This weekend entrepreneurial thought is a question I have asked myself many times.
When is it ok to lose some of your personal ownership in your company in exchange for an outside investment, also known as equity investment?
It is difficult for many startups to imagine losing complete control of their operations, and it is even harder for a startup if it is comprised of only one person with 100% ownership.
However, any company with any aspirations for large-scale growth needs to realize that it is better to have 50% of, say, a 50 million dollar company than 100% of a $1 million company.
In the past few months I have had the option to pursue forms of equity investments for Sand Shack on a few different occasions. Although I currently am the sole owner of the company, I have not closed those doors at this time. More so now than ever before do I realize that if I am going to grow Sand Shack at the pace and to the size I want, I will need outside investment. On its own, the company’s cash flow cycle only generates enough cash to sustain slow to moderate growth year after year.
{ 4 comments… read them below or add one }
I have a question. I am working on starting a business with another individual who will be putting in 100% of the capital. However, operations-wise I will be managing and building up the company (ie putting in the ‘effort’ part). I would like to, now, early on, determine my own “founder” ownership stake in the company as my return too also hinges on the company’s eventual success and not some pre-determined salary. Obviously, the primary owner will be the investor, but wanted to see what other folks think about what is a reasonable %, and any other thoughts on structuring ownership!
This fits right in with this topic, so thought maybe we could get some conversation going! Thoughts, Brian? Anyone else? Thanks… enjoying the blog
Brian,
If you had an outside investor, do you know where that money would be directed to get the biggest bang for your buck? What target growth rate would you be looking for if you received 100k, 250k or even a million dollars? Could you structure your deal in such a way that they receive a 50% equity share in the company but do not take part in operations?
Interesting post Brian. Fred Wilson wrote on this subject a couple of days ago as well. Saying that the best time for a business to raise money is when they do not need it. At that point the business is in a much better bargaining position to raise money at more favorable terms. On the other hand if I were you I would be looking to connect with angel investors who will be able to value add your business in other ways apart from the financial. Assisting you in growing your distribution network, adding more product lines or getting you in touch with individuals who could provide you with mentorship would be something I would be looking for.
@Yoshie I have some material written on equity splits that answer your question. You can find it at http://www.usmansheikh.com/financial/equity-splits
@Scott According to the 80/20 pareto principle 80% of profits are generated by 20% of one’s products. Those should be the areas new investment should be directed towards to ensure that a high rate of return. As for the structuring part it is all dependent on who the investor is and what their objectives are. Everything is pretty much negotiable.
@Yoshie – What you are putting forth is also known as ’sweat equity’. Sweat equity is not money, but it is called ’sweat’ because it is your effort and sweat that you put into the company instead of money to build your equity stake in the business. You really have to sit down with a lawyer and the other investor to nail out the details of this agreement. But if the investor is only putting in money and you are putting in all the effort, you may still own the majority of the company. Good luck!
@Scott – Yes, you can definitely structure the deal in a way where they receive equity share in your company but not control of the operations, and this is something that I would most likely want to do – however, not all investors want to sit back and not be involved. And as Usman in the above comment said, I would be directing the invested money towards the development and sale of my company’s most profitable products (in this case the apparel line)…so if I was to receive investment of upwards of $1 million I would use that to develop an entire line of apparel…and also use it to hire more people, attend more tradeshows, and work on some viral internet marketing campaigns and improve my website.
@Usman, You are right on about the angel investors – and those are exactly the type of people I have been talking to. Thanks for the comments and addressing Yoshie and Scott!