Q: I will be meeting a potential investor next week and have no idea how much equity or ROI to offer for a capital investment. Is there an easy way to calculate the starting point for negotiation?
Jul 23 2008
Answered by: Clive Lewis Ask a question
The key issue when seeking outside investment is the degree of risk attaching to the shares.
The greater the demonstrable success the company has achieved the more the investor will be prepared to pay and the smaller the stake they might expect. If the company’s product or service is completely unproven, or even yet to be fully developed and sales made, the greater the uncertainty attached to the share and therefore the greater the potential shareholding the investor will seek so as to maximise their share of the rewards (if any) arising from their investment.
You must also realise that an offer of an equity stake in a business is not just about the money. An equity stake means the other party will have rights. They may want to have a say in the running of the business. So think what skills they might have that could help you grow the business – contacts, marketing, finance skills or links to finance providers.
They will probably want a seat on the board. This means they will expect to see regular information on how the business is performing – monthly management accounts at least. They will have expectations in regards to the rewards for investing in the business – a salary or dividends. And they may want to exit their investment after a predetermined period of, say, 3 to 5 years.
Some other issues to consider regarding the stake to offer. In reality there is only one stake which counts and that is owning more than 50% of the shares (assuming the shares are all of one class) although some rights attach to having more than 25% of the shares.
Finally you need to consider how much equity finance you need to raise and what the implicit valuation of the business your valuation of the equity represents. So, for example, you may suggest offering a 20% stake for £200,000 which values a 100% stake at £1 million.
If the forecast annual profitability is £150,000 that implies an annual ROI of 15%. The investor will consider a number of factors - the degree of uncertainty attaching to the profitability, their interest in the sector, what comparable investments will yield - before deciding whether to invest or not or, perhaps, to make a counter offer.
A discussion with your accountant might help you to form a negotiating position. You should also involve your accountant in the Shareholders Agreement which you need to draw up if the potential investor makes the investment.
Comments