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Giving up equity

Investors will often ask for a slice of your business in return for their financial backing. But how do you know how much you should give away?

Giving up equity

When Ben Gardner wanted to fire up growth at his food safety management company, Navitas Group, he turned to equity investment.

Last summer Navitas, which has devised digital food safety technology to help food and hospitality outlets better monitor and record appliance and food temperatures, secured £750,000 of private equity from the Midlands Engine Investment Fund.

“We had struggled for debt finance and so we turned to equity,” explains Ben. “It wasn’t an easy decision, especially as Navitas grew out of my family’s 31-year-old environmental health consultancy, ESB. We merged the two last May and I took over as CEO, but we remain a family business with my mum and sister working here. We wanted and did manage to retain majority control.”

Doing your research

Similar emotive dilemmas were experienced by Julianne Ponan, boss of free-food brand Creative Nature, when raising £500,000 in a Seedrs crowdfunding campaign last year. She gave up 7% of equity.

“It was our first funding round and I didn’t want to give equity up too early. We have big export plans, including the US, and we will need to do other funding rounds. You also go into business to be your own boss and giving up a large amount of equity means you lose control,” she explains.

Smart money

Professor Colin Mason of the University of Glasgow’s Adam Smith Business School doesn’t like the phrase ‘giving away’ when it comes to equity. “Entrepreneurs should see it instead as getting something back. They use that investment to grow and improve their valuation,” he says.

“The motivations are ‘do I want to own 100% of a small business or less than 100% of a bigger business?’ If you come across to an investor as someone protective of their equity, it sends out a negative signal and means you may not raise anything! Take the view that it is ‘smart money’ - a partnership - and that in addition to money investors are contributing their experience, advice, connections and skills you don’t have.”

On the issue of how much equity to sell Colin says, like Julianne, you must judge whether this is the first of more funding rounds. “Each amount will dilute your equity so don’t give away too much in the first go - probably around 15% or 20%,” he adds.

This resonates with Anthony Rose, founder and CEO of SeedLegals. “We’ve found that 15% is the median amount founders are giving away in a funding round. They are thinking sequentially about future funding stages,” he explains.

“Each round you want to raise enough money and give away just enough equity – that 15% – to get you to the next growth stage. This boosts your valuation and means that even after a third round you will still own the majority of your company. If you give away 30% each time you will soon lose control. This also doesn’t suit investors who want the owners to have skin in the game to remain focused.”

He also agrees with Mason that giving up small equity slices threatens investment hopes. “Some founders try to hold all the cards by giving away only a little equity. Many companies are looking for investment and investors want to give them their cash for a good return. Don’t give them red flags not to choose you!”

Negotiation and deal structure

Rishi Anand of Venture Giants, which connects start-ups with ultra-high-net worth individuals, says equity negotiations with entrepreneurs is about negotiations and deal structuring.

“You consider estimates of cash invested, future revenues, sweat equity  (the amount of time an entrepreneur has already put in to the business), and future funding rounds. It can get very complicated and subjective, especially if an investor brings other things to the equation, such as industry contacts. This then has to be valued in terms of future revenue growth and deducted from the entrepreneur’s proposed equity offering.”

Ultimately, giving up equity for investment can be a huge benefit. Ben Gardner of Navitas explains: “We have gained by being aligned with a major investor. It has helped us expand our team and we are now looking at opening a UK factory.”

Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place.