Advisable amount of equity to part with during seed funding
What is the advisable range of the amount of equity to part with during seed funding? If I give too much then I risk becoming an employee at my own company during a later round. Worse yet I risk not being able to attract money during the next round. How do I make an argument for the valuation of 1% of the company?
4 Answers
Commonly you'll want to release more than 10%, but less than 25%. And also as little as possible. If you let go of more, you runt at risk of becoming a hard choice when (if) you're going for a Series A round. If your investors have too little invested they're likely to just not engage as much, and their lack of interest may be noted by the Series A investor.
Brad Felt has written in depth about Term-sheets for investments, and you should check it out. Also, start reading Venture Hacks, especially about how Angel List works. Also, both Paul Graham, and Fred Wilson have written about the effects of dilution down the run.
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This is a good answer. Don't sell more than 25% of your company during the seed funding round. Fixing a price should be easy, for example try to convince the potential investors that your company is worth $1 million and that you would like to sell them 10% of the stock for $100 thousand. If you can't find investors willing to accept these terms then they think the value of the company is less than $1 million. As long as you keep the amount of stock fixed at some small percentage, the game is to try to raise as much money as possible. – Nathan Farrington 14 years ago
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Both, very good comments. I especially like the methodology set forth by Nathan. – John Berryman 14 years ago
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Thx guys! Nathan is right. You'll want to go for as much money as possible without selling too much (for future rounds or control) and with losing as little equity as possible. – John Sjölander 14 years ago
You can't necessarily do that - the investors are going to attempt to formulate their own valuation.
A good middle ground is something called "Convertible Notes," also called "Convertible Debt." With this, you can avoid the hassle of creating a valuation for the company that might be too young to really pinpoint a price on, and get the money earlier without giving up control now.
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Ah... I worded my question a bit ambiguously. I've changed the last sentence to say: How do I make an argument for the valuation of 1% of the company? Thanks for the article. – John Berryman 14 years ago
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Convertible notes are the way to go. – Mitch 14 years ago
Start getting very comfortable with the idea of HATING giving away equity to investors, and valuing the equity that your company holds. You always risk being hostage to investors. Worse than being an employee of your own company (which you always would be), is to be a former employee of your company, with a raw deal.
Not all investors are your friend. Not all investors are friendly, or "Angels" in the common sense of the word. When I have my investor hat on, I want an investment that will earn me more than I could with my own money, working it myself. I like to diversify a little, therefore I invest, but my expectations of equity for high risk are very high.
Seed funding, for an early stage company is very risky. Web apps are my personal cup of tea, and with my experience I am able to mitigate some of that risk. Still a lot of risk exists.
My point is this... Think outside the box, See if you can move forward without raising seed money, or use family, friend or your credit cards for this stage. Sell your car, move into a cheaper apartment, sacrafice so that you can hold on to your equity.
Once you have build a real brick and mortar business it will be A LOT easier to attract investors, and their expectations of equity will be a lot less due to the greater number of investors that dont have the highest appetite for risk.
PS. Read this..
http://www.gidgreen.com/startups.php?topic=investors
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I'm proposing a high risk venture with a potentially very high return (or of course ... none). It is a web app of sorts. One thing I need some expertise on is web service design. I need to design something like the backend to twitter (except significantly simplified). Do you have any contacts that could help me out with that? – John Berryman 14 years ago
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John, are you talking about web service as in API (programming interface?) If you know exactly what you want your product to do, most senior level developers (they usually call themselves architects if they are involved in concept and planning) can help you out. I have a great contact in Belarus for high level programming work. They are not cheap, but they do great work and have a deep team that understands all aspects of web apps from planning, to technology, bottle necks, security, etc. My concern is that you are seeing your venture as high risk, and way to minimize that risk? – Frank 14 years ago
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y B Perhaps *I* am feeling the risk. It's my first venture (well there was that other one... but). The apparent risk is due to the fact that success depends upon the network effect. It's a winner take all market. However, the cost to compete is relatively low and if I get the whole market, then... well it's a Twitter or possibly even Facebook sized market. ... I don't guess that you would happen to know any "architects" in central Virginia would you? – John Berryman 14 years ago
John, my apologies if my answer perturbed you.
I am dealing with the same questions as you are in terms of putting a value on my company for my seed investors. We are also developing a Web-based application and are building our programming team in Eastern Europe or Asia, but this has yet-to-be determined.
I noticed you needed help in the design/development area and offered to help. At any rate, here are some links to help you out:
zther.com, an L.A. based digital agency. They should be able to build you a brilliant app, but at US prices. (disclosure: it's run by a friend of mine but I have absolutely no financial interest in recommending them. They do great work and their portfolio speaks for itself).
A Polish firm I have considered partnering with is Merix Studio (http://www.merixstudio.com). I have vetted their portfolio and I think they are very strong in both design and development. They are not dirt cheap but cheaper than working with US-based suppliers.
Good luck.
