How to Decide how much Equity to Give to an Investor

The most common question entrepreneurs ask about raising capital is “How much equity should I give up to an investor?”

There’s a really simple answer “As little as humanly possible!”

Sitting across the table from an investor doesn’t have to feel like a game of Texas Hold’em. You don’t need to bluff your way into a great deal and hope to “beat” the investor. There are some easier ways to determine how much equity to hand over to investor in a way that makes you both feel great about the deal.

Numbers on a Dart Board

In most cases you’re working off a completely subjective valuation of the company. Maybe you’ve been in business for six months or even a couple of years. You probably don’t have any meaningful revenues coming in the door and there’s no concrete evidence that the business will sink or swim.

The truth is that you and the investor are both going to throw a dart at the wall and hope it lands on a number that you can both agree on. Since you can’t concretely determine a valuation, you need to start by nailing down the greatest amount of equity you are willing to give up. The investor is going to look at that number and their gut is going to say “yes” or “no.”

What’s it worth to you?

As you’re trying to come up with that magic offer of equity, ask yourself at what point the investment is no longer equitable for you. Just because the investor says he wants half of your company doesn’t mean it’s the right deal for you.

The basic formula comes down to this – does the value that the investment brings outweigh the value of retaining the additional equity?

Unfortunately it’s too easy to say “yes” to this question. Your thinking may be “my company is worthless without this investment, so anything that gets added to the pot will be increasing the value of the company.”

That’s the wrong line of thinking. If you believe your company truly has potential, don’t sell yourself short! You need to take a longer view of your future.

Think about what your company will be worth in three years, no matter where the investment comes from. If you think the company will be worth $5 million in 3 years, then giving up 25% of the company for $100,000 of capital isn’t necessarily a sweet deal for you.

The value of your company’s future is largely determined by you. If you want to sell your company short and assume it will be small, then you’re going to pay the price (literally) of a limited vision.

The Value of Waiting

Sometimes the best way to get the deal to work in your favor is to just wait. Waiting on an investment can be great if you use the time spent to advance the company in a meaningful way.

In some cases there is a true cost to waiting. Perhaps there is a rush to get to market, and waiting could force you to forgo your opportunity altogether. In that case you need to put a cost estimate on what will happen if you wait too long.

Yet not many companies are truly in that dire of a competitive situation. Although you may be excited to start your company, waiting six months or a year to take on investment may be the best thing for you. In that time you can spend more time on your product, talk to more customers, and hopefully even land some sales.

By the time you come back to your investor you may have also increased the valuation, as well as your credibility to the investor. Nothing drives the value of your company upward like showing an investor that a great opportunity is passing them by!

Remember, You’re Married

At some point, once you do settle on a valuation of the company and an equity stake that you’re going to hand over, the two of you are going to tie the knot in wedded corporate bliss. If this marriage starts off on the wrong foot, where either party feels like they’ve been slighted in any way, it’s going to end in a bitter divorce.

The best way to avoid the divorce is to stay the heck away from getting into bad situations to begin with.

If you’ve given up half of your company and things go well, you’re probably going to feel like you gave up too much. If you give up half of your company and things tank, you’re going to have very little equity to raise more capital with. It’s a no-win situation.

The true value of an investment can’t be considered at the deal table. It needs to be considered after the deal is signed and the relationship is started. Think about what your life will look like after you tie the knot, not before you get engaged!

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