expected profits from holdings). So to that investor he has 20% shares that have whatever value they have at that point, plus the ROI of 180k - i.e. if he values the shares (as he is likely to at that point when looking forward at point of investment) at purchase price he holds 75k + 180k cash = 255,000 a gross profit of 105k - or 21k per year which is 14% non compounded. The question the investor will ask is - does the risk for 14% on 150k investment out weigh the peace of mind of investing in something safer. Does 14% sound good to you? Not to me - not with such risk (no assets).

Of course you may be able to convince them that the turn around will be in 2 years or even 1 - some investors will invest simply on their belief in you. However, as a dark pitch (i.e. one say sent in the post without seeing or hearing a decent pitch) it is not a great sell.

These sort of investments are offered very often - ideas with no backing (no execution experience) - it takes a good sales man to sell it to an experienced investor. Have a great plan, be ready to explain where the 150k is going in fair detail (and don't say to pay you for your time!), reasons you believe (with evidence of research helps!) showing how/why you will recoup their money in a given time span, where you sales are coming and when (and any advanced sales if poss.) and a great pitch to sell the idea.

It is not an easy sell - and investors may want to take just too much of your company - you may want to look ant banks/remortgage instead (investors may well ask you why for a mere 150k you haven't)

answered Jun 18 '12 at 00:37
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Wolf5370
191 points
  • +1 I found the breakout of thinking of how much the investor would be making in this scenario to be helpful. – Joseph Barisonzi 7 years ago

0

Does this sound reasonable? too good? or not good enough?

I have been in business 15 years and thinking back about my business's history, your offer sounds very fair to me. Some will think not enough ROI, however point out that as the revenue grows, they'll get their 20% of the shareholder distributions, which will/should be going up with profit. Additionally, they get the investment back, continuing income through distributions, and as the company's value grows, their 20% share does as well.

IMHO, it will be more fair to people who believe in small business and "the long run". For someone wanting to get it sellable and punch out, they'll want a bigger share all around.

answered Jun 16 '12 at 05:23
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Chris K
139 points
  • If you're taking the effort to downvote, a comment would be appreciated. – Chris K 7 years ago
  • That is a fine request Chris. I appreciate your answer to the question. I personally think the answer is wrong. (see my answer and Wold5370's answers above) It think that it missed the critical issue of the confusion between ownership, ownership distribution and a loan with preferred repayment. Without more detailed explanation on why you felt it was fair --even to someone who believes in small business I did not think it was a particularly useful response either. There is not a culture or expectation on the site of explaining votes -- but I sincerely appreciate the request, so here it is! :) – Joseph Barisonzi 7 years ago
  • @JosephBarisonzi, thanks. Actually, on SO downvotes will get an explanation. Thank you for sharing why: great points & fantastic reminder that hard facts are better than gut instinct; even if that is what runs some of our companies. – Chris K 6 years ago

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