July 7, 2022
Startups and small businesses have numerous avenues for investment, and each of them comes with its own benefits and drawbacks. It’s in assessing these that you decide where to look for capital, but knowing how to make the right deal once you’ve found your source can be an added challenge.
Perhaps you know where to look, but you’re not sure what you’re offering, or how to figure it out. Maybe you do know your worth, but you’re not sure what else your investor brings to the table, or how to translate that to a percentage of the equity in your company. There are so many factors to consider when negotiating an investment deal.
So, what percentage do investors get? The answer for you is an easy one: as little as possible. Unfortunately, figuring out what that means is the hard part. To break it down, you have to understand your investors, what they want, what they’re offering, and what you bring to the table. And for all of that, this article has got you covered. So, let’s get going.
Types of Investors
We can generally break down the types of investors by the stage of the company they’re investing in. Investors come from different social and economic backgrounds, and they will all have their own reasons for investing. These will be covered in more detail when we talk about investor motives, but for now, let’s separate investors into the following three categories:
- Pre-seed – This is essentially what used to be referred to as the seed round before career investors found the niche and occupied it. Now, pre-seed rounds are typically the friends and family, a zero-point investment that allows you to buy the pen and paper to get your idea off the ground.
This is a big gamble, as for this stage of your startup, there likely isn’t even a product to market. The best you can offer investors at this stage is a bare-bones idea and some significant market research. Therefore, you’re mostly relying on those who know you to invest in your character and potential.
Pre-seed funding might sit somewhere in the range of $50k to $250k, and is aimed to cover a stage of around 12 months just to get you on your feet.
- Angel – This is for when you’ve got a bit more proof of concept and you’re looking for the seed round. By now you should have some staff on board, you’ve found your market fit, and you’re looking for somewhere between half a million to $2 million to get you to the next stage.
Angels are usually independent, high-value individuals and can often be found within your local social or professional network. However, they could also be part of a company or own their own businesses and can recognize potential in startups they’re familiar with. They’ll typically be looking for something they’re passionate about and can relate to on a personal level.
- Venture Capitalist (VC) – These are usually firms or members of firms that come with teams of analysts and economists to pinpoint the companies with the most potential. They’re looking to drop huge proportions of capital onto the right investment, and are usually coming in when the company is running well and has good penetration in the market.
You might look for venture capital to get a rapid boost in growth in your startup, but it’s likely you’ll want to have an exit plan if going with VC, because the long-term goal of these investments are usually to pass your company on in one way or another.
The average investment from VC’s is around $7 million.
Each type of investor has their own reasons for investing, and understanding these reasons will help you understand how much is a fair price to pay.
So, to get a little closer to a fair price, we can now take a closer look at the motives for each investor type.
- Pre-seed investor motives - Of course, if you’ve successfully designed a startup in the same area before, you’re likely to inspire confidence in your investors, but you’re also likely to be able to fund the pre-seed round yourself, or by later-stage investor types. So, chances are, if you’re looking for pre-seed funds, you’re new at this.
Your investors at this stage are taking a huge gamble on you. As such, pre-seed investors are mostly investing in how much they believe in you. This means they may not be as strict in terms of the amount of equity or rate of return they expect from the company. In fact, there are some companies that began with grant money at this stage.
Some of these investors will likely be looking to get their money back where possible, and some may want a significant portion of the shares, but it’s likely that they will be more flexible in their negotiations for their stake in the company.
- Angel Investors - Of course, investing early in companies provides the chance of a much higher ROI in the future, but there are other reasons than money that Angels consider. Chances are you won’t know the angel investor but you may be connected with them somewhere in your network. Angels are typically looking to invest in causes they believe in, and people they respect.
For example, Harvard Business School demonstrated that 33% of female investors and 15% of male investors placed more importance on social impact, stating that a startup’s social mission is an “extensively used” criterion.
There is also an emotional connection with building a startup that commonly motivates Angel investors to take on the risk early.
However, Angels know that 90% of the returns come from only 10% of the exits, so those looking to make a return may demand a high stake in your company to cover the anticipated return of about 20%.
Fortunately, they aren’t typically accountable to any partners in the same way a VC investor might be, so the payback time might be more flexible.
- VC Investors - These are professional investors, and form highly skilled teams with which they identify the best possible chance of return. Further, they’re not looking to buy and hold your company. They want to sell it on to a larger company or make it public, typically within ten years of your launch.
With great investment comes great responsibility, and in order to get a fair deal, your ideal timeline needs to match theirs. They will also do their due diligence, so in order to get the best position for negotiation, you have to understand where they’re coming from and exactly what they’re looking for.
The main motivation for a VC investor is ROI, and as such, the strength of your foundation is what’s going to give you the best leverage for a VC investor percentage.
But there are more things to consider than investor motives. Capital is one thing you’ll gain from any of these investors, but there is more than just money you can make use of when growing your business.
Different investors bring different qualities to the table, and their level and quality of involvement and value addition can play a huge role in how you calculate what is a fair percentage for an investor.
- Pre-seed investor - If this money is coming from friends and family, it’s unlikely that there’s much else that’s of use to you. There’s a chance you’ll be given a venue to design your product or a place to stay, rent-free, while you get on your feet, but in general, you’re just looking for capital to boost you to the next funding round, and your pre-seed investors are unlikely to be qualified to help you much with that.
- Angel Investor - Angels, however, may be able to bring a wealth of experience to the table. If they’re founders themselves, or if they’re experienced business people who have climbed the corporate ladder in your industry and know what works, they may be extremely useful as allies in your growth.
Since angels will often invest in a cause they’re endeared to, there will be a personal drive to help out where they can. They may also be able to provide access to a valuable network of like-minded people.
- VC Investor - VC investors will almost certainly do what they can to maximize their return. They will have the most experienced and expert resources available to make your project profitable and set it up for their exit strategy.
These investors may also have a powerful network at their disposal that you will be given access to; something which could help you in future ventures.
This all comes with its disadvantages though, in terms of control. You may give up more direction than you wanted to with this route, so depending on your choice of VC, you’ll be in a better or worse place to negotiate terms whether your vision aligns closely with theirs or not.
So, with all this in mind what percentage do investors get? Let’s look at some averages.
What is a Fair Percentage for an Investor?
So far, we’ve looked at who your potential investors are, where they’re coming from and what they want to get out of the investment. These are all relatively established, general rules that likely won’t change much in your specific case. From these, we can understand why investors typically take the percentages they do.
- Pre-seed investor percentage - In this stage, you’re looking to make a deal with someone who probably knows you, who has little in the way of a guarantee that they’ll get a return on their money and is investing in your character and a desire to see you succeed. With all these factors considered, it’s not surprising that pre-seed investors typically only expect a 5-10% equity stake, if any at all.
- Angel Investor Percentage – Angels don’t know you as well, but believe in your cause. They’re also dropping higher amounts on this cause, and aren’t in a rush to have it returned.
Balancing what they’re offering with what they need, you can expect to give away 10% to 30% equity in a reasonable deal with an Angel investor, depending on the stage of your company, the individual, and how much they’re willing to work with you.
- VC Investor Percentage - This is the tough one. Dealing with VC might end up with you giving up the majority share to them. This means you will lose your management of the company and hand over the keys to your investors.
It also means they’ve seen something in you that is worth investing in, and can set their team of experts onto the project of making it profitable. Venture capitalists may demand a 50% share in your company.
However, what we haven’t covered yet is your leverage in the deal. That’s something that’s going to vary significantly on a case-by-case basis, and won’t be something we can tell you specifically.
Ultimately, the percentage you give to your investor depends on what you’re getting and what they’re getting. Looking at your investor motives and resources is only one half of the story. It’s up to you to know what you’re bringing to the table too, and for this you need to know how to accurately value your startup.
How to Value Your Startup
Investors, especially those with no personal connection to you, will simply see you as a means to an end for their ROI. This means they’ll likely try to squeeze the best deal for them as possible, and the only way to work against this is to know your value.
Your leverage will depend on many things, but your best chance in negotiation – and investors can be negotiated with – is to accurately value your company.
Business valuation is basically the process of calculating the financial position of a company, both in its current state and as a means for projecting into the future. The stage of your company will determine how accurate and difficult it is to make these assessments, but most common metrics for assessing a company’s worth are revenue, profits, losses, debts and risks. Our free IRR Calculator can help you understand how investors will look to value your company.
Valuation is somewhat subjective – especially in the very early stages of startups, and when planning to approach investors it’s important to keep this in mind, especially with the anticipated due diligence of a VC investor.
If you’re just starting out, it can be hard to predict financial forecasts, however, there are some elements that should shine through in any assessment.
- Competitive advantage – Your business plan needs to show that you will be able to hold your ground in the market.
- Company size – The size now, and as a result of investment can be a good metric for assessing market value.
- Reputation - This goes a long way as an intangible asset, and can come from both customers or prior investors.
- Staff – The quality of your workforce matters. Experienced managers will draw in better investment.
If you have already generated revenue, your records need to be accurate and your projections need to be honest. Nothing turns an investor off more than overly-optimistic projections, as it shows a naivete in business and a lack of honesty in your processes.
ProjectionHub can help you with your financial projections with any number of preset templates, and can design or modify them specifically to suit your specific needs. Financial documents are the single most important part of finding your leverage when dealing with investors. And if you're curious to learn how to create your own set of investor-ready projections, watch our free course to do just that:
Once you’ve got an honest and robust valuation of your position, you’re in a position to negotiate. Follow some simple steps to maximize your chances of getting a good deal with your investors:
- Leverage – This is the basic principle of any negotiation. Particularly with VC, understanding your leverage is going to make a huge difference. Maximize it by valuing your company accurately, as mentioned above, but to further enhance your position, visit numerous investors and gather their interest. Have your investors outbid one another to play a role in your project.
You can also consider what you need out of the deal. If you can survive for longer without their capital, you’re in a position of strength to turn down their offers.
- Trust – At any stage of your investment requirements, this is crucial. Particularly in the early stages, angels and friends need to see that you’re reliable and on the right path as a person. Later stages need to see that you’re business-savvy and switched on.
At any stage, you also need to be somewhat reliable as a person. Reply to emails, respond with accurate information, and demonstrate hard, intelligent work.
- Value – This isn’t just about ROI. Find the value that you’re adding to your investors as people. Angels in particular want to see that you’re changing things for the better, and investors, in general, will consequently offer part of their funds as charity for causes that they feel attached to. This translates to accepting a lower share of the equity.
At any stage of your company, it can be tricky to know what to ask for. Negotiating a fair deal with investors means understanding your worth, and knowing what you’re getting out of the deal. And angel investor percentage is likely to be higher than a pre-seed funder, but significantly lower than a VC. Knowing what to ask means knowing both what your investor is risking and what they’re offering.
But it also means knowing what you’re giving. No matter whether you’re dealing with a wealthy uncle of a venture capitalist firm, you’re dealing with people, and their diversity and complexity as people and professionals will determine the deal you get out of them.
Contact us at support@Projectionhub.com if you need any help preparing for raising investment!