So I have 20k shares of stock. 65% of the shares are spoken for between the co founders leaving 35% for an investor. We are bootstrapping it to make the prototype function. It's a piece of b2b electronic equipment meant for the consumer market. What I want to know is when I contact my first Angel assuming they show interest in what we are making. What would they realistically ask for regarding shares? Would I have to dilute? We're not looking for a large sum of money. Likely around 50k at the outset. Each unit will cost 500 to manufacture and the b2b ticket price will be between 2500 to 3k per unit netting us about 4 to 6X profit. I'd prefer not to dilute, not until farther down the road, but is that realistic?
You're making this too complicated.
How much is your business worth now (called "pre-money")? Let's say $4M.
How much investment are you taking? Let's say $1M.
That company is worth $5M immediately after investment so the investor gets 20%. ($1M is 20% of $5M.)
You should consider alternatives to selling equity, such as royalties or revenue share. For example, they get 30-50% of the revenue until they get 3x their money back. You may have to do this a couple of times in order to get sufficient working capital, but the terms will get better and in the end, you'll own 100%.
The reason to own 100% is not just control, it's because most investors want liquidity, to take their profits out and do something else. Revenue share and royalties are simple. Dividends in an SMB are complicated and you're not asking for enough money to justify complicated. (I'm assuming that acquisition and IPO are not realistic options.)
First question you are going to be asked will be: If it's only a 50.000K investment, why don't you take a loan or fund it yourself if you are going to make such a profit. (ticket is very small)
The average for Angels in the US is to take a stake of 10% to 20% for a 1M seed round. However there are larger seed funds who invest USD 50K for a stake of around 7% regardless of your valuation. They have fixed terms for their investments.
Justin, as usual with CoFounders lab, answers are made without sufficient info, but there are some good thoughts to pick out from among the advice that is made on assumptions. 10% for 1M??? Please share this investor! He is either really inexperienced or really generous! More power to you if you find someone who will commit $1M for a mere 10% prior to ANY revenue. I don't think you will find that investor personally. I certainly have never met them, but hey more power to you if you can. BUT, the advice about the loan is very good...if you can afford that risk. But...if you came to me and you told me you had a sure thing...in your mind…you have a great business plan that projects profitability….I would suggest the same thing…go get a loan. However, many entrepreneurs don’t want to take the risk, or they can’t…so nothing wrong with finding the investor. But keep in mind the minute you infer you don’t want to take the risk of a 50k loan, the investor may put a premium on his investment because he may see an unsure entrepreneur. You may find a generous one who works with you or one who sees a bit of desperation and ups his %.
No, you are not making this too complicated. Assuming “pre-money” valuation with such simplicity is making it far too simplified. I believe you are somewhere in between. You are thinking about…letting it roll around in your head. This is good. Always great to think about dilution.
If you walk into an investor with an over simplified “pre-money” valuation, they are likely going to be annoyed with your assumption that you have placed such a value on your company with ZERO revenue. So in this case, you don’t have much valuation because as you mentioned you are bootstrapping. You can certainly put a reasonable value on your investment thus far, but be reasonable. The rest of the valuation lies on assumptions of establishing revenue. This is where if you have a strong business plan and team, the investor can make a leap of faith…how much of a leap depends on what you present. The idea of royalties is good to entertain. It is essentially a premium ROI for the investor for him taking the risk on the 50k that you are not comfortable taking with a loan (assuming you structure the contracts appropriately). One challenge with the royalty approach though is that if you present this business that you are stating could be worth a lot of money one day…possibly be acquired for millions….mere %of royalty may not entice the investor.
What is the minimum order for your manufacturer to have cost of $500? (is that “out the door” so to speak including all fees to import..if it is offshore?) Is it 100? The reason I ask this, is if for example you could do an order of 25 or 50 for say 700…with your projected sale price and profit, that will decrease your loan to a pretty reasonable risk and then you can keep all of your equity. I will make an assumption in your favor that you have thoroughly negotiated with your manufacturer.
There is no right answer. A good approach would be to find an attorney experienced with startups. Go in with all your concerns and gain advice from a legal perspective.
But your numbers look good…they are in the right range of return. And $50k is a good sweet spot for most angel networks with $250k being on the higher end and $1M being more rare of a deal…for most markets. Of course once you go beyond official “angel networks” that number can get significantly higher.
Maybe there's a different way to look at this. As David points out, we don't have enough information to assess the situation. But instead of thinking about giving something away, consider that your investor is trading something of value for the risk you're asking them to take. The more risk, the more they're going to want to hold. The number of shares is irrelevant, as you can have any number of shares and they can be assigned any value (initially).
Your potential investor is likely going to want the same kind of deal as any initial stage investor. If you two put in ~$100K cash, and the last third is available for another $50K, that seems fair. But business isn't about fair, it's about what's reasonable and can be negotiated. If you as co-founders simply assigned yourself shares without any cash contribution, is that going to look fair to an outside investor? What are you risking?
I also agree that when you're talking about bank loan size amounts of money, why go through the extreme hassle of dealing with an investor when you can deal with a bank? I mean, I have multiple credit cards with available balances of over $30K each. Why aren't you funding with credit if you're so sure that you will be profitable? What is the money you're asking to borrow going to be used for?
There are at least 5 different kinds of investors, each has very different reasons for and expectations for investing. Angels are only one kind, usually the only kind that gets involved pre-revenue. But if you don't understand what motivates investors, you won't likely succeed in accessing their funds.
My initial suggestion, since you probably don't have an M&A attorney willing to spend the time to explain investor perspectives to you, is to get a book. Maybe try the book written by Alejandro Cremades, creator of CoFoundersLab on "The Art of Startup Fundraising" and read some insights on why and how investors attribute the risk and rewards of investing.
I think right now you're too worried about investors and not worried enough about your marketing strategy and proving that your product has buyers.
I"m in that same position. I am looking for at least $100,000 to fund my beverage business. Banks and loans are not an option for me.