When you first start a business with a great idea but have no product or sales, you really only have two funding choices: bootstrap or ask friends and family to invest. As you start to gain traction you may reach the point where you have the option to take angel or perhaps even venture capital. With each of these stages comes a multitude of decisions: “Can I grow fast enough by bootstrapping to take market share?” “What is my company worth?” “Do I want to involve these people in my company?” And, of course “How much equity will I give up?”
This article will focus on the last question: “How much equity will I give up?”. The answer will vary greatly depending on the stage of your company. The earlier your company is in the process of creating its product and demonstrating product market fit, the more you will have to give up.
If your company is successful you might have as many as four or five funding rounds, and with each round the founder’s equity decreases. This might be ok if you have the next Unicorn and sell for $10 billion. At that point do you really care if you only own 10% of the company? Probably not! But what if you get to the third or fourth round, you only own 20-35% of your company and it sells for a much more likely $10 or $20 million. Let’s do a quick thought experiment here with what would be considered a very successful capital raising strategy (Silicon Valley Bank has a great article walking through the math below):
Round 1 (Seed): you raise $250,000 at a pre-money valuation of $750,000 which results in a company valuation of $1 million. That sounds great but now your ownership has just been reduced to 75%.
Round 2 (Series A): you raise $1 million at a pre-money valuation of $4 million resulting in the company being valued at $5 million. You and the Seed investors own $4 million or 80% of the company and the Series A investors own 20%. That also sounds pretty good, but of course you only own 75% of the 80% so now you are down to 56%.
Round 3 (Series B): you raise $2 million at a pre-money valuation of $8 million resulting in a company valuation of $10 million. The new investors get 20%, and you are now down to 45% (80% of 56%).
Round 4 (Series C): you raise $5 million at a pre-money valuation of $15 million resulting in a $20 million post investment value. You are down to 34% (80% of 45%). And the reality is those Series A, B and C investors will have preferences which include the right to get paid before you do. Undoubtedly you will also have issued stock options to key employees along the way which further dilutes your interest.
Woohoo! You are able to sell your company for $20 million, which happens to be the median exit price for those companies that do exit successfully. 34% is yours, or $6.8 million before taxes and fees (which will be substantial).
Now imagine that you used Revenue Based Financing (RBF) in place of one of those rounds, and as a result did not have to give up the associated equity. In this scenario, you own 45% of the company instead of 34%, and your share upon exit is $9 million; an increase of $2.2 million or about 1/3 more. This is not insignificant money and it came about by you being smart about the financing strategy.
Here’s the math summarized:
We recently held a webinar on the other costs of equity capital in addition to founder dilution. You can view the recorded webinar and learn more about Revenue-Based Financing on our website and our other blog articles. If this form of funding makes sense for your company, we would love to hear from you!
Sage Growth Capital makes revenue-based investments in companies who need growth capital. It is our mission to provide a more flexible funding option to growing companies who do not fit traditional equity or lending models. To learn more about Sage Growth Capital or to apply for funding visit: www.sagegrowthcapital.com.