Start-Up Funding: Read This Before Accepting Money From Any Investor
One of the most important discussions in the tech ecosystem today is funding. Today, startups celebrate and publicise raising investment and it is indeed seen as a validation that a startup has potential for success.
There is no doubting the fact that startup founders need these investments to grow their businesses.
However, sometimes desperation forces them to take investments that are not favourable to their businesses. This eventually leads to sour relationship between them and their investors.
This also sometimes ultimately leads to the death of the business. So, it becomes a lose-lose situation.
This is called predatory investing and Managing General Partner of EchoVC, Eghosa Omoigui told Bounce News in a chat that it is not peculiar to Nigeria but could be surmounted by vigilance from the beginning.
“I have been investing in several parts of the world and I have seen predatory investing. It is not a problem that is unique to Nigeria or Sub-Saharan Africa.
“But what happens is that there is a misalignment of both understanding on the part of investor and entrepreneur. The other part of it is misalignment in terms of goals,” he said.
To avoid falling prey to these types of investors, Omoigui said a startup founder needs to ensure the following.
1. Gauge The Intention Of The Investor
Stories of how investors want to take 70 to 80% of a business is not uncommon in the ecosystem. And according to Omoigui, such level of equity demand is a sign of predatory investing and a founder should be on the lookout for it and guard against it.
“If an investor wants 70 to 80% of a company, that kind of investor is not an investor but an employer. He just wants to hire the entrepreneur. But I think it is shortsighted for investors to want to take a lot equity in the business they want to invest in,” he said.
2. Think Long Term
As a founder, it is important to think long term and it is equally important to find an investor who shares the same perspective.
“On average, a startup would probably need to raise money, about 4 or 5 times to be able to hit escape velocity. But the way it is, is that when a founder raises money, his equity gets diluted by a third.
“This means that when you raise money with a reasonable person, not someone who wants to employ you, you are typically selling 30 or 35% of your company. So, as a founder you end up with about 70% of the company,” Omoigui said.
Explaining further, he said, “If you raise money again, you get diluted more, because more people are now buying ownership of the company, so, your existing ownership has to shrink.
“If you do that 4 to 5 times, maybe at the end of the day, you own 20 or 25% of your own company but the difference is that you now own 20 or 25% of company worth 100 million dollars.
“So, you have kind of ended up in a good place because even though your ownership may have shrunk but the value of what you own has multiplied.”
3. Ensure You Own The Majority From The Beginning
“This is super-important and sums the whole point of fundraising,” Omoigui said.
This is because, if you give a larger chunk of your business to the investor in the beginning and are left with smaller percentage, you could be left with nothing by the end of the day.
“If you start the other way around where you own around 30%. By the time you have gotten the company to where it is now worth a lot of money, you might own 1%.
“This makes no sense to us at all because at that point in time, it is a very significant risk to the investor because the founder may just leave, and it is not good for the business.
“This is because the truth of the matter is majority of the investors do not know how to run these businesses. So, it is important that a founder own almost a super majority of the company,” noted Omoigui.
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From the beginning, a good place to start would be understanding how much your startup is worth.
According to another tech entrepreneur and investor, Tomi Davies, founders need to understand the tangible and intangible assets of their business to even get a fair idea of how much their business is worth.
Such assets include, intellectual property such as patents and trademarks and even ideas.
“You have to protect your thought capital. It gives you competitive advantage before investors,” said Davies while speaking on Company Valuation recently at a function in Lagos.
“Trademarks, patents and designs that give the startup market advantage which can justify an increase in valuation should be registered,” he added.
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Speaking further, he said, some other important considerations include understanding the value of all the principals and employees.
According to him, “value should be assigned to all paid professionals as their skills, training and knowledge of the operations and technology are valuable.
He also insists, founders need to get co-founder(s).
“Without a co-founder, your business is already minus 10% in your valuation,” said Davies.
According to him, one of investor’s important consideration is the founding team. If then, you have no co-founder, it is difficult to trust you with an investment because it shows your lack of ability to assemble a team.
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