When seeking funding, many founders look to the world of equity financing. After all, there are many advantages to selling off percentages of a company for capital. For example, angel investors and venture capitalists can also serve as mentors for burgeoning entrepreneurs that can shepherd them through the rigors and challenges of establishing a new small business. However, owners need to consider three factors before selling equity stakes in their businesses.
Your company’s worth
Before seeking out potential investors, owners need to understand what their company is actually worth. With this information in hand, founders can figure out exactly how to price equity stakes. While there is no universal method for determining a company’s value, Stanford University recommends using the sum of annual sales plus inventory. To add a greater level of accuracy, try Business Valuation’s handy valuation calculator. It uses last and current year sales, depreciation, industry and earnings before interest and tax data to determine a company’s worth.
The importance of quality investors
When a company is at its earliest stages of its development, founders may be very tempted to sell off small pieces of the company. The prospect of a large cash infusion of a 1 to 5 percent ownership stake holds obvious appeal for emerging businesses. However, the reality is selling off small parts of your business to investors who lack experience and dedication can lead to a lot of headaches. As this Bplans article notes, having too many small stake investors can kill the interest of larger VCs and investment firms down the line. Having to answer to a group of equity holders who are only interested in reaping short-term profits can be a major problem when trying to bring a company into maturity.
The need for control
Lastly, power dynamics should play a big role in an entrepreneur’s thinking when considering how much of their company they want to sell. In order to attract serious investors, owners need to make a significant amount of equity available. At the same time, founders need to make sure they don’t put themselves in a position where they lose control of the businesses they’ve created. Accordingly, Entrepreneur recommends that you should never give up more than 75 percent of your company until you reach the IPO stage. After all, you don’t want to find yourself taken out of the race when the finish line is just inches away.
This article was written by Mario McKellop for CBS Small Business Pulse