Lesson 1: Investor Equity

Equity Percentages to Give Investors

The valuation of your start-up is an important component of any negotiation discussion. Investors may not refer to the valuation directly, but they will often refer to a target equity they want to acquire in your company. Based on the type of investor, they will expect or require a particular percent in equity and that will impact the capital amount they invest in your business.

Source: Equidam (https://www.equidam.com/ranges-of-negotiation-at-different-stages-of-a-startup/)

There are three variables to keep in mind for these negotiations: valuation, equity stake, and investment. If you do investment divided by post-money valuation, you get the equity stake that investors receive. If you reverse the formula, so that the valuation is equal to the amount of investment divided by the equity stake, which is a percentage. This means that if the equity is fixed and less flexible as a negotiation lever all while the total investment amount still varies. 

Typical Equity Ranges Based on Company Stage

As you enter negotiations with investors, keep in mind that the equity stakes will vary based on the stage of the start-up. Below is a breakdown of the typical average equity stakes and valuations at different stages.

Stage 1 – Co-Founder Equity 

This stage is typically in the earliest stage of the company, a time when the valuation of the start-up is mostly irrelevant. The average equity negotiation range is 5% for co-founders. Keep in mind that anything below 5% could signal a red flag with long-term sustainability and engagement. Then again, you want your co-founder(s) to be incentivized and aligned with your business for the long run.

Stage 2 – First Fundraising Stage 

Angel investors are usually part of this fundraising stage and the typical range falls between 10-20%. The focus at this stage is more on the amount of capital invested and less so on equity stake. Keep in mind that going over 20% may create excessive dilution for the founding teams since the start-up will likely go through further fundraising rounds (Series A, B, etc) in the future. 

As such, you want to stay within the 10-20% range to keep your earliest investors and founders incentivized and aligned to the company. Moreover, at this stage you will negotiate investment based on near-future valuation of your business, meaning that your (angel) investors must demonstrate how they will add value to your company (i.e., mentorship, networking, etc) when setting up a deal.

Stage 3 – Seed & Series A Stage 

At this stage, it is common for early-stage VCs and larger angels to get involved. Unlike Stage 2, the focus in Stage 3 is on the equity stake and the negotiation centres around the amount of capital invested. By this point, VCs already have an ideal equity percentage in mind when approaching the negotiation table. 

However, the typical range falls between 15-35% with an average stake of 25%. Keep in mind that the VCs are thinking of the future valuation of the company, especially in the context of an exit. To maximize the amount of capital you raise from investors at this stage, make sure that you demonstrate solid KPIs, a clear product roadmap, and promising growth outlook.

Stage 4 – Series B & Series C Stage

The kind of investors who inject capital at this point are growth and later-stage VCs with a particular focus on achieving larger scale. Valuation is the key focus at this stage and your target range should fall between 10-20% with an average stake of 15%. Investors will pay close attention to your track record and benchmark it against industry peers and competitors. 

Many start-ups don’t reach the Series B or Series C stage as these are more comprehensive and raise larger amounts of capital. As a start-up, you should expect VC investors to prolong the deal cycle as the due diligence is extensive. 

Stage 5 – Series D, Series E & Series F

Valuation remains the focus in these later fundraising rounds. Any start-up at this stage will typically have a high valuation and seek a large round of investment. However, the amount invested by investors is primarily determined by the start-up/company. The reason for this is that investors trust that the company knows what it needs based on its current valuation, performance, and outlook. 

For this reason, investors will want to know exactly how much equity they will get which is why valuation will be focused. The target range for these later stages can fall anywhere between 5-15% with an average of 10%. 

Stage 6 – Pre-IPO Funding Stage

As the name may suggest, the Pre-IPO funding is usually the precursor to a major exit or liquidation event, like an IPO. The reason why companies take on this last funding round is because they want the extra cash to maximize their valuation prior to going public. In this sense, this type of fundraising is more like mezzanine finance than earlier-stage equity plays focused on building ownership. 

To that end, the company will likely minimize the equity stake for these last-call investors going no higher than a 5% maximum. The reason for this lower percentage is because the company will likely offer a bigger stake in the public markets once it goes public, ranging anywhere from 15-25%. As such, the company will want to preserve as much of its stake in this final fundraising round.