Equity is such a hot topic in the startup world. It is a great way to incentivize co-founders, employees, investors, and advisors, but can also be incredibly difficult to understand. However, we here at the Founder Institute have created an exhaustive two-part guide that dives deep into the ins and outs of splitting equity. This installment focuses on splitting equity with investors and whether equity crowdfunding is worth your time.
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How much equity should I give to investors?
Because of the complex nature of equity, especially in the realm of fundraising, there are no standard rules on how much equity you give to investors in exchange for a certain amount of funding. However, in the Bplans blog post, “How Much of My Company Do I Offer Investors?”, Tim Berry outlines some of the biggest considerations to take into account when giving equity to investors. Below are the most important takeaways:
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Investors don’t like small deals. While it’s not uncommon for early-stage founders to give small pieces of their company (around 1% to 5%) to friends and family who gave money to their startups, investors typically won’t settle for such a small amount of equity, as the return is likely to be very small or nothing at all.
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Investors want some influence over your startup. That doesn’t mean that your typical investor will want 50% of your company. However, if they only have 5% of your company, that’s not enough equity for them to have any say in your company’s decisions, like when you have an opportunity to sell.
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Only give equity to those who have a long-term interest in your startup. Giving numerous 1%-5% shares to friends, family members, and others who only contributed to your startup when it was in its early stages will come back to haunt you later on. If your company succeeds, those shares you gave away early on will be necessary for compensating employees, whereas if your company fails, those early “investors” will bother you about why your company isn’t succeeding.
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You need to know the valuation of your company before offering equity. The amount of money investors invest in a startup is based on how much it’s worth, which is necessary for negotiating equity shares. For example, if you offer 10% equity for $250,000, you’re saying that your company is worth $2.5 million. However, it is then your responsibility to prove that your company is worth that much, which means you have to have your case for that before you begin even speaking to investors.
How much equity should I give to investors when raising my first round of funding?
In the WeWork article, “How much equity should I give up when raising my first round of capital?”, Ali Hamed describes several other important points to consider when negotiating with angel investors. Here are are the most essential concerns:
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Angel investors are more picky about who they invest in, so they’ll want more equity. Venture capitalists generally make far more investments throughout their careers with little equity in exchange, operating under the idea that at least one of those investments will deliver a massive return in the future. However, because angel investors make far fewer investments overall, they are more careful about who they invest in, and will therefore want more equity in return for their investment.
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The bigger your market, the higher your valuation, and the less equity you’ll have to give up. If your startup’s market is large and has high potential to continue growing even more, you have a strong case of valuing your startup at a higher price. And because of this, you’ll be able to give a smaller amount of equity to investors, as the potential return for them is still fairly high.
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First-time entrepreneurs will have to give up more equity. If you’ve launched a company before, you’ve established yourself in the startup world and now have the credibility to negotiate for a higher investment for lower equity. However, because of the risk associated with someone who’s building a business for their first time, rookie entrepreneurs will have to give up more of their company in the early stages to convince an investor to invest in them.
For more on dealing with investors, watch the video below featuring Adeo Ressi, CEO of the Founder Institute.
How does equity crowdfunding work and is it worth it?
Equity crowdfunding allows people to invest in early-stage, private companies in exchange for equity (in the form of shares or a percentage of ownership) in that company. This differs from traditional crowdfunding, in which people give money to company in exchange for perks or rewards.
As this is still a relatively new form of fundraising for startups, there are several unknown factors and risks that need to be considered, but there is no denying that it is quickly becoming a more viable for companies to raise capital.
If you’re thinking about using equity crowdfunding for your startup, below are some considerations you must look at before you commit:
Equity crowdfunding can complement a rewards-based crowdfunding campaign.
It’s entirely possible to mix an equity crowdfunding campaign with the more common rewards-based crowdfunding campaign, as long as you’ve done your research and carefully planned out contingencies for if you don’t reach your goals. For example, you can run a rewards-based crowdfunding campaign to fund your first product, and if you reach your goal and successfully launch your offering, you can follow it up with an equity crowdfunding campaign to grow your business, as you will now have demonstrated a demand for your product.
You still need to demonstrate your company’s traction and progress.
Just because equity crowdfunding can expose your company to a wider base of potential investors, at the end of the day you’re still trying to attract investors, and investors are still interested in the potential a company has to grow and expand. As stated in the previous section, a rewards-based crowdfunding campaign is a great way to generate traction for your company, but it’s not the only way. When posting your company on an equity crowdfunding platform, it’s important to list all of your company’s milestones. Don’t be humble, as the more progress your company has made, the better your chances are of attracting investors. (Just don’t make up your company’s previous achievements, as this will come back to haunt you.)
Lead investors are still important.
As with any funding round, finding a lead investor can greatly increase your potential of attracting other investors in your equity crowdfunding campaign. Because few investors are willing to take a risk on an early-stage company, finding a lead investor can be the hardest step, but can be instrumental in proving that your startup has promising prospects. Smart entrepreneurs should wait until they’ve raised 5 to 10% of their funding before seriously marketing their equity crowdfunding campaign, and really smart entrepreneurs should wait until they’ve raised around 25% of their funding.
Not all equity crowdfunding platforms are the same.
Just like rewards-based crowdfunding campaigns, the platform you choose can have a huge impact on your success, as each platform has its own set of rules and regulations. If you’ve decided to run an equity crowdfunding campaign for your startup, it’s essential that you conduct considerable research into each platform and how they align with the goals and mission of your company. When looking into potential equity crowdfunding platforms, make sure that they have strict policies when it comes to preventing fraud, offer numerous crowdfunding tools, and come with a sizeable, vetted investor base.
SeedInvest is one of the top equity crowdfunding campaigns for startups. Click here for the deck they presented at our last FounderX event.
Equity crowdfunding requires extensive legal protection.
Because of the unique nature of equity crowdfunding, there are numerous legal considerations that need to be taken into account before kicking off an equity crowdfunding campaign for your startup. There are three main types of equity crowdfunding, each of which has its own share of regulatory compliance and limitations on who can invest in your startup and how much you are allowed to raise. Below is a quick summary of each type:
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Equity I: Equity I allows for accredited investors to view private investment opportunities on a password-protected website, and is best for founders who want to prefer to stay away public exposure of their fundraising campaigns.
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Equity II: Equity II allows founders to publicly advertise their need for funding, and those who choose this path can raise unlimited capital from an unlimited number of accredited investors.
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Equity III: Equity III allows unaccredited investors to participate in a funding round. While this enables entrepreneurs to reach a much larger audience of investors, there is also the risk that investors who they reach are not as experienced and can put more responsibilities on the founders.
There are still many other points that need to be considered before an entrepreneur chooses to give away equity during an equity crowdfunding campaign, and founders are encouraged to conduct further research into the topic. However, the points listed above are some of the most primary concerns, and should be enough for you to get started.
Closing Thoughts
As in anything in the startup world, there are only a handful of tried and true methods of building a successful company, which means you're going to have to make up your own way of doing things. Unfortunately, when it comes to the financial aspect of your startup, you're left with little room to experiment, as a miscalculation can put you at risk. Hopefully, this blog post gave you some necssary insights into how best to manage the equity of your company, and helped put you on the right track.
