This article explores how an entrepreneur should negotiate with an angel investor.
The internet is saturated with articles based on how to pitch your idea, how to draft, plan, practice and implement your pitch to perfection, but there isn’t enough information on equity valuation and how to negotiate when meeting face to face with angel investors.
Angel Investment vs Equity
So the first real consideration for an entrepreneur to make when seeking to raise investment capital is to consider a realistic market value on his/her business before even considering entering into negotiation or investment pitch.
The bottom line to the entrepreneur and the business angel investor will always come down to one simple fact:
If an entrepreneur is overly confident or overvalues his business by solely looking at future growth prospects or thinks he will IPO (very rare), the deal may not work or be worth thinking much further about.
So an entrepreneur’s valuation of his/her business is virtually always the deal-breaker. Looking at this from a business angel investor’s viewpoint may make the situation clearer.
Though this may sound like a lot, an entrepreneur looking to raise angel investment must understand that there are always alternatives for the investor. He could get a Bank of England base rate add 1-4% (depending on fixed term rates) with minimal risk, or he/she could send the money to a BRIC country (as an example) and gain 6%-10% interest and also gain on the currency movements. Or the investor could easily seek 10-15% with a good solid blue-chip type investment or on equities on the FTSE.
Angel investment deal
In order for the angel investor to take on such a high risk angel investment deal with an entrepreneur (and all small companies are considered very high risk, unless of course the entrepreneur has rock solid accounts with a healthy amount of assets, with a good trading history, which again brings up the red flag question on why the entrepreneur is seeking investment in the first place) the angel investor would want more than he/she would commonly gain through traditional investments to outweigh this risk.
Every investor is different, however the fact will remain that an angel investor will be seeking a 30-40% ROI/year* from an entrepreneur’s seed, early stage or business investment proposal.
This is why it is absolutely crucial for an entrepreneur to take this ROI figure into consideration when working out his/her realistic business valuation.
For example, if an entrepreneur was seeking £100k investment for 20% equity, but the business was only making £50k net profit per year (not considering taxation) an investor would only receive £10k pa.
Percentages are brutal, and the angel investor would seek a 50% share at these numbers or seek to reduce the investment amount. This is the reason that sizing your company up from the beginning and knowing the exact numbers on your valuation is crucial for credibility and leverage before negotiations begin.
* unless the angel investor motivations are looking at the longer term with perhaps a view on capital appreciation and raising net worth as opposed to simply income generation.
In the ensuing negotiations that will follow, the entrepreneur must learn to detach themselves from their angel investment proposal and understand that deals are not consummated overnight.
Patience is a virtue and the negotiations can well end up taking many many months. Experienced business angel investors will usually take their time, with the belief that the entrepreneur will eventually come around to their terms.
So it’s important for an entrepreneur to understand this before entering negotiations and engage in ‘the give and take’ process with a patient attitude.
Relinquishing too much of what the angel investor is seeking early on could easily prove to be a costly mistake as the angel will end up taking much more in the future.