To support entrepreneurs registered on VC4Africa we have created an easy to use format for the financial plan. In a series of articles on VC4Africa, financial coach Arnout Kroezen goes through the key points. Also see the previous posts with the introduction, steps 1 & 2 (costs & revenue), step 3 (writing the summary), and step 4 (finance request). Below Step 5: Deal closing!
Say the investor is willing to invest 80k. They argue that you only put in 20k in sweat equity so they want 80% of the shares…
Some investors start their negotiation like this, so see it as a test. They want to see if you are a strong negotiator! If you even think about giving an investor more than 50% know that you have lost control of the company. They will never invest in you if you give your company away that easy, and it means you don’t really believe in its potential yourself or don’t really have a clue about the figures you have presented.
Make sure you know what deal you want to make and start the negotiation at a realistic level, with some room for negotiation. Also know what you will not accept and don’t let yourself cross this line. Decide this before you start fundraising and the negotiation process. Be sure to remind yourself when you get emotionally attached to the deal J Most investors are realistic as well and don’t want to sit on the entrepreneur’s chair. It is important to keep 51% of the shares (or at least 51% of the voting rights, there can be shares with lower votes), in this way you as entrepreneur(s) keep the control of your company in your own hands. In most cases this is also what investors want. They want to support a motivated and driven entrepreneur and join in their success (ROI).
Part of the investment process has to do with knowing what the value of the company is today and what it might be in three or five years. But so what is the value of your company right now? To get a reasonable indication of the value we have to look at the future expected profits and losses. See example 3.
Example 3:
In this example the results from the first 5 years were calculated back to this moments value requesting a 20% return rate. This rate is flexible, the higher the risk, the more return investors demand. The higher the demanded return, the lower the actual NPV (Net Present Value) with the same estimated results.
If in Y1 50.000 is invested, and in Y2 30.000, this 80.000 investment represents 80000/228597 = 35% of the company. That sounds more reasonable, but maybe still a bit higher than the entrepreneur would want. In most cases the investor gets somewhere between 10-30% of the shares. If this is the first or second round, make sure there is room for follow on investment (if needed)…. Leaving some % on reserve up to 50%.
In our example, we can choose for a hybrid-financing model that combines both debt and equity. In a construction like this (adding a debt component) you are able to raise the same amount of capital but keep more equity (shares). This could be interesting for the entrepreneurs because they get to keep more of the company. It could also be good for the investor because they actually get some of their investment back when the company starts to make some money.
Equity: 20% shares for 45.000
Debt: loan at 10% for 35.000
Equity + Debt: 80.000
Most likely, the first revenues will be used to pay back the loan (before any dividends are paid out to the shareholders). So in addition to a nice interest rate, the investor is able to reduce some of the risk by getting some of the investment back when the first revenues are made.
Things to remember when negotiating:
– The investor will become a partner, not an opponent! You need a good deal, but also a good team! You need to be a good negotiator without upsetting them…
– The other way around works the same way. Only accept a deal when you feel you have a good party on board. Don’t let the money be leading and don’t let it push you past your own boundaries.
– Know where you would like to end and start at a reasonable level with little room for negotiation. In this example, you might start with 15% shares for 50k and 30k loan at 6%….
After you agree on these conditions it is also very common to discuss the exit strategy. Many investors want to be involved just for 3-5 years and almost all entrepreneurs would like to have an opportunity to become 100% owner of their company at some time. A call option to buy back shares within a certain period for a predefined price or calculation (x times profit), or a price to be calculated at year 5 by an independent accountant, is common to negotiate in a deal!
Also see the previous posts with the introduction, steps 1 & 2 (costs & revenue), step 3 (writing the summary), and step 4 (finance request). VC4Africa welcomes you to share your experiences and insights in the comments below! Do you have questions? Just ask them below in the comments!