A candymaker wonders what he'll have to give up for an angel investment
QWe're expecting $400,000 in revenue this year and considering seeking outside capital for the first time. What do investors usually want in terms of percentage of ownership and rate of return?
La Quinta, California
The answer, in two words: a lot. Which makes sense, because they are taking on a lot of risk. Out of any 10 investments, half will fail completely, says Lewis Gersh, an angel investor and managing partner of Metamorphic Ventures, an early-stage VC firm. Of the remaining five, two will break even and two will return a couple of times the investment. "The profit needs to come from that last company," Gersh says, "which means that every one of them has to have the potential of being a home run."
What's a home run? In an angel's ideal world, an equity investment of $100,000 would turn into $1 million to $3 million in five to seven years. Angels won't complain about a lower return, however, if they can exit more quickly.
You may have to give away a large stake to get the money you need. Whereas a tech company with your level of revenue might be valued at $4 million to $5 million, a toffee maker probably is worth from $1 million to $2 million, according to Rebecca Lovell, program director for the Seattle-based Alliance of Angels. If an angel estimates that your company is worth $1 million, then gives you $250,000, the investor will get a 20 percent stake. That's because the size of the stake is determined by the postmoney valuation of the company -- in this example, $1 million plus the $250,000 investment. If you can show that sales are growing rapidly, you may have some leverage to negotiate a higher valuation. But maybe not. Consumer products is a risky sector; even if your toffee is already on grocery store shelves, a larger company could drop its prices and drive you out.
Don't want to give up a large chunk of your company, only to see it sold off? You could approach friends and family members instead. Unlike a professional investor, Grandma probably can't tell you how to find a great new VP of marketing. On the other hand, she is much less likely to demand a full-ratchet anti-dilution provision. And there's something else to keep in mind. Like VCs, angels are increasingly asking for their shares to come in the form of participating preferred stock, which ranks higher than common stock. In an exit, your angels will receive the face value of their original investment plus any accrued dividends (usually worth about 8 percent a year) before you or any friends-and-family investors receive a cent. Then, if there's any money left over, the angels share in the rest of the pie. If the pie is big enough for all to share, great. If not? Well, you're in for an uncomfortable conversation with Grandma.