How much stake should I offer my investor?
Aug 14 2012, 19:14 | By SME Mentor
The rule book is silent on how much stake an entrepreneur should offer to early stage investors. Let's put it this way - the percentage depends on your fund requirements and your level of desperation, so to speak.
- Stake to investors determines valuation: It is advisable that you go slowly on this front, the reason being that the amount of equity that your offload against the amount of money coming in establishes the valuation of your enterprise for now. Eg: If you offload 25 percent of the shares of your company for Rs 10 lakh, it would immediately mean that your company is valued at Rs 40 lakh. This, then, becomes a benchmark for future fund raising occasions.
- Ideal is 5 to 10 %: There have been instances where early stage investors have been offered 2 percent stake, and there are extreme cases where promoters have sold as much as 90 per cent equity at the initial stage. But in ideal cases, experts believe that the sale of initial equity should be between 5 to 10 percent, so that you have enough headroom left.
- Dilute phase-wise: "You must dilute in phases as the value of your company grows through different stages. Investors commit large amount of money for companies with a viable business model and you can draw as per your requirement," says Vinod Keni, CFO & Director, Aavishkaar Venture Capital.
The trust between you and your investor(s) also increases as you grow over a period of time and you also create more value in your company. You can negotiate on valuation at a later stage with the existing or prospective investors.
Negotiate with your Angel Investors and VCs
At an early stage when you approach someone for funds, investors, in a sense, are betting on your business "blindly" despite all the due diligence, as you as an entrepreneur are yet to prove your mettle and credentials. They may thus want a larger pie in your business in return for the seed capital. In most cases they expect over 40 percent returns on their investment due to the risk involved. However, do not allow an investor to get away with a cheap deal as far as possible or you may come to regret it at a later stage.
- Like you need investors for your business, the investors also need you to maximise their investment through your idea and efforts. So do understand that nobody is in that sense doing anybody a favor.
- The negotiations should be based on what your company has achieved, the market potential of your product, the team you have put in place and the competition in your sector.
- If your business plan is unique and you have the confidence then that can be the major differentiator and your business can have a better valuation.
- If you have the option of raising money through debt, then equity funding may come at a cheaper rate, but if you don't have the option of raising funds through loans at all, then you have to give away whatever stake the angel investor or VC wants.
Should you always want majority stake?
Yes. As a promoter you should not shed majority control ever as the company may then go away from your hands. At the same time, investors do not want to go beyond 50 per cent, because they do not want to run the company as they lack the knowledge.
"If the promoter has only 10 percent stake in a company, what is left for him in the business? He will not get any motivation to run the business," says Anjana Vivek, Founder, VentureBean Consulting.
There is something called the Termsheet which is like an agreement between the entrepreneur and the investor. It spells out everything and is a legal document. The entrepreneur can draw up a termsheet while approaching an investor but most of the times, the former will have to give in to the latter's terms and conditions. If that happens, let the investor draw up a termsheet but get it thoroughly examined by your legal expert before signing it.
A quick checklist
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May 20 2013, 21:04
May 20 2013, 20:41