Have you come up with an idea that you believe will be the next big thing? Good going! To make your dream a reality, you’ll likely need some money and someone to help guide you along, such as a mentor for entrepreneurs.
Even if you can do most of the work, you’ll probably need to pay employees once your business is ready to scale up. Here, the next step is to look for an investor. Investors go beyond the provision of capital and offer valuable insights into the best ways to monetize your idea. Considering the lucrative acumen investors bring, you’ll have to part with a certain percentage of your startup. But what is a fair percentage for an investor?
When it comes to angel investors, the general rule is to offer approximately 20-25% of your business earnings. If you’re selling the business in its infancy, this is the amount that investors will expect in returns.
While this is the general rule, most startups offer 15% equity in a funding round. If the investor negotiates for a steeper percentage, you can always propose a series of smaller raises. Of course, each business is different, and these percentages won’t always provide an accurate picture of what’s fair and what isn’t.
How Much Money Do You Need To Raise?
The required startup money for a business should be enough to cover projects for twelve to eighteen months before you’ll be in need of another source of income. By calculating startup funds, you’ll be able to convince investors that the business is profitable and worthy of their funds.
So, how do you calculate the amount of money needed within a period of twelve to eighteen months?
Look at your monthly burn rate, also known as expenses. Account for the headcount needed to complete business operations within the stipulated period. Factor in development costs, marketing spending, cost of new premises, and other costs required to meet business demands.
Factor in a buffer to cushion against business contingencies. Add up your total monthly expenses and multiply it by a figure between twelve to eighteen months. The sum is the startup money needed for your business and its operations for your designated length of time.
What Is The Best Way To Calculate Returns?
If you’re to part with a percentage of your company, you need to be confident of your business return. Not only will this help negotiate with investors, but it ensures that both sides get a good deal.
The best way to calculate business returns is to consider your cash flow while accounting for the money injected by the investors. From this point, you can easily decide whether to give your investors financial returns or equity. From the cash flow, you’ll be able to negotiate for a friendly percentage that will not harm the business.
Note that this process is heavily dependent on calculations and business evaluation. An error in the evaluation process will negatively affect the entire business venture and compromise potential funding with investors.
Calculate The Value Of Your Business
The first step to determining a fair percentage for an investor is to calculate the value of your business. From this point, you can map out how much the business needs, and in turn, the percentage you can afford to give the investor in exchange for funding.
Unfortunately, a black and white formula for calculating business value doesn’t exist. Investors might prefer different options. So, it’s up to you to choose the best formula. Let’s look at various formulas that you can use to determine the value of your business.
Book value method: Assets – liabilities
Revenue/Earnings: Business earnings x Industry Multiplier
Market Comparison: Based on similar startups within the industry
What’s A Fair Percentage For The Investor?
Entrepreneurship is a cut-throat venture that requires more than just blood, sweat, and tears. While these elements are essential in getting the business up and running, one needs to have their head on their shoulders to calculate a fair percentage. With most startups, the general rule is to offer approximately 20-25% of your business earnings to an investor. That’s assuming that the investor is pitching in when the business is still new.
However, as most startups operate at a loss for a while, most investors are interested in equity growth rather than business earnings. As such, 15-20% equity is usually a good number to offer an investor, depending on how much money they inject into the business.
Conclusion
Getting an investor is crucial to materializing your vision. Contrary to popular belief, investors are not the big bad wolf out to get your money. They share the same interests as you, which is the success of the business. You don’t have to hand over a massive chunk of your business to get funding.
As they are risking their money, they’ll want to share in the profits and growth of the company. To determine the ideal percentage for investors, you need to understand the value of your company.
A common mistake made by startup businesses is to choose a percentage based on hard work and sacrifices, but these are irrelevant. Our advice is to stick to the general rule of 20 to 25% of businesses income. If your investor is more interested in cashing in on equity growth, you can offer 15% of the business or more, depending on how much money the investor provides.
