Posted on: 25 February 2015
Equity crowdfunding involves selling a share of your business to the crowd, some of whom could be professional investors. It’s a sound alternative to debt crowdfunding (P2P business lending) if you already have a lot of other debt, or if you don’t make a big profit (although this can make it a less attractive investment for the crowd).
As part of this, you relinquish some control of your business – you, as the business owner, decide how much – 10%, 20%, 30%? It’s a figure that requires a lot of thought because of how it’s related to the value of your business and how it affects how much of the business you can own in the future.
Valuing your business
How you value your business has far reaching implications in equity crowdfunding, because there is an intrinsic relationship between how much money you want to raise, how much of the business you are willing to sell and what you think it is worth.
Frank Webster is Senior Investment Associate at Seedrs, the equity crowdfunding platform. “How much money you are seeking to raise and the equity you are prepared to offer decides the value you are placing on your business,” says Frank, “so it may help to get advice from professional advisors or perhaps anchor investors.”
As he explains, “the valuation of a company at the time of any fundraising round is calculated using the amount of investment sought, and the amount of equity being offered in return for that investment. If you're looking to raise £100,000 for 10% of your company, that's a pre-money valuation of £900,000, and post-money valuation of £1,000,000 (i.e. the value of the shares plus the cash invested).”
On some equity crowdfunding platforms, you can overfund, which means that you raise more money than you sought. In this instance, “the pre-money valuation of your business remains constant, but the post-money valuation continues to rise (as more cash is invested and further shares are issued),” says Frank. “Using the example above, if you were to get to 200% (i.e. raise £200,000), this does not mean you have sold 20% of your business, as the pre-money valuation remains the same, but the post-money valuation moves up (in this example, to £1,100,000). The calculation is (200,000 / 1,100,000) x 100 = 18.18%.”
So getting the valuation right is a factor in making sure you retain the right level of control in the business. It also impacts how attractive your business is as an investment opportunity – placing too high a valuation on it puts investors off.
How much should you sell?
The main risk of selling a higher percentage of your business through equity crowdfunding is that you give too much muscle power to the crowd, potentially making it more difficult for you to influence key decisions made in the future.
This may have been part of your strategy – you have chosen your investors specifically because you want them to be permanently involved in your business as you know they give sound business advice and are more experienced than you are. But be careful that bringing a relatively large crowd along for the journey to achieve your business’s goals may hold up progress along the way, or even take the business in a completely different direction.
Another thing to keep in mind is how you will make sure you keep aside enough equity in the business to give to employees down the line. Or even to other, more sophisticated investors who can add particular value to your business in the future.
The risk of dilution
Lastly, consider ‘dilution’. “If a business raises a later round of finance (normally at a higher valuation), this means that new shares are issued to new investors,” says Frank. “There is therefore a larger number of shares making up the total share capital in the company, so each individual share is proportionally worth a slightly lower percentage than before the round.”
If mismanaged, the knock on effect of selling various stakes in a business over time could result in the value of the original business owner’s share of their business going down.
However, as Frank explains, if you’re running a successful business and are mindful of the risks of dilution, the overall value of the company will be going up: “So whilst the percentage of the company owned by its founder and early investors may have gone down, the value of the whole has gone up - and the original ownership stake is thus worth more,” concludes Frank.
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