Inside Business Angel negotiations: Valuing your Seed or early-stage business
The internet is saturated with articles based on how to pitch your idea, how to draft, plan, practice and implement your pitch to perfection - ad nauseam! But there simply are not enough articles and resources on how an entrepreneur should negotiate when an Investor starts talking numbers.
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 any kind of negotiation or investment pitch with ANY business angel investor.
The bottom line to the entrepreneur and the business angel investor will always come down to one simple fact:
Angel Investment Vs. % Equity/Stake
If an entrepreneur is overly confident or overvalues his business by solely looking at future growth prospects or thinks he will IPO (very small chance of this actually happening) 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 investors viewpoint may make the situation clearer:
Any angel or business angel type of investment should and will aim for a return of anywhere from a very low of 25% to a high of 40% return on investment depending on the amount of risk a business angel investor is willing to take on. Though this may sound like a lot, an entrepreneur looking to raise capital angel investment must understand that if an angel investor was willing to put in a £100K of angel investment into your business - as an alternative the angel investor could get a Bank of England base rate add 1-4% (depending on fixed term rates) from the bank with no risk, or he/she could send the money to a BRIC country (as an example) gain 6%-10% interest and also gain on the currency appreciation (or depreciation dependant on the timing of the investment), or the angel investor could easily seek 10-15% fairly easily with a good solid blue-chip type investment - or alternatively gain 20% ROI on equities on the FTSE All share index (or so the angel investor will state).
So, 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 and enough to outweigh this risk. Everyone is different, granted, 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 before pitching and negotiating to a business angel investor is crucial to gain the entrepreneur the necessary credibility to demand what their company is actually worth before negotiations even begin.
In the ensuing negotiations that will follow when an entrepreneur is trying to raise investment capital, he/she must learn to detach themselves from their angel investment proposal and understand that deals are not consummated overnight. Patience is a virtue as the negotiations can well end up taking many many months especially as experienced business angel investors will usually be experienced enough to know that by being patient an entrepreneur will eventually come around to their terms.
So it’s important for an entrepreneur to understand this before he/she enters into a negotiation and paces ‘the give and take’ process with this understanding. Relinquishing too much of what the angel investor is seeking to early on could easily prove to be a costly mistake as the angel will end up taking much more in the future.
Next article: Learning to understand different types of Limited Company Shares:
* 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.
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