Determining A Fair Percentage For An Investor
Money matters, so you need to know what is a fair percentage for an investor before you write a single word of your fundraising pitch.
Investors might be open to lending money to get your venture going, but it's vital to have an exit strategy for paying back investors when the term reaches an end. Likewise, you don't want to sell yourself short and give away huge chunks of your equity, leaving you with minimal profit share and potentially less motivation to succeed!
So, let's recap some investment basics to give you an idea about what you should be asking for and what an established investor will expect in return.
You can also visit our additional guides for information about advisory shares including an advisory share definition. The guides will help you explore other routes to securing investor experience without instantly diluting your ownership.
How To Calculate A Percentage For Investors
Deciding on how much of your business to offer up for investment isn't easy.
On the one hand, you want an investor to have enough stake in your business that they have a vested interest in your progress and will tap into their resources to support company growth. On the other, if your investor holds over 50% of your business, that might be appealing to you, as you risk potentially losing control of your company.
It can also be tricky to attract new investors if you already have one shareholder with a majority share since they'll have limited returns and less say in company decisions.
Evaluating Your Investment Share Proposal
1. Cash flow: How much capital, realistically, do you need?
A solid investment partnership that brings long-term benefits to your business can be an exceptional competitive advantage, so focus on quality as well as share size!
It's imperative that you pitch for enough capital to get your ideas off the ground, since too little or too much can cause challenges.
2. Business value: Investor negotiations hinge on how much your company is worth, and if they disagree, it can get sticky.
Offering a 10% equity stake for a $250,000 investment, for example, means you're valuing your firm at $2.5 million, so check your figures carefully.
Ideally, you need a five-year plan to set out your prospects and itemize how you'll use the investment to generate increased profits. Use that plan as a starting point, and work backward to calculate the optimum investment requirement.
You'll have a better idea about the capital injection that's going to make a tangible difference.
Predicting Future Returns On Investment
The next hurdle is to look at investment returns. The definition of equity in a company is that your investor owns a proportion of the business so that you will split any profits the same way.
In many cases, you won't be able to guarantee a specific level of return. However, you can enhance your investment pitch with detailed projections and forecasts, illustrating the potential returns that are up for grabs if all goes to plan.
It's wise to incorporate contingencies, so a potential investor has confidence that their ROI will be sufficient to warrant the investment. Many investors aim to recoup their investment when a small business has grown and is sold, so long-term valuation estimates are just as vital as immediate dividend expectations.
As a rough guide:
● Business investments tend to be over a five to seven-year period.
● Target return rates fall between 20% and 40% in most sectors, depending on the pace of growth.
Keeping a clear head and making sound judgments about where your business is heading will appeal to investors, and help you avoid giving away more shares than you need to.
Of course, it's worth taking baby steps when moving through this process of valuing a business and determining the investment you need.