Over the last two years or so I've been developing a software product in my spare time(I'm still currently consulting at an investment bank). It's fairly niche in that it's targeted only at banks and trading venues. For the last month I have had a swedish developer working for me on a full-time contract basis whom I've known for a few years and who has experience in this space; I've been thus far paying him out of my own pocket, however, I'm not going to be able to continue paying him indefinitely
And now to the crux of the matter :
I am being courted by a potential investor(an established hardware reseller with deep pockets) who I have known for a few years and have a degree of faith in. He wants to get into this space because he, like I, sees a large opportunity. To avoid destroying all my savings I'd like to ask him for the £100,000 I need to cover the ongoing costs of my full time Developer, the esoteric the hardware we need(which is not cheap) and sundry other startup costs. In addition, I need(and he's offered) his legal, marketing and sales muscle. In return he wants equity, not sales commission in return for a loan. The question is, how much equity should I offer him ??
Key points(I guess these speak of the level of risk associated with the investment) :
We project sales of :
Year 1 - £300,000
Year 2 - £800,000
Year 3 - £1,600,000
I've read quite a few questions of this type on this site but many of them don't really deal with this situation; I would like to know what I should be offering the potential investor in terms of Equity. I know the % is based on the risk profile and I've read low 20s (20-23%) a number of times; I'd certainly not like to give away more than that if possible - but is this realistic in this situation ?? I think that if I'm offering 20% of the Company in return for £100,000 then(forgetting sales) I'm effectively saying that the company is worth somewhere near £.5M...we believe it is since competitor turnover has been far higher than that in the last few years.
Any pointers greatly appreciated !!
If your sales projections can be met, you are giving away too much of your equity.
So instead of making your product feature rich, try to get it out in beta mode to few clients at a a discounted price (say x% of the actual price). Try to offer the discount for a fixed period so that you don't loose money when you are ready to launch your full product. The biggest advantage here is that you are not loosing out your equity and still getting sponsored or funded.
Once you start generating revenue, you can make a better pitch to the investors. The more number of clients and revenue you generate, the better valuation.
Another option is see if the developer could take some of his pay in the form of equity. That will also allow him to be more committed to your project. So if he somehow agrees to take 50% equity, your money will go almost twice the initial time. But, please be respectful to him and have a very clear communication. Some of the developers don't like this idea. So make sure your offer is reasonable and polite.
I would go this way.
15% - for your current and future employees.
45% - for promoters and founders
40% - for investors.
So, use the 40% carefully, if you plan to go big.
Raise equity in phases, with higher valuation every time.
Read about Seed and Series A fund raising and get a handle on them before you sell your equity.
http://en.wikipedia.org/wiki/Series_A_round Best of Luck!
for the questions asked below: This seems to be lost in the comments. So I am updating it here.
Yes, for 1 and 2. Inline with my thoughts.
Looks like he falls into the category of Angel Investor. So, you might be able to convince him for a lower equity if you are taking the installments in part. But, if he doesn't agree, it is still ok I guess as you only give up the equity for the amount of funds you have received. But, as you grow and start generating revenue, you should either avoid giving away your equity of start selling it for a higher cost that is proportional to your revenue. So at some point, if you approach VCs, you can raise larger sum.
But, one interesting thing that you shared is about his networking skills. So, if you can potentially use his network for the other things you mentioned, I guess you can squeeze out more than what you are willing to give him away. The biggest advantage is that as a techie, you can concentrate on building a better product and he would help market and bring additional financing to your product. Also, his interest would be to market his equity for a higher share to the potential VCs. So I agree with your thoughts on getting him on board even if you are loosing out a bit.
One more very important thing, create a very detailed business plan. Take the help of a professional, if you have to. You should also go to your local seminars or meet some organisations that can give some basic advise. In USA, we do have something like SCORE.org and SBA.That will help you a lot and gain an insight of what others are doing. A friend gave shared this link with me startout.org.
I did not quite understand about 'sliding scale of equity' where you are giving up more equity every time, raising the same amount. I was thinking of getting more every time or giving less equity.