Introduction
Access to capital is crucial to accelerating the growth of all startups. Typically, getting investors to believe in your business through investments is one of the most reliable ways of getting funds. Investors are individuals, businesses, or financial entities who invest their money in a particular company. In exchange for their investment, equity is one way of rewarding investors for believing in and investing in a company.
“Equity” means the value of shares issued by a company. For investors in startups, this is the percentage of the company’s shares that a startup is willing to issue to investors in exchange for an amount of money injected into the company by the investors.
With equity, investors own some part of the company’s shares and some rights to the potential profits of the startup. These shares tell us how much each investor will receive from the business’s net profits and how many claims any investor will have over business assets should they fail or liquidate.
Factors that Influence the Portion of Equity to Give Investors
There is no hard and fast rule for how much equity a startup founder should give investors in their business. However, founders must understand that once they give equity to investors, they give up a portion of ownership and dilute control to the investors. These are the factors that influence the equity of given investors;
- The total amount an investor gives: The higher the amount invested by an investor, the higher the investor demands equity.
- Company valuation at investment: Analysts conduct a company valuation before investors invest in a startup. The valuation reflects vital factors, including management, proven track record, market size, maturity level, growth prospects, and company risk.
More importantly, valuation is vital in any funding stage as it influences the investors’ share. You can also talk to startup founders in your niche or the most similar one to understand your company’s worth. The more ideas you get, the easier it will be to establish what is a “norm” for your case and how much equity you are willing to let go of.
Calculating the Percentage of Equity Ownership
Conventionally, the general guiding principle for a startup is that when giving equity to investors in exchange for their money in your startup, the equity should be somewhere between 10-20% of total equity. Giving more than that to an investor is too much, which is risky for your business.
The pitfall of giving more than 20% may not be immediate, but sooner or later, it will become apparent, especially if your business grows as time goes on. A successful startup faces multiple funding rounds further down the line, diluting you further. Hence, the reason why it is essential to ensure equity is between 10-20%.