How to Negotiate with Investors for Your Start Up Capital
Tuesday, June 1, 2010 by Doron F. Eghbali
Every start up needs lots of financial backing to build a brand and bring in customers or clients. Nonetheless, the sine qua non for starting up a business and successfully sustaining it is money. Many start up entrepreneurs wonder what would be the figure they should sacrifice to secure needed capital from investors. Although the answer is virtually different in each case, there are some guidelines to be strictly followed.
SOME GUIDELINES
1. Some Money Now, Some Money Later: Investors seek to value your start up and based on that valuation they decide whether and how much they should lend you money. Almost always, a start up with a website, business plan and entrepreneurs' aspirations is valued less than a profitable and viable business. As such, investors often ask for a bigger share of the pie in the beginning in the form of equity. This means in addition to low valuation of the start up you have to still give up more equity in your business. As a rule of thumb, you should never give up more than 20 to 30% of equity.
What you do is to raise some money in the beginning with low valuation and more equity largess. However, you will have to raise more equity later when your business has proved to some extent profitable and investors value your business higher.
In fact, if you have to give up more than 20 to 30% of equity in your start up- business to investors, then you had better stay on the sidelines and not launch your start up since at the end your business might be profitable but you will not see the profits.
2. Some Debt Some Equity: It is prudent to think of debt financing along equity financing to the extent possible and prudent. Debt could be straight or convertible. This means investors would have a chance to convert their debt to stocks if and when the company becomes profitable or goes public. The investors feel protected since they are often paid first even if the company goes under. However, you should pay higher than prevailing market interest rates to lure investors. In addition, debt financing might have serious tax consequences and as such your debt/equity ration should stay below 75%. This means you must have at least 25% equity in your start up.
Every start up needs lots of financial backing to build a brand and bring in customers or clients. Nonetheless, the sine qua non for starting up a business and successfully sustaining it is money. Many start up entrepreneurs wonder what would be the figure they should sacrifice to secure needed capital from investors. Although the answer is virtually different in each case, there are some guidelines to be strictly followed.
SOME GUIDELINES
1. Some Money Now, Some Money Later: Investors seek to value your start up and based on that valuation they decide whether and how much they should lend you money. Almost always, a start up with a website, business plan and entrepreneurs' aspirations is valued less than a profitable and viable business. As such, investors often ask for a bigger share of the pie in the beginning in the form of equity. This means in addition to low valuation of the start up you have to still give up more equity in your business. As a rule of thumb, you should never give up more than 20 to 30% of equity.
What you do is to raise some money in the beginning with low valuation and more equity largess. However, you will have to raise more equity later when your business has proved to some extent profitable and investors value your business higher.
In fact, if you have to give up more than 20 to 30% of equity in your start up- business to investors, then you had better stay on the sidelines and not launch your start up since at the end your business might be profitable but you will not see the profits.
2. Some Debt Some Equity: It is prudent to think of debt financing along equity financing to the extent possible and prudent. Debt could be straight or convertible. This means investors would have a chance to convert their debt to stocks if and when the company becomes profitable or goes public. The investors feel protected since they are often paid first even if the company goes under. However, you should pay higher than prevailing market interest rates to lure investors. In addition, debt financing might have serious tax consequences and as such your debt/equity ration should stay below 75%. This means you must have at least 25% equity in your start up.
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