I am currently talking with a potential investor who is asking for a 90% equity stake in my start-up for a $1 million investment.
We have both agreed that the EBIT in year three will be $5 million and we would be looking to sell the business at this time for $30 million.
In my opinion a 30% equity stake would be more realistic for this potential investor. What do you think?
You are in a difficult situation and it raises a range of important issues about valuation, motivation, and capital strategy. All fast growing and early stage companies require capital, whether it is the founders own funds, or seed funds from “friends and family”, or angel capital from professional investors.
Your current potential investor is clearly either trying to take advantage of your requirements for capital or has little idea about the issues surrounding founder motivation, and the potential of any future capital raising to dilute you even further and below 10%.
It is more common practice for founders to retain a majority stake in their own business in the early rounds of capital raising. This aligns effort, motivation and reward. With only 10% of your own business, you may not be motivated to work 24/7 to grow the business for someone else’s gain.
There appears to be a mismatch between you and your investor in the current valuation of your business. If your investor is seeking a 90% stake, they are valuing the current business at approximately $111,000.
For a business that is agreed to have EBIT of $3 million in three years this is clearly too low a current valuation.
Unless you have no actual business or any commercial traction, this investor is effectively backing your idea and, effectively, you will become a salaried employee, rather than a major shareholder, of your own business.
Unless your investor can drive 90% of the value in the future, I would gracefully decline the current offer. Instead, raise a smaller amount of capital elsewhere, prove your business model, and then return to the investor with a stronger valuation story.
This article was first published in StartUpSmart.
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