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I am starting a business that will require $450k in start-up funds.  I am putting up $50k and I have an angel who is putting up $100k.  I plan to recruit three other angels at $100k each, but I need to figure out ownership positions.  The pro-forma calls for profitability in year 3.  Dividend payments would be issued in year 4 and the net profit for year 4 is projected to be $200k +/-.

Based on the fact that it is my idea, and I will be putting up approximately 11% of the start up funding, what percentage of the business should I be entitled to for ownership?  Would a split of 30% for me and 17.5% for each of the angels be appropriate?

Thanks for any feedback!

Will you be drawing a salary during the first 3 years?  If so, in what capacity?  If in sales, then that would be an expected cost to the company, no matter who fills the role, with no equity impact.  If in an executive/managerial position, then that may impact what equity position you would hold.  If your time were "sweat equity", then that would be entitled to compensation, which would be in  the form of additional equity.  It would be a form of contributed or "in-kind" resources.  If that were the case, a value for your time would need to be determined before you could ascribe a percentage of equity in the venture.  On the other hand, if you are drawing a salary while they are waiting to make a profit, then your stake might be diminished, because you will be drawing financial resources out of the venture.

Being an idea man, all my ideas are worth at least 50% of the venture, regardless of the costs to start up.  Somehow, the guys with the money don`t see it that way.  To them, ideas are cheap and the capital is what its all about.  If they don`t fund your idea, there are 20 more in line to ask them for their funds in other ventures. 

Your unique idea is your baby, not theirs.  So unless you have a killer presentation and can make the case that your idea is far superior to their other investment opportunities, you`ll have a tough time justifying a significant equity position just for the concept. 

Have you ever talked with a VC,  or potential angels?  Ultimately, if you can convince them that you`re worth the equity, then you are. And then your 30% may seem too little to you.  I had a very wise businessman and client once tell me to enter all deals and negotiations as if all the money for the project were sitting in a pile of cash in the middle of the table.  Then make all your decisions based upon you walking out of the room with whatever amount you negotiated.  If you`d be happy with the deal under those circumstances, then you`ll be happy with the long term result. 

Then again, another position to consider is they take a preferred position, with a larger stake on the front-end with a pre-determined time or performance buyout, whereby you guarantee their return in a given time.  After their out, you own whatever equity remains. 

 

Green:

Thanks for the feedback.  I will indeed be drawing a salary and being the sales rep for the business.  My salary would be equal to my salary at my current employer, so the transition will not be that bad.  However, that obviously means there will not be "sweat equity" in terms of investment.

A preferred position is an option, but my $25k of my $50k investment is in savings and the other $25k is from a home equity loan.  So, I think I would want to pay off the loan when the dividends are issued in year 4.  That may be short sighted but I am trying to be realistic.

So, in my current structure (30% for me and 17.5% for angels) do you think I am being conservative on my cut or overly agressive.  I am trying to look at it from the perspective of recruiting 3 other angels.

Thanks for your help.

Dear Florida start up:

Let`s look at this from a different point. One of valuation.

If you (the company) is going to sell 70% of the equity for $400,000 (the amount your angels will be investing) that means that the valuation of the "business" pre-money is $572,000!

Assuming you put in your $50,000 to start the company, then there needs to be other things there that make up another $522,000.  Obviously hard assets, if any would be part of the valuation. Some of the other things that are typically part of the valuation include - Intellectual Property, contacts, specific knowledge, business plan andother previous work, the team, etc.

Hope this helps.

Robert Johnson

 

-------------------------

Business Growth Masters, LLC -
Capital Catalysts for Entrepreneurs
Home of the Scalable Business Plan and QuikStart Capital Programs
http://www.bizgrowthmasters.com
info@bizgrowthmasters.com

Robert is correct in applying total asset valuation to the venture.  It takes all types of assets, money, people, time, facilities, product, management, market share, good-will, customers, contacts, prospects, concept. 

And there are several ways to evaluate a venture.  There is asset based, revenue based, share valuation (what your shares are valued at in the open market), and variations on these themes. 

Many analysts use all three and pick the valuation or average of these depending on what they are trying to do. 

Obviously, we don`t know the details of your proposed venture, so forgive me if what I`m suggesting is too simple or you have already done this. 

To strenghten your position on the concept, have you done significant market research to support the marketability of your idea, the anticipated revenues, market acceptance, position, share?  The more solid, researched numbers you can bring to the investers, the more valuable your concept will be. 

To the extent you possibly can, turn the tables psychologically, make them want your idea more than you want their money.  You`ve heard the term "opportunity cost", which is a component in evaluating where to put money.  Make the opportunity cost for your venture greater than any others they may be considering and you will have your increased value.

I`d love to hear some business analysts chime in on this.

My experience for making these suggestions is in starting and operating companies.  I`m an idea guy that has started a couple of companies and am currently raising funds for a bio-diesel operation and an ICF manufacturing plant near Baton Rouge, to the tune of $5MM.

 

The business I am building is a publishing based business, so there will not be a great deal of hard assets.  I would like to know what you think about the valuation of the business from a potential income perspective.

It is slated to generate $200,000 in profits and $750,000 in gross revenue in year 4.  If it was generating that type of income today, what would the business be worth from a sales standpoint?

Like all entrepreneurs I believe I have a very good business model and market potential.  However, I have gone beyond my biased perspective and paid a national publishing consultant (who is well recognized in the industry) approximately $4,000 to analyze my business plan and he has given it high marks.  He believes the publication is not only viable, but extremely viable.  He has stated that there appears to be a big need in the market for the publication and he feels it is investor worthy.  The only thing he has recommended I change is my initial projection for profitability from year 3 to profitable starting in year 4.  This would delay dividend payments until year 5.  However, he also said to build a back-up plan that accelerates profitability in case the business exceeds my current expectations.

So, again based on the profit projections what would you gentlemen use for ball park equity figures?     

Florida Startup,

I`m not trying to avoid your question, but what I think doesn`t matter.  Its what you can negotiate with your investors that counts. 

A few questions and then I`ll give you my opinion.  These questions are for you to consider, I don`t need to know. 

1. What are other similar publishing companies valued at?
2. What volume are they doing?
3. What is their profitability?
4. What is it about your market segment that makes it : " . . . there appears to be a big need in the market for the publication and he feels it is investor worthy."
5. What does your lead angel feel about the 30%?

Now, the disclaimer: from a standpoint of relative ignorance with your market and having not seen your plan:

IMHO, given what I`ve experienced from other efforts, 30% is not bad for your stated circumstances, so if you can get it, take it.  But always negotiate for more.

I hope this helps, and I really hope you get other members` input to your question.

Green:

Thanks for the input.  My lead angel says that angels usually expect a 20%-25% annual return once dividend payments begin to be issued.  If the business in fact generates $200k and he had a 17.5% share this would mean he would get a 35% return starting in year 4.  If the business only did half that ($100k in net profits) it would still mean 17.5% return which is at least close to 20%.  So, if you say that a very safe rate of reurn is projected to be anywhere between 17.5% and 35%, it definitely appeals to him.

Since its hard to give ball park estimates because of not knowing more details about the business, would you be willing to share some of the parametrs on the deals you`ve structured?  If anyone else can give some of their scenarios that would definitely be helpful as well.

Thanks so much

Based on your angel`s comments, you could reduce his stake to make the anticpated return 20-25%, or you could offer the other 3 a lower equity position for the same money, with your first angel having the bigger share because he put up the first round of funds.

BTW, he is willing to wait 4 years before any payout?  If so, you`d take the 35% in the 4th year and divide that by 4 to get a true return on money (non-compounded) at 8.75% annualized rate.

Most of my deals have been on the other side, I was the majority equity shareholder.  Like I said, my idea, my work, 50%+ equity.

Florida Start up:

Using your $200,000 as a net before figure as year 4 profit - with none before that, a quick "net present value" calculation indicates the valuation at about $1.1 million. Which means nothing unless you can get the investors to agree.

However, in your latest message, you discuss the return as a dividend which sort of changes the "ball game". Generally, when investors get an equity stake in the company there is some planned liquidity event (sometimes referred to as exit strategy) where the invesotrs can realize the results of their investment.

If your invesotr is looking for long term cash flow in the form of dividends rather than a stock sale - your should consider something different from equity.

All the best,

Robert Johnson

robert@bizgrowthmasters.com

 

 

-------------------------

Business Growth Masters, LLC -
Capital Catalysts for Entrepreneurs
Home of the Scalable Business Plan and QuikStart Capital Programs
http://www.bizgrowthmasters.com
info@bizgrowthmasters.com