What do investors want? This is a question that every startup founder should ask themselves. In this blog, we will explore the different types of investor and what they might be looking for in a company.
In an email, I got the following question:
What is the usual term of a company investor’s return and what is the average return? What would most investors want in return if a total stranger wanted to invest $50,000 in our business (at the start-up stage)?
The question reminds me that the majority of the investing buzz on the internet is focused on high-tech and high-growth angel and venture capital investments. However, at the very top of the investing pyramid, it is a very tiny subgroup. There is a scarcity of knowledge on what investment looks like in the rest of the globe.
So here’s a quick rundown of the fundamentals of startup investment:
- In a startup, everything is done on a case-by-case basis. Although the points I make in this article are usually correct, there are always exceptions.
- In most cases, investment entails ownership. A hypothetical $50,000 investment would purchase a portion of your company’s ownership.
- Divide the amount of the investment by the company’s valuation to calculate how much ownership the investment is worth. A $50K investment will give you 50 percent ownership of a $100K business, 20% ownership of a $250K company, and 5% ownership of a $1 million company.
- There are rules that regulate who may invest and how you can raise funds for your business. Make certain you consult an attorney about this. Legally, the words “friends and relatives” and “angel investment” are important.
- Only until the beginning firm produces real liquid money for its owners by selling its shares does a standard startup investment provide a profit. Because everything is done on a case-by-case basis, you might give investors dividends or other forms of drip compensation, but this isn’t the norm. The general rule is that investors earn money when they can sell their ownership shares for much more than the $50,000 they initially spent. Because investing in startups is extremely hazardous, angel investors want to think that their investment will increase 10x or even 100x in 3-5 years.
- Risk and return are linked. If your company is low-tech and low-growth, you may be able to attract friends and family investors who are content with an annual payout or something similar (and small). That’s very uncommon.
- Always compare the return on an investment in your business to the return on less risky assets such as certificates of deposit or mutual funds. Every startup is a gamble. Investors should anticipate a greater return.
- Non-monetary factors, such as family support, may lead to individuals investing in a company.
So, what’s the solution to that particular $50K investment question? I can’t respond without first learning about the business in order to assess its growth potential, likelihood of ultimate departure, and so on. However, it is assumed that the investment will include the sale of a part of your business.