Investor wants to drip feed money by quarter, how to reward?
I have software product I've been developing for a few years that is just about at the beta stage. I am still working full time as a IT consultant and working on the product in the evening and the weekends, however since last month I do have developer working on the project full time, and I am currently paying him out of my own pocket.
I can't continue paying him myself indefinitely and I have been approached by a private investor who wants to invest in the company in return for equity. Once the current quarter ends I'm going to need 80k in order to pay the developer for the following year and the investor is prepared to cover that cost. However, he wants to deliver the money in lumps, every quarter, i.e give me the money I need to pay Q1 wages at the beginning of Q1 and Q2 wages at the beginning of Q2. To me, this doesn't sound like a model that fits with equity at all. It seems clear(to me at least, maybe I'm wrong tho) that he's just trying to limit his risk and I feel I should not give equity in this case. I'm not sure, however, how to reward his input and would greatly appreciate some advice
Thanks
John
1 Answer
If he wants to limit his risk by paying in drip, then he should also be willing to lower his equity stake: lower risk = lower reward. So for instance, you could counter his offer like this: "At the moment I need X to build my business. If you give me X in one lump sum then I'll give you Y% equity in the company and if you want to give me X in 4 installments the I'll give you Y-n% equity". It's sort of a pay-to-play deal. That's just an idea and you have to decide how you want the deal to work out. If you agree to receive funding quarterly then that potentially sets up a situation where in Qn, you might not get the funding you need and then you'll be in a tough spot.
One thing's for sure, early-stage investor(s) will partly determine the business outcome of your venture; take a look here: Losing Controlling Interest in a company, can that be bad? Good luck.
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Thanks very much !! Since I've known the investor for a few years I have a fairly high degree of confidence in him delivering the subsequent payments, however your suggestion of dialing down his equity stake - justifiably due to his reduced risk - is a good way for me to retain more equity, which will be useful in subsequent investment rounds. I guess the question is, if I was considering offering 10% for lump 100k investment(to make things easy for this example) what percentage sould I be offering if the funds were drip fed instead ?? 5% ?? or maybe 7% ?? – John 11 years ago
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If you already have an established relationship of trust with your investor then that's a really positive element. As for giving you a price tag on the value of the discount, that's much harder; most people aren't going to put their neck on the line on this one. But, if I had to, and if you're currently offering a 1Mio valuation, I'd suggest proposing something like "7% for quarterly payments, 8% for bi-annual, and 10% for a lump sum payment". Again, most people aren't going to venture out on a guess like this so don't ding me for offering one. Another option is to ask a lawyer. – Frenchie 11 years ago
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Also, if the investor asks why you're discounting his equity, you can justify it by saying that he's essentially buying a warrant: the right to purchase stock in the future at a pre-determined price. If in 6 months the valuation of your business increases then the investment he'd be making then would mechanically buy him less shares, hence the discount. If he wants to put in 100K at 1Mio post-money then that's 10% today but if he's putting in 50K now (on a bi-annual basis) then that's 5% now and the remaining 50K invested in 6 months at a 1.5Mio post-money would then buy him less than 5%. – Frenchie 11 years ago
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I really appreciate your pointers on this one - I wasn't at all sure what would sound reasonable so this is really valuable, thanks, especially for the justification element !! – John 11 years ago
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ok, you're welcome and good luck on your business! – Frenchie 11 years ago
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As a follow-on, money isn't worth the same depending on where you're at in your business development. When you're just starting out, the initial money is super expensive: you have to give a lot of equity for it, not to mention control. So when money is that "expensive", and yet that much needed, it's also worth considering borrowing it. – Frenchie 11 years ago
