Bure Valley Group is an investment brokerage business which links successful investors with exciting, innovative UK startups seeking funding. This content is for information purposes only and should not be taken as financial or investment advice.
As an investor, knowing how much equity to ask from a startup seeking funding is a key skill. Ask for too little, and the founder(s) may get the impression that you are offering a “handout”, and that you do not want to be too involved in the running of the business. Come in too high, however, then you may risk taking on too much responsibility than you really have time for, and the startup owner(s) could feel resentful or taken advantage of.
Here at Bure Valley Group, we offer this short guide to angel investors regarding how much equity to request when investing in startups. We hope you find this content helpful. Find out more about our EIS and other investment opportunities by visiting our portfolio page here. To enquire regarding our latest projects and funding, you can reach us via:
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The matter of valuation
One of the main challenges with negotiating equity distribution is establishing the value of the startup. It is common for business owners to vastly overestimate how much their business is worth. At the same time, many also want to retain as much control over their startups as possible (which is understandable; after all, they have likely poured considerable time, effort and expense into building it to where it is). This can lead to awkward situations where the angel investor(s) are asked for a large investment sum – say, £300,000 – in exchange for 2-3% equity. For most investors, this will likely not be accepted unless the proposition is near irresistible.
Conversely, there can be instances where owners hugely undervalue their startup. Perhaps the owner has not fully grasped that their product could quickly scale across multiple markets rather than just one, leading to much higher growth potential. In which case, you as an investor may wish to ask for a large equity stake to help ensure that the business is guided towards its full potential and does not miss out on these previously-unseen opportunities.
There are many ways to value a startup, and it will be important to use a method which both you and the founder(s) are comfortable with. Here are just three to consider:
- Standard Earnings Multiple Method. Here, you multiply the company’s profits by a chosen metric (e.g. EBIT) to establish its value.
- Discounted Cash Flow Method. This approach involves looking at the estimated total market for the startup’s product/service, as well as its anticipated growth. Then, you figure out how much market share the business could reasonably expect to capture within a defined timeline. After this, fixed and variable costs are estimated and a discount rate is applied (to take into account that many startups fail). From here, you should be able to construct a valuation.
- Comparison Valuation Method. Quite simply, you look at recently sold comparable assets (e.g. a competitor of the startup) to help determine the value of the startup.
Equity stakes – general principles
Finding the right percentages when it comes to gaining a stake in a startup is more of an art than a science. There are no universal, hard-and-fast rules. As such, there are no universal rules when it comes to dividing equity. Yet there are some good, time-honoured principles:
- Expect a significant ownership stake. As an angel investor, it is unlikely that you will want to settle for a single-digit percentage stake. Rather, more plausibly the ballpark will be in the 20-40% range.
- Seek ways to safeguard your money. If the business founder(s) expect you to simply hand out a lump sum and not hear from you much again after the negotiation, then they likely haven’t grasped your role in this vital seed stage of their business. You’ll want to establish concrete ways to be involved and help steer things, such as by gaining a seat on the board and/or bringing in your own consultants or executives.
- Keep a long term view. Some business owners are poor negotiators and, therefore, it is possible for angel investors to take advantage of this. However, consider the fact that a poor negotiator could represent a bad deal. After all, if the business owner cannot stand up for their interests to an angel investor, can you be confident that they’ll withstand the pressures of steering their business through this crucial growth phase?
- Shop around for the right deals. Of course, not every negotiation with a startup needs to end in an agreement. Perhaps the startup’s industry/sector is not one that you want to be involved in. Alternatively, perhaps the business owner will simply not budge from their untenable negotiating position. Fortunately, the great news is that there are plenty of other opportunities which could be a better fit. Here at Bure Valley Group, for instance, our investor network offers a wide range of projects in a diverse range of sectors which could be perfect for your portfolio.
Get in touch today to start a conversation with our team, and discuss some of the great investment memorandums we have available here at Bure Valley Group:
+44 160 334 0827