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?
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.
Even if that means offering an investor a chunk of equity to catapult yourself forward.
Contrary to common misconceptions, investors are not solely focused on making money at the expense of the business.
Instead, because their returns are contingent on the success of the company they invest in, the right investor will share your goal of growing your business in a strong and sustainable way.
Remember that investors can bring more to your business than just finance; their expertise and networks can be crucial as your business matures.
You also do not need to relinquish a substantial portion of your company to obtain funding.
In this article we’ll highlight some of the things to think about when deciding how much equity to offer an investor.
Whenever it comes to financial decisions, it’s a good idea to first seek independent and specialist advice to help you decide which type of finance is right for you and your business.
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 for 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
Keeping Perspective
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.
It reflects well on you and your company and provides investors with a transparent view of your business as an investable proposition, 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.
Learn more about how to value a business.
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.
Learn more about carrying out due diligence on investors.
Think about further funding rounds
Securing adequate funding for your business frequently requires multiple rounds of investment.
It is crucial to aim for a minimum of twelve months of financial runway with each round.
The journey to obtaining funding varies significantly between businesses, including differences in timelines and the amount of equity sacrificed.
Be mindful that with each new round of funding, you are relinquishing additional equity, which in turn dilutes the overall ownership pool.
Therefore, it’s a good idea to think carefully about your Capitalisation table or Cap table.
A Cap table is a spreadsheet that shows who owns what percentage of a business.
It includes all the securities in the business including equity ownership shares, convertible notes, and warrants.
Some Venture Capital funds may be hesitant to invest in a business where less than 60% of equity is still in the business.
Learn more about equity funding stages.
Pay attention to your debt-to-equity ratio
A debt-to-equity ratio of 1.5 indicates that your company utilises £1.50 in debt for every £1 of equity.
This ratio is a crucial measure of leverage, reflecting the total debt relative to the company's investment and retained earnings over time.
Understanding this ratio is important because potential investors use it to assess whether your business might be in financial distress or excessively leveraged when considering additional funding rounds.
While some tech start-ups cannot raise debt and thus don't need to worry about this ratio, product companies and e-commerce businesses often carry debt, making it essential to monitor their leverage through this metric.
To calculate the debt-to-equity ratio for a funding round, divide your company's total liabilities by the total shareholder's equity.
Both of these figures can be found on your balance sheet.
Reference to any organisation, business and event on this page does not constitute an endorsem*nt or recommendation from the British Business Bank or the UK Government. Whilst we make reasonable efforts to keep the information on this page up to date, we do not guarantee or warrant (implied or otherwise) that it is current, accurate or complete. The information is intended for general information purposes only and does not take into account your personal situation, nor does it constitute legal, financial, tax or other professional advice. You should always consider whether the information is applicable to your particular circ*mstances and, where appropriate, seek professional or specialist advice or support.
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