Now that you have finally received funding, it seems you have reached the finish line, but getting funding is not the end of your startup journey. It’s time to go to the drawing board again. The journey may still be tough, but at least, you now have some desperately needed resources.
When you are raising money for your startup, it helps to also understand how the investors you are pitching will make money for themselves. The formula for paying investors is often not as simple as taking their return on investment and allocating it equally among the key players.
For angel funds, venture capital funds and other investment partnerships, there are often complex formulas for how the individuals involved in managing investments make money. Ultimately, you should remember that all the investors want in return for their money is pretty simple: more money.
[READ MORE: To become a millionaire, set these benchmarks]
What is the implication of raising funding?
By seeking funding rather than taking out a loan, startups can raise money that they are under no obligation to repay. However, the potential cost of accepting that money is higher – while traditional loans have fixed interest rates, startup equity investors are buying a percentage of the company from the founders.
This means that the founders are giving investors rights to a percentage of the company profits in perpetuity, which could amount to a lot of money. Big-name companies like Amazon, Facebook, and Google were once venture-backed startups.
4 ways startup investors can make money from their investment
- The startup is acquired by another company: For an investor in a startup, this is frequently the quickest way to make money on your original investment. When a startup is acquired, an investor may receive cash or new stock (or a combination of the two) from the acquiring company. So, how much an investor would see back on a merger or acquisition of this kind depends on his share of the startup and the valuation the company was being acquired at (Example here is Instagram).
- The startup goes public (IPO): If you had invested just $10,000 in Amazon, Dell, Apple, or Microsoft, when they went IPO, you’d be a million dollars richer just from that investment according to the IPO Playbook. Apple kicked that 100x ‘Franklin Multiple’ to the curb with a 4,581.7% rise in stock value between 2002 and 2012 alone.
- The company begins paying dividends: Some companies decide not to get bought or IPO. Their founders have a vision of running large, standalone businesses. To repay investors, they can pay out part of their cash flow in the form of ongoing dividends or if the cash buildup on their balance sheet is large enough, they may decide to dividend out a chunk of that cash in a one-time, special dividend.
- Investors sell their shares to other investors: Investors in startups typically have the ability to sell their shares to another buyer for a profit if they can find one.
What is Equity?
Equity essentially means ownership. Equity represents one’s percentage of ownership interest in a given company. For startup investors, this means the percentage of the company’s shares that a startup is willing to sell to investors for a specific amount of money.
As a company makes business progress, new investors are typically willing to pay a larger price per share in subsequent rounds of funding, as the startup has already demonstrated its potential for success. If the company turns a profit, investors make returns proportionate to their amount of equity in the startup. If the startup fails, the investors lose the money they have invested.
Returning Money to Investors: How to calculate their actual return
Often you know how much you want investors to invest, and they are demanding a certain rate of return. What cash flows do you need to provide to give them that rate of return?
If they provide $100,000 and demand a 40% rate of return per year, that means you’ll have to pay them $40,000 each year. If you agree that they get their money in a lump sum when the company goes public, then the 40% compounds.
The calculation is easy — the total due each year is the previous year’s total plus the interest (40%). If you estimate the company will be worth $5,000,000 at the end of the fifth year, then the investors will need to own 10.8% of the company ($537,824 / $5,000,000) in order for them to get their 40% return.
[READ FURTHER: What Is A Share Reconstruction and How It Affects You]
Splitting the Pie
Every time you get funding, you give up a piece of your company. The more funding you get, the more company you give up. That ‘piece of company’ is ‘equity.’ Everyone you give it to becomes a co-owner of your company.
The basic idea behind equity is the splitting of a pie. When you start something, your pie is really small. You have 100% of a really small pie. When you take outside investment and your company grows, your pie becomes bigger. Your slice of the bigger pie will be bigger than your initial bite-size pie. When Google went public, Larry and Sergey had about 15% of the pie, each. That 15% was, however, a small slice of a really big pie.
Let’s look at how a hypothetical startup splits its equity from idea stage till it gets external investment:
Idea stage: At first, it is just you. You own 100% of it now and you are the only person in your company, you are not even thinking about equity yet.
Co-Founder Stage: As you start to transform your idea into a physical prototype, you realise that you could really use another person’s skills. So you look for a co-founder. You also realise that since she will do half of the work, so you give your co-founder 50%.
Soon you realise that you need funding. You would prefer to go straight to a VC, but so far you don’t think you have enough of a working product to show, so you start looking at other options. The Family and Friends Round, then The Angel Round. And then more options:
Incubators and accelerators: These places often provide cash, working space, and advisors. The cash is tight – about $25,000 (for 5 to 10% of the company.)
Angels: Let’s say it is still early days for you, and your working prototype is not that far along. You find an angel who looks at what you have and thinks that it is worth $1 million. He agrees to invest $200,000.
Now let’s calculate what percentage of the company you will give to the angel. We have to add the ‘pre-money valuation’ (how much the company is worth before new money comes in) and the investment:
$1,000,000 + $200,000 = $1,200,000 post-money valuation
Now divide the investment by the post-money valuation $200,000/$1,200,000 = 1/6 = 16.7%
The angel gets 16.7% of the company, or 1/6.
What about you, your co-founder and the family member that invested? How much do you have left? All of your stakes will be diluted by 1/6. Is dilution bad? No, because your pie is getting bigger with each investment. But, yes, dilution is bad, because you are losing control of your company. So what should you do? Take investment only when it is necessary.
Venture Capital Round
Finally, you have built your first version and you have traction with users. You approach VCs. How much can VCs give you? Let’s say the VC values what you have now at $4 million. Again, that is your pre-money valuation. He says he wants to invest $2 Million. The math is the same as in the angel round. The VC gets 33.3% of your company. Now it’s his company, too, though.
Your first VC round is your series A. Now you can go on to have series B, C – at some points either of the three things will happen to you. Either you will run out of funding and no one will want to invest, so you die. Or, you get enough funding to build something a bigger company wants to buy, and they acquire you. Or, you do so well that, after many rounds of funding, you decide to go public.
Why Companies Go Public?
There are two basic reasons. Technically an IPO is just another way to raise money, but this time from millions of regular people. Through an IPO, a company can sell stocks on the stock market and anyone can buy them. Since anyone can buy, you can likely sell a lot of stock right away rather than go to individual investors and ask them to invest. So it sounds like an easier way to get money.
There is another reason to IPO. All those people who have invested in your company so far, including you, are holding the so-called ‘restricted stock’. The people who have invested so far want to finally convert or sell their restricted stock and get cash or unrestricted stock, which is almost as good as cash. This is a liquidity event – when what you have becomes easily convertible into cash.
A prime example is Google, which launched as a startup in 1997 with $1 million in seed money. In 1999, the company was growing rapidly and attracted $25 million in venture capital funding, with two VC firms acquiring around 10% each of the company. In August 2004, Google went public, raising over $1.2 billion for the company and almost half a billion dollars for those original investors, a return of almost 1,700%.
[READ ALSO: Determining the Best Savings Account for You]
The term sheet
In the context of startups, a term sheet is the first formal document between a startup founder and an investor. A term sheet lays out the terms and conditions for investment. It is used to negotiate the final terms, which are then written up in a contract.
The downside of receiving funding
- After the investment, it’s not entirely yours anymore. That dream you had of building your own business ends when you take on outside startup investors. You have partners now. You have people who have a claim to ownership, shares, and having a voice in key decisions. You no longer set your own goals, strategy, milestones, and pace.
- Investors aren’t generic. Some become collaborative partners and even mentors, some are nagging insensitive critics. Some help, some don’t.
- Investors can be bosses. You are not your own person when you have investors; you’re part of a team. You can’t decide everything by yourself.
- Investors don’t make money until there’s a liquidity event. That’s why we always talk about exit strategies. You can be the world’s happiest, healthiest, most cash-independent company, but your investors won’t be happy until you get them cash back. The win is getting money back out of the company.
Founders should raise money when they have figured out what the market opportunity is and who the customer is, and when they have delivered a product that matches their needs and is being adopted at an interestingly rapid rate.
Look for ways to keep the amount of equity or percentages as low as possible when negotiating with an investor. For instance, ask for a smaller amount of money initially, rather than a sum you feel you’ll need over a few years. This allows you to give away a smaller slice of your business in exchange for the capital, leaving you with more as the owner of the company.
What are the Alternatives?
If it’s the advice you need more than the financing, another option is to take on a partner willing to offer working capital and expertise to your company. Your partner gets a cut of all profits, depending on your operating agreement, but you may have more options for terminating this arrangement.
Your partner can agree to sell his portion of the partnership to you, for example. Then you own his share and do not have to pay a percentage of the profits to him anymore.
[READ FURTHER: Top eight investment destinations for Nigerians]
How to pre-qualify for your banks’ Retail/SME loans
The cash flow of borrowers taken in context with the nature of their businesses is crucial in determining their loan eligibility status.
The CBN’s directive of July 3rd 2019 compelling Nigerian Banks to maintain a Loan to Deposit Ratio (LDR) of 60%, wherein SMEs, retail, mortgage and consumer lending would be assigned a 150% weight in the computation of this LDR, has definitely been a game-changer in the industry as more commercial Banks focus on retail and SMEs to meet their lending quota in order to avoid stiff CBN sanctions that accompany noncompliance.
Indeed, the mass market has become the battleground for Nigeria’s financial institutions with institutional giants previously considered huge corporate giants jostling with Fintechs and MFBs for retail and SME customers, each outdoing themselves with mouthwatering rates and relatively easy to fulfil covenants for loans that are “a click away.” Naturally, this should be good news for the market as getting a loan has reportedly never been easier, but it is not. Most retail customers simply do not qualify for the type of loans they need.
No matter the pressure from CBN, banks are still profit-making institutions that are duty-bound to protect the interest of their stakeholders, hence their need to comply with best credit practices even when disbursing the smallest of amounts as loans. Their loans are thus, only given to those who meet their requirements, whose records show favourable odds.
Here are a few ways of increasing your odds at being pre-approved for your Bank’s retail/SME loan:
Consolidate your banking activities
If you are reading this, then I can safely guess you have an account in a Nigerian bank. If yes, then you probably have accounts with more than one bank; and you probably wear your resources thin trying to service these accounts because “they serve different purposes.” While this may be good for financial planning, it definitely works to your detriment in showing your true cash flow from your turnover.
Most retail loan applications require just one bank statement, and in the case where you may be allowed to present statements of more than one bank account for your loan application, a reviewer may suspect duplicity of transactions. Save yourself the hassles and consolidate your banking activities to one account for the purpose of your loan request; to show your capacity.
Ascertain your credit status
Do you have any outstanding debts owed to any financial institution? Perhaps you guaranteed a loan with your bank details or one of your abandoned accounts has a negative balance? Clear it before putting in your loan request.
Credit is mostly about character. Any financial institution willing to lend you money will make sure that you are in the habit of settling your debts, hence their need for a credit check. There are no forgotten loans in the system; whilst they may have been written off, they are not forgotten. Know your credit status today.
Build turnover and average balance
Turnover is the total amount that passes through an account within a period while the daily overnight balance on the account summed up and divided by the number of days under review is the average (daily) balance.
There is much emphasis on turnover amongst customers who seek loans; however, any credit officer worth his pay usually uses turnover in tandem with your average balance to make decisions on a loan request because the turnover addresses capacity while the average daily balance addresses available capital. Turnover may be easy to manipulate but your average daily balance is not. Build both.
“Show your workings”
As simple as it sounds, this could be the most common reason why some account statements are rejected as fraudulent and the loan requests of their owners denied – because they do not show any underlying transaction or pattern. They are haphazard at best.
It has become commonplace for SME owners to use their company’s account for personal expenses; withdrawing cash with their ATM cards and hardly describing their transactions in details such that a reviewer is unable to decipher who their suppliers or customers are from their bank statement. Not even salary payments appear to be recurring on these statements, as most transactions are in cash.
Account statements like this show early signs of impropriety that will have any credit officer doubting the management competence of the loan applicant.
All of these points, well-observed, may get you pre-approved but no loan is disbursed without a verifiable source of repayment. Collateral will definitely help to assure the lender but the cash flow of the borrower taken in context with the nature of the business is key.
While personal loans may be approved based on account analysis, valid Know Your Customer (KYC) documentation and credit checks (depending on the amount); contracting financial experts for proper bookkeeping and development of business plans could go a long way in getting your SME loan request approved.
How to grow rich with the power of profitable relationships (Part 1)
You need two currencies to become successful. The first currency is money and the second currency is relationships.
- There are two currencies you need in the world to grow rich and become more financially successful. The first currency is money and the second currency is relationships. These two currencies must work for you to create wealth and achieve financial success. And among the two currencies relationship is the most powerful and beneficial. This is because you can get to the top without money but with the right relationships. But you cannot get to the top having money alone.
Money needs relationships to thrives because all the wealth in the world is created in the context of a relationship. That is, two people must first like, trust and agree with each other to do business or engage in an income-producing activity to create wealth. And while Relationships can produce money, money cannot produce relationships. Thus, you can have all the money in the world and still be far behind in life if you lack important relationships.
Charlie “Tremendous” Jones, a one-time legendary speaker and author, puts it this way, “you remain the same person year after year except for the people you meet and the books you read. So, if becoming rich and wealthy is important to you. You must master the art of building profitable relationships and connecting with the right kind of people. Building relationships that produce wealth is thus the fastest way to get to the top. And getting to the top is all about connecting with people that have the advantage that you lack in your own life.
How then do you create profitable relationships?
To create profitable relationships, you must first recognize that there is an unequal distribution of wealth and advantage in the world. And that for you to be successful, you need to connect with other people. That is, those who have the advantages that you seek. The truth is other people have the answers, deals, money, access, power, and influence that you need to achieve your goals. And they will only give it to you if you are in a relationship with them.
There are two elements that must be present in a relationship to make other people want to invest in your own success. The first is trust. And the second is your ability to solve their problems or offer value. Trust is saying something and doing it consistently over a consecutive period of time. Solving problems for the people you want to attract is also key. This is because people generally care less about your success and more about their own success. So, the only way to get them invested in your success is to first solve a problem that they care about. And the only way for someone to open up about their problems to you is if you are in a close and trusted relationship.
What is a Close Relationship?
Close relationships are relationships that are bound by mutual interests, mutual respect, and mutual values. Most close relationships are formed within private and sometimes closed environments. A typical example is relationships formed within the confines of a family, a school, an office, a club, an estate, or an event. This kind of relationship is the most trusted relationship and it carries the greatest potential for wealth. Thus, to create wealth two things are important – the quality of your close relationships and your ability to convert strangers into close friends. All relationships must first become close for them to be beneficial for your success. Thus, without trusted close relationships and the ability to create them, it is hard to create wealth or achieve financial success.
Now you may say to yourself, ‘but I have close relationships, why am I not yet successful?’
The answer is simple.
While every close relationship has trust in them, not all close relationships can produce income. In fact, no close relationship is designed to automatically create wealth. You have to make them create wealth. Close relationships are like a seed. They are ineffective as seeds but when planted and nurtured can become trees. This means that you must master the art of planting and nurturing your close relationships to become wealth trees.
How do you build wealth-creating relationships?
Before I show you how to build wealth creating relationships. Let me first show you the two kinds of close relationships that exist.
The first is the wealth-consuming relationships. And the second is the wealth creating relationships.
Wealth-consuming relationships are relationships that use up capital. They are also known as social relationships. And comprise family relationships, certain friendship relationships, and religious associations. The way the members of this group add value to each other is by offering emotional or spiritual value in exchange for financial support. Wealth-consuming relationships are thus not designed to create wealth and it is hard to make them wealth creating in nature. Nevertheless, they are important relationships. And provide essential spiritual and emotional balance. So, the only way to thrive financially regardless of them is to combine them with the second kind of relationship – the wealth-creating relationship.
Wealth-creating relationships are relationships that produce income or enlarge opportunities. They are also known as professional or business relationships. Professional or business relationships comprise relationships with co-workers, peers, and club members. They also include relationships with your neighbors, customers, partners, vendors, advisors, etc. Members of this group are pre-sold on creating wealth. They are open to learning about new information. Discovering new ideas and opportunities. Open to doing business together and meeting new people. The way this group adds value to themselves is by pointing each other in the right direction. They connect each other to people, businesses, opportunities, and organizations that can help them. And they support each other through difficult times. Although most people have these relationships, they are still not wealthy.
The reason for this is simple
Professional and business relationships will not automatically create wealth for you. They have to be made to create wealth. These relationships are like seeds. They are ineffective as seeds but when planted and nurtured can become trees. This means that you must not only know how to develop these relationships. You must also know how to turn them into wealth trees. To convert professional or business relationships into wealth-creating relationships you need to do three things.
First, you need to become a high-income problem solver. Second, you need to become a value connector. And third, you need to join a wealth-creating problem-solving platform. Let’s look at each of these points in detail
1.Become a high-income problem solver
A high-income problem solver is anyone that solves problems that produce high income. Solving problems for people is the only way to create wealth and enter into high-quality relationships with other people. To solve problems, you need experience. And the fastest way to gain experience is through your own personal journey. Personal experience can make you an instant expert in an area that would usually take years of hard labour in school to develop. Being an expert is important to build trust with your close relationships.
For example, if you are passionate about weight loss but are struggling with losing your own weight, you have an excellent opportunity to become an expert in that area especially for those who are struggling to lose weight. All you need do is overcome your own struggles and lose weight. And then you can help other struggling people do the same. When you successfully solve your own personal problems, you become the expert that can help others solve the same problem. This makes you more magnetic and interesting to other people. The key here is to create such a rich life that has many inspiring stories, experiences, and achievements. You must reach the point in your life where you have a lot of “How Did You Do This” stories. How did you get enough money to start your first business? How did you rise to become the CEO of a multinational company? How did you overcome cancer? How did you stay married for 50years? How did you achieve Financial freedom etc.? The more “how did you do this” stories you have the easier it will be to connect with people and build rich relationships.
However, you must ensure that some of your how did you do it stories can produce high income. And involve solving problems that affect a lot of people. You must also ensure that you begin helping people as soon as you start taking the right steps and not after you have achieved your end goal. Sometimes being an expert does not mean that you are perfect or have arrived. It simply means that you have taken certain steps that others are struggling to take. And you can guide them. If you are ahead of anyone in a particular area you can become the expert in that area to them. Becoming a high-income problem solver is thus not just important for earning a high income but also important for building rich relationships. When you master the art of solving high-income problems you become a valuable person that other people want to meet.
To be continued next week…
About the author
Grace Agada is the most sought-after Financial Planning expert in the country and is quoted frequently in leading Newspapers, magazines, and blogs. Grace is a Renowned Keynote Speaker, Author, and Column Contributor in Punch Newspaper, This Day Newspaper, Vanguard newspaper, Business Day Newspaper, Leadership Newspaper, The Tribune Newspaper, and Online Platforms like Nairametrics, Proshare, and Bellanaija. Grace is the Founder of “The University of Wealth” The author of “The Financial Freedom MBA Program”, “The Better Life in Retirement Planning Blueprint” and “The Wealthy Business Blueprint”. Grace is on a mission to shrink the middle class and populate the upper class. She has been featured on BBC Africa. Business Day TV. Inspiration FM. and inside Naijatv. And she consults for Numerous Top Organizations, Company Directors, CEOs, Senior Executives, and High-Income Professionals.
Nairametrics | Company Earnings
Access our Live Feed portal for the latest company earnings as they drop.
- 2021 Q1 Results: FTN Cocoa Processor Plc reports loss after tax of N162.21 million
- Tantalizers Plc reports a loss after tax of N97.75 million in FY 2020 in Q1 2021.
- Courteville Business Solutions Plc proposes final dividend of 3 kobo per share for FY 2020.
- 2020 FY Results: UPDC Real Estate Investment Trust records over 500% growth in Profit after tax.
- Sovereign Trust Insurance records a 43% surge in profit after tax to N392.1 million in Q1 2021.