How Much Equity Should You Give To Investors?

Your company is doing well, but you’ve exhausted the money that friends and family had given you. It’s time to turn to an angel for another round of funds. How much of your company do you part with?

That comes down to valuation.

What does that mean?

Well if 250,000 is only 1/10 of the company that means you’re saying your company is worth $2,500,000. That’s a lot of money, but more so a hefty valuation. So let’s say the investor doesn’t like that but instead values you at 500,000 and wishes to invest 250,000.

This means that at this valuation you would be giving away 50% of your company!

But not quite.

500,000 is pre-money valuation. How you would calculate the equity trade is post-money.

500,000 + 250,000 = 750,000, and then with a 250,000 investment the trade would make 33%.

See how that works?

There are a few things also to consider. Yes, there is such a thing as too low of an equity offering. How does trading 1% equity sound? It’s a terrible idea. 1–5% equity often is too low for an investor to see any real returns (They’re looking for about 10–20x their original investment. But say down the road you take funding from a VC in exchange for 30% of your company. They’re looking for your exit but the guy/gal you’ve given 1% still has a say.

You calculate how much money investors provide you and how much equity they take for it. Depending on this you can easily calculate what your company is really worth.

But can you negotiate with the investors for more with less equity? Will they agree with these terms? It all depends on you, and remember never throw a valuation without backing it by real numbers and solid data. Don’t just throw a random valuation in the air!!!

What does that mean?

It means you set aside a certain amount of equity (say 20%) to be later distributed to your early employees. For a startup that is rapidly growing this not only helps to recruit the right people but also ensures that a portion of your company is off-limits — it’s not up for grabs by Angels or VCs.

Don’t provide equity to anybody you don’t need for the sake of your business. Those 1–5 or 10 % equity that startup entrepreneurs provide to experienced advisers, relatives or someone with technical knowledge aren’t crucial for its development. Those small percentages will drive you crazy later. If you grow and prosper, you’ll want those shares for your productive employees. If you fail to grow, those people will bother you over the future, pressuring you to offer them cash compensation when there’s none.

The Bottom Line

Investment by outsiders is for scalable, defensible, high-profile startups with an established management system. Non-scalable hyper growth services don’t attract good investors. And there must be a true commitment to an actionable and doable exit strategy in 3 to 5 years.

Investors need to have enough incentive to hold the shares they own in case you decide to sell your company later on so they can profit from the exit and they’re making sure that you can’t sell the company at their loss. That doesn’t mean that every VC will need more than a 50% equity stake. However, they will always need to have some skin in the game and make sure that their money isn’t blown in the wind and wasted. They don’t make money when you’re building your company or raising more money, they get solid returns when you exit (IPO, Merger or Acquisition).

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