How much equity should you be prepared to offer to get that first investor? Is it worse to ask for too little or too much? We chat to financial experts to find out.
As an entrepreneur, your business can be an intensely personal thing. Turning a burning idea into a fully-fledged entity takes you on a rollercoaster of emotions that only those who experience it can truly understand.
Little surprise then, that the impact this journey has can make it all the more difficult for you to give up control.
But as hard as it may be, you have to be prepared to take advantage of investment when the time is right. Even if that means offering an investor a large chunk of equity to catapult yourself forward.
Searching for the magic number
Every business is different, so whether you’re considering Angel Investment, Private Equity or another type of finance entirely, there’s no set standard to determine how much equity an entrepreneur should be looking to offer.
There are, however, a number of words of wisdom to take on board and pitfalls for a business to avoid when taking their first big step.
A lot of advisors would argue that for those starting out, the general guiding principle is that you should think about giving away somewhere between 10-20% of equity.
Giving up any more right off the bat could prove risky if your business grows as time goes on, as it’s possible you may face multiple funding rounds further down the line, which will dilute your share further and further.
So, if you’ve ‘chased the money’ and immediately given away a significant chunk, you could end up with far less than you’d initially hoped further down the line.
What about going lower still? Why not opt for a series of smaller raises instead? It’s certainly an option, but along with the potential risk that you may not secure the amount you feel you may require up front, it’s also worth reversing the situation and asking how involved an investor with so little equity may be.
“An investor needs skin in the game. There’s a natural alignment between the investor and the entrepreneur. The investor wants the entrepreneur to grow and succeed and to get them their exit. The only way they’re going to do that is if they’re adequately incentivised to push, to fight, to drive.”
|Roderick Beer Strategic Relations Director @ UK Business Angels Association|
In most cases – from Angel Investment to Venture Capital – asking for too little is worse than asking for too much, suggests Tim Hames, Director General of the BVCA.
“Asking for 5%, for example, is not enough money to assist you, and it’s not enough money for the investor either because it’s not enough of a commitment for them to decide they should spend their time introducing you to people you don’t know, giving you the benefit of their experience etc.”
There are longer term relationship implications here too. Hames advises to: “Pitch high and you can always be scaled back – because if you end up going back and asking for more it annoys people and looks like you don’t know what you’re doing.”
And investors won’t be afraid to scale you back.
“As an angel investor myself, I always ask ‘what do you need the money for?’ Businesses come to you and they say, ‘I need £1 million’, but once I get that story I can tell that actually they only need £250k right now – and will need £1 million over time. That journey is what you’re planning.”
|Jenny Tooth Chief Executive of the UK Business Angels Association|
However, ultimately, valuing your business as accurately as possible – and showing your working – in the first instance is important.
It reflects well on you and your business, and provides investors with a transparent view of your business, the finance you need and why you need it. From there, an investor may look to scale you back or look to invest more, depending on your business and their view of it.
Know what you want
Still, what you can ask for and expect may come down to factors beyond your immediate control.
The experience or proven record you may or may not already have, will play a key role in investors determining how much control they feel they need, meaning they may look for more equity to cover their backs.
You may also be operating in a fast-growing sector or have seen your business generate a buzz that means you can justifiably look to retain more equity than other companies of a similar size.
Ultimately, it comes down to understanding your business and being on top of how you think your business might grow, before identifying where the value lies.
That won’t just be appealing to investors who are keen to see that you’ve done your due diligence, but it will also help you work out what you need right now to move forward and later, help you translate that in to how much you’re willing to part with.
If you believe an investor’s injection of finance, expertise and influence will collectively help your business grow by a larger percentage than the percentage of equity they are looking to take, then in general this could be seen as a good option.
Have an idea of where you might be heading and what you’ll need to get you there.
“We really like it when entrepreneurs come and can really demonstrate their handle over the business. I would encourage founders to really contextualise their offer and understand their market, understand the competition and understand why their proposition has a real chance of success.”
|As David Mott Co-founder and managing partner of Oxford Capital|
Then you can find the partner – not just the figure – that works for you.