Starting a business isn’t easy. If it were, everyone would be doing it! Depending on the running cost of your business, you may struggle to get it off the ground without millions of dollars in the bank. This makes reaching out to investors one of the best ways to get your business off the ground.
But how much equity should investors get? This is, quite literally, the million dollar question, and unfortunately, the answer isn’t necessarily a straight one.
Think of Value instead of Percentage
Many founders get bogged down by percentages when it comes to getting investment, but this is the wrong way to look at it. Of course, at the very beginning, you will own 100% of the business, which may seem a hugely attractive option. However, it’s important to remember that if the value of your business is nothing, 100% ownership doesn’t mean very much!
Because of this, you should think of value instead of percentages. As the business starts to grow and you give away investment, you will own less of the business but the value will be higher. Thinking of investment in this way will it stop you getting too attached to equity – potentially missing out on a good opportunity to make money.
That said, in each round of financing, you should not be giving up more than 20-25% of the company. If you have a term sheet on the table for more than that, I’d call into question its fairness and the motives of your potential investors. Make sure you have an experienced venture attorney looking over these docs every step of the way — including before you sign a term sheet — to make sure that what you’re doing is in line with what’s typical in the market.
Do you Need an Advisor?
Too many people try to go it alone and end up struggling. Hiring an advisor with knowledge, experience and great connections is a fantastic way to make your business boom – but this will come with a cost in terms of equity. The appropriate equity to offer will depend on their experience and knowledge, as well as which round of investment you are in.
Advisors are generally given 0.1%-0.25% of the company’s stock post-Series-A. Their responsibilities aren’t enormous, with advisors usually just introducing the company to an important investor or customer, or they may advise you on certain aspects of the business.
Some investors will try to argue for advisory shares. They may say that they can bring more to the company than other investors, and try to convince you into giving away more of your company. In general, don’t do this. Most investors act as advisors anyway, and they’re doing it because they’re invested in the company, not because they’ve been given a formal advisory role. While outside advisors can be very helpful, giving an investor additional shares because they advise is uncommon these days and seems shady.
Your Own Personality
Your own personality should also determine how much of your company you decide to give away. The Myers Briggs Type Indicator is one of the most popular personality tests used for business all around the world, and often founders will only hire people of a certain personality type.
If you know that you are someone who needs to micro-manage and want complete control over your business, of course, you will want to give away less in terms of equity. When other people have equity in your business they will have opinions, and in some cases (with board seats, etc.), they’ll have the formal ability to enforce those opinions.
If, on the other hand, you are someone who welcomes thoughts, opinions and love having people to bounce ideas off, you might be tempted to give away slightly more. You will be rewarded with experience, knowledge and advice that may help make your business a success.
The Value of your Business
Like most questions asked in business, the answer to how much equity you should give away is, it depends! Again, the general rule of thumb for each round is 20-25% of the company. Investors are sort of funny this way — they’ll have a target ownership percentage rather than a target valuation for your company. If you want to raise more, they’ll often be willing to raise the valuation and invest more, as long as they hit that ownership percentage.
It’s important to remember that investing in any new business is high-risk. With so many new businesses failing, investing in a business is a bet, and if it falls through then your investment will be left with zero return. For that reason, they need to own a substantial amount of the winners in their portfolio — those winners are paying for themselves and for the failures that generated no return.
Remember when you’re pitching investors and discussing amounts and valuations that you aren’t a commodity. Investors are looking for a company that they believe will make them money, and that is hard to find. They should be pitching you as much as you’re pitching them! And when you’re about to make that deal, remember that it’s not all about the numbers. As long as you’re within throwing distance of fair, getting the right investors on board — those that will stick with you through the hard times and the good times — is what’s most important.