When asking an investor to put money into your business in exchange for shares, the return on investment should be enticing enough for them to agree to the deal. However, what constitutes a fair percentage for an investor varies depending on the type of investment. In this article, we will examine what different investors are seeking and what kinds of offers may be appealing to them in return.
Investment Types
To better understand how investors contribute to your business, let's take a look at the different types of investments available:
Equity
Equity investment involves the exchange of money from an investor for partial ownership of a company, and can also take the form of an initial public offering (IPO). If you're looking for guidance on how to secure equity investments, consider seeking fundraising consulting services.
Debt Investment
Debt investment involves acquiring a significant amount of debt with the expectation of repayment with interest in order to invest in a company or project. Debt investment is less risky than equity investment because the investor is guaranteed a fair percentage.
Sources of Funding for Start-up Founders
A startup entrepreneur should be aware that their company may obtain funding from a variety of sources. We have highlighted some of them below:
Angel Investors
An angel investor is a high-net-worth individual, usually a close friend or family member, who provides financial support to small businesses or entrepreneurs in exchange for owning stock in the firm.
Venture Capitalists
A venture capitalist is a person or organization offering funding for a business's launch. Venture capitalists are often large companies that can manage greater risk and seek a more significant return on investment than standard investments. This is mostly done in exchange for stock. Click here to learn about the difference between an angel investor and venture capitalist.
Crowdfunding
A crowdfunding campaign solicits modest donations from a large number of individuals to collect money for a business or project. Crowdfunding works well on sites like Kickstarter, IndieGoGo, etc.
Bootstrapping
This describes the process of starting and expanding a business utilizing solely available resources, such as personal money, home computers, and garage space.
Seed Investment
During this stage of venture capital financing, a company attempts to obtain initial funding to pay for the development of its product and business strategy. Typically, seed money is provided by friends, relatives, and angel investors.
What is a Fair Percentage for an Investor?
Several variables, including the type of investment, the level of risk, and the expected return, will affect what constitutes a fair percentage for an investor. For angel investors, the typical standard is to provide between 20-25% of your company's profits. This is the return that investors will expect if you sell the company when it is still young. Investors must have enough power to prevent you from later deciding not to sell the business. However, the individual investor will often need to ensure that outside investors, when their property is consolidated, have more than 50%. This does not mean that each investor would require more than 50%. They do not bring in cash compared to you, but you can make money when you sell. Although the standard offered by most companies is 15% equity in a capital round, you can always propose a series of smaller raises if the investor negotiates for a higher proportion.
What to Offer Investors in Return?
Most investors expect to receive a stake in your business in exchange for their funding. Venture capitalists might be willing to take on greater risk, such as requiring 40% of the company if the product is still in development. On the other hand, angel investors typically expect a return of 20-25% on their investment in your business. Keep in mind that the funds are not a loan; you are asking the investor to make a risky bet with their money.
The best way to determine business returns is to take into account investor capital and cash flow. You can choose to offer your investors either money returns or stock at this time. However, your priority should be negotiating a fair percentage that won't hurt the company's cash flow. To do this, you will need to prepare a pitch deck, calculations, and business analysis. We recommend working with a leading pitch deck agency to ensure that you include everything that needs to be calculated.
If you are just starting a new business, add up all of your monthly expenses and multiply that amount by a period between 12 and 18 months. This amount represents the start-up capital required for your firm and its activities for the specified period.
How Much Share to Give an Investor?
An investor will generally require stock in your firm to stay with you until you sell it. However, you may not want to give up a portion of your business. Many advisors suggest that those just starting out should consider giving somewhere between 10 and 20% of ownership. When making your first investment agreement, be sure to avoid big mistakes. Depending on the amount of money the investor offers, you can offer them 15% or more of the firm if they are more interested in profiting from equity growth. Additionally, do not provide shares to somebody you do not want working long-term in your company. Do not give 3-10% shares to acquaintances because, as your business grows and prospers, you will need those shares for your staff. If you do not develop, such people will persistently bother you and demand money from you.
How Do Investors Get Paid Back?
The repayment scenario can vary depending on the different investment types and situations. To make things easier, we have listed some of the most common methods for repaying an investor:
Repayment Plan
This method is ideal for commercial loans or short-term investment contracts with payment assumptions. Simply make regular monthly payments or pay all at once to the investor for the loan and interest due.
Repayments at a Preferred Rate
The investor receives priority payback according to your pre-arranged terms.
Ownership Buy-Outs
Depending on the amount of stock owned by the investor and the value of the company, you may decide to buy back the investor's shares. Shares of the company owned by the investor may be repurchased at a predetermined price.
Share Transfers
You can repay a loan by swapping the debt for equity shares, giving the investor a proportionate ownership of the business equal to their investment. Consider paying dividends to your stockholders. Dividends would be cash payments made to shareholders and would be paid from the company's net income.
Do Investors Get Paid Monthly?
Investors can choose to decline monthly income funds and instead invest in ones that pay out on a regular basis. By having their dividends sent to a separate bank account, investors can receive a consistent monthly income. Typically, investors are reimbursed based on their ownership of the firm or their investment's share of the business. This may be paid out through preferred payments, depending solely on the amount they currently possess.
Factors that affect what investors consider a fair percentage
There are several factors that can affect what investors consider a fair percentage when investing in your business. Some of the most important factors include:
Type of Investment
The type of investment is one of the most important factors in determining what investors consider a fair percentage. Equity investments, for example, typically involve a higher degree of risk than debt investments, and investors may expect a higher return on their investment as a result. Debt investments, on the other hand, are generally considered to be less risky, and investors may be willing to accept a lower return.
Level of Risk
Investors will also consider the level of risk associated with your business when determining what constitutes a fair percentage. If your business is in a high-risk industry or is still in the early stages of development, investors may expect a higher return on their investment to compensate for the increased risk.
Expected Return
Investors will also consider the expected return on their investment when determining what constitutes a fair percentage. If your business has the potential for high growth and profitability, investors may be willing to accept a lower percentage in exchange for a larger return on their investment.
Competition
The level of competition in your industry can also affect what investors consider a fair percentage. If your business is operating in a crowded market with many competitors, investors may expect a higher return on their investment to compensate for the increased risk.
Business Model
Investors will also consider your business model when determining what constitutes a fair percentage. If your business has a proven track record of generating revenue and profitability, investors may be willing to accept a lower percentage in exchange for a stake in a successful company.
Stage of Development
The stage of development of your business can also affect what investors consider a fair percentage. If your business is still in the early stages of development, investors may expect a higher percentage to compensate for the increased risk. As your business grows and becomes more established, investors may be willing to accept a lower percentage in exchange for a stake in a successful company.
Market Conditions
Finally, market conditions can also affect what investors consider a fair percentage. If the market is favorable and there is high demand for investments in your industry, investors may be willing to accept a lower percentage in exchange for a stake in your business. On the other hand, if the market is unfavorable and there is little demand for investments in your industry, investors may expect a higher return on their investment to compensate for the increased risk.
Understanding the Risks and Returns of Different Types of Investments
When considering investment options, it is important to understand the risks and returns associated with each type of investment. Here, we will take a closer look at the different types of investments and what investors can expect in terms of risk and return.
Equity Investments
Equity investments involve purchasing ownership in a company in exchange for a share of the profits. These types of investments are typically high-risk, high-reward, as the value of the investment can fluctuate based on the performance of the company. The potential returns on equity investments can be significant, but investors also risk losing their entire investment if the company fails.
Debt Investments
Debt investments involve lending money to a company or individual in exchange for a set rate of interest. These types of investments are generally considered lower risk than equity investments, as the investor is guaranteed a fixed return on their investment. However, the potential returns on debt investments are also lower than equity investments.
Angel Investments
Angel investments are made by high-net-worth individuals who provide financial support to small businesses or entrepreneurs in exchange for partial ownership of the company. These types of investments are typically high-risk, high-reward, as the success of the investment is dependent on the success of the company. The potential returns on angel investments can be significant, but investors also risk losing their entire investment if the company fails.
Venture Capital Investments
Venture capital investments are made by firms or individuals who invest in early-stage companies with the potential for high growth. These types of investments are typically high-risk, high-reward, as the success of the investment is dependent on the success of the company. The potential returns on venture capital investments can be significant, but investors also risk losing their entire investment if the company fails.
Crowdfunding Investments
Crowdfunding investments involve soliciting small donations from a large number of individuals to fund a business or project. These types of investments are generally considered lower risk than other types of investments, as the investment is spread out among a large number of people. However, the potential returns on crowdfunding investments are also lower than other types of investments.
Real Estate Investments
Real estate investments involve purchasing property in order to earn a return on investment. These types of investments can be either high-risk or low-risk, depending on the type of property and the market conditions. The potential returns on real estate investments can be significant, but investors also risk losing their entire investment if the property does not perform as expected.
Commodities Investments
Commodities investments involve investing in physical goods, such as gold, oil, or crops. These types of investments can be either high-risk or low-risk, depending on the commodity and the market conditions. The potential returns on commodities investments can be significant, but investors also risk losing their entire investment if the commodity does not perform as expected.
Overall, the risks and returns associated with each type of investment can vary widely. It is important to carefully consider the potential risks and rewards before making any investment decisions. Additionally, investors should consult with a financial advisor before making any investment decisions to ensure that they are making an informed choice.
Negotiating with Investors: Tips for Getting a Fair Deal
When negotiating with investors, it's essential to keep in mind that both parties have a shared goal of making a profit. However, investors will be looking for the best possible return on their investment, while entrepreneurs will be looking for a deal that won't hurt their company's cash flow. Here are some tips for getting a fair deal when negotiating with investors:
1. Know Your Business
Before entering into any negotiations with investors, it's essential to have a clear understanding of your business, its strengths, and its weaknesses. You should be able to articulate your business model and explain how it will generate revenue. Additionally, you should be able to provide evidence that supports your claims and demonstrates the potential for growth.
2. Do Your Research
Research is key when it comes to negotiating with investors. You should be aware of the current market conditions and the typical terms of investment deals in your industry. This will help you to determine what constitutes a fair deal and avoid being taken advantage of.
3. Understand the Investor's Perspective
To negotiate effectively with investors, it's essential to understand their perspective. Investors are looking for a return on their investment, and they will be assessing the potential risks and rewards of investing in your business. You should be prepared to address their concerns and demonstrate why your business is a good investment opportunity.
4. Be Realistic
It's important to be realistic when negotiating with investors. You should have a clear idea of what you want to achieve from the negotiations and what you're willing to concede. While it's important to be confident in your business, it's also crucial to be realistic about its value and potential.
5. Be Willing to Negotiate
Negotiations with investors should be a two-way conversation, and both parties should be willing to make concessions where necessary. You should be prepared to listen to the investor's concerns and feedback and be open to adjusting your proposal to accommodate their needs.
6. Seek Professional Assistance
Negotiating with investors can be a complex process, and it's important to seek out professional assistance where necessary. Working with a reputable pitch deck agency can help you to prepare a professional pitch deck that accurately reflects your business and its potential.
7. Be Clear and Transparent
Transparency is key when it comes to negotiating with investors. You should be clear about your business's financials, including revenue, expenses, and projections. Additionally, you should be transparent about the risks and challenges associated with investing in your business.
By following these tips, you can increase your chances of negotiating a fair deal that benefits both parties. Remember that negotiations with investors should be a collaborative process, and both parties should be working towards the shared goal of making a profit.
Examples of Successful Investment Deals and Their Terms
There are many successful investment deals out there, but each deal is unique and depends on the type of investment and the needs of the business. Here are a few examples of successful investment deals and their terms:
When Facebook was just starting out, it received a $500,000 investment from PayPal co-founder Peter Thiel in exchange for a 10.2% stake in the company. This investment helped to kickstart Facebook's growth, and Thiel's investment is now worth billions of dollars.
Uber
In 2010, Uber received a $1.25 million investment from angel investor Chris Sacca in exchange for a 5% stake in the company. Sacca's investment helped to fund Uber's early growth, and the company is now valued at over $70 billion.
Airbnb
Airbnb received a $600,000 investment from Sequoia Capital in 2009 in exchange for a 10% stake in the company. This investment helped to fund Airbnb's expansion, and the company is now valued at over $30 billion.
Dropbox
In 2007, Dropbox received a $15,000 investment from Y Combinator in exchange for a 6% stake in the company. This investment helped to fund Dropbox's early growth, and the company is now valued at over $10 billion.
In 2011, Pinterest received a $10 million investment from Bessemer Venture Partners in exchange for a 10% stake in the company. This investment helped to fund Pinterest's early growth, and the company is now valued at over $12 billion.
These are just a few examples of successful investment deals, but they illustrate the importance of finding the right investor and negotiating a fair deal. When seeking investment for your business, it's important to do your research, understand the needs of your investors, and be prepared to negotiate a fair deal that benefits both parties.
Common Mistakes to Avoid When Negotiating with Investors
Negotiating with investors can be a tricky process, especially if you're new to the game. To avoid making costly mistakes, it's important to be aware of some of the most common pitfalls that entrepreneurs fall into when negotiating with investors. Here are some of the most common mistakes to avoid:
1. Failing to Prepare
One of the biggest mistakes entrepreneurs make is failing to prepare adequately for negotiations with investors. Before entering into any negotiations, it's essential to have a clear understanding of your business, its strengths, and its weaknesses. You should also have a clear idea of what you want to achieve from the negotiations and what you're willing to concede.
2. Overvaluing Your Company
Another common mistake is overvaluing your company. While it's important to be confident in your business, it's also crucial to be realistic about its value. Overvaluing your company can turn off potential investors and make it difficult to secure funding.
3. Failing to Listen
Negotiations with investors should be a two-way conversation. Failing to listen to investors' concerns and feedback can make them feel undervalued and unappreciated. Make sure to listen carefully to what investors have to say and be willing to make concessions where necessary.
4. Failing to Build Relationships
Investors are more likely to invest in businesses where they feel a personal connection to the founders. Failing to build relationships with potential investors can make it difficult to secure funding. Take the time to get to know your investors and build relationships based on trust and mutual respect.
5. Failing to Get the Right Advice
Negotiating with investors can be a complex process, and it's important to get the right advice. Seek out experienced advisors who can guide you through the process and help you avoid common pitfalls.
By avoiding these common mistakes, you can increase your chances of securing funding and building a successful business.
How to Value Your Company and Determine a Fair Percentage to Offer Investors
Before you can start negotiating with investors, you need to determine the value of your company. The value of your company is the total worth of the business, which includes all assets, intellectual property, and future earnings potential. There are several methods for valuing your company, including:
Comparable Transactions Method
This method involves analyzing the sale prices of similar companies in the same industry. By comparing your company to others that have been sold recently, you can get a good idea of what your company might be worth.
Discounted Cash Flow Method
This method involves projecting the future cash flows of your business and then discounting them back to their present value. This method is based on the assumption that the value of your company is equal to the present value of all future cash flows.
Asset-Based Valuation Method
This method involves determining the value of your company's assets, including any intellectual property, and subtracting any liabilities. This method is often used for companies that have a lot of tangible assets, such as real estate or equipment.
Once you have determined the value of your company, you can begin to negotiate with investors. A fair percentage for an investor will depend on a variety of factors, including the type of investment, the level of risk, and the expected return.
For equity investments, a fair percentage for an investor is typically between 10% and 25%. If you are offering equity in exchange for investment, you will need to determine what percentage of the company you are willing to give up. Keep in mind that the more equity you give up, the less control you will have over the company.
For debt investments, a fair percentage will depend on the interest rate that you are offering. Typically, investors will expect a higher interest rate for higher-risk investments.
When negotiating with investors, it is important to be realistic about the value of your company and the potential return on investment. You should also be prepared to explain how you arrived at your valuation and to provide evidence to support your claims.
Overall, determining a fair percentage for an investor requires careful consideration of a variety of factors, including the type of investment, the level of risk, and the expected return. By taking the time to value your company and understand the needs of your investors, you can negotiate a fair deal that benefits both parties.
Legal Considerations When Seeking Investment for Your Business
When seeking investment for your business, it is important to consider the legal implications of accepting funding. Here are some legal considerations to keep in mind:
Securities Laws
Securities laws regulate the offer and sale of investments, including stocks, bonds, and other securities. These laws require that companies register their securities with the appropriate regulatory agencies or qualify for an exemption from registration. Failure to comply with securities laws can result in significant legal and financial consequences.
Investor Agreements
Investor agreements outline the terms of the investment, including the amount, the percentage of ownership, and the rights and responsibilities of the investor. It is important to have a clear and detailed agreement in place before accepting funding to avoid any misunderstandings or legal disputes down the line.
Intellectual Property
If your business relies on proprietary technology or intellectual property, it is important to protect your rights before seeking investment. This may involve filing patents, trademarks, or copyrights, or entering into licensing agreements with third parties.
Tax Implications
Investment funding can have significant tax implications for your business. It is important to consult with a tax professional to understand the potential tax consequences of accepting investment, including any reporting requirements or tax incentives that may be available.
Corporate Governance
When accepting investment, it is important to have clear corporate governance procedures in place to ensure that the business is managed effectively and in compliance with applicable laws and regulations. This may involve creating a board of directors, establishing committees, and developing policies and procedures for financial reporting and decision-making.
Due Diligence
Before accepting investment, it is important to conduct due diligence on the investor to ensure that they are a good fit for your business and that their funding is legitimate. This may involve reviewing the investor's financial statements, credit history, and legal history, as well as conducting interviews and background checks.
By keeping these legal considerations in mind, you can help ensure that your business is well-positioned to accept investment and grow successfully.
Conclusion
Understanding investors and securing funding for your business requires careful consideration of a variety of factors, including the type of investment, the level of risk, and the expected return. By preparing adequately, doing your research, and seeking professional advice where necessary, you can negotiate a fair deal that benefits both parties. Remember to be realistic, transparent, and willing to negotiate, and to keep legal considerations in mind when seeking investment for your business. With these tips in mind, you can increase your chances of securing funding and building a successful business.
