How Much Ownership do Angels Require?

June 1 2010 one Commented

How Much Ownership do Angels Require?

A frequent question from entrepreneurs is “how much ownership do angels expect to purchase with their investment in my start-up venture?”

First, a reminder:  Angels are investors, not bankers.  So, in most cases angels purchase equity in new ventures, and are not lending funds to entrepreneurs, in anticipation that the debt will be repaid over time.  We angels typically expect to sell our ownership in start-up businesses in the same transaction and at the same time that entrepreneurs sell the company.

Angels usually expect to purchase 20-40% of the equity of a firm with an investment of $200,000 to $1 million.  Agreed…these are rather wide ranges.  What determines how much equity an investor purchases?  The more milestones the entrepreneur has met prior to angel investment, the lower the percentage purchased by the investor – milestones such as patents issues, prototypes completed, customer validation, first revenues, reduction of cash burn via earnings, etc.  Let me provide a couple of examples:

  • A software entrepreneur completes beta testing of the product and achieves revenues with local customers.  The company quickly achieves breakeven cash flow with these revenues.  But, the entrepreneur needs to raise $200,000 to enter new offshore markets.  In this case, the entrepreneur has eliminated substantial risk in the venture by hitting several important milestones.  In this case, $200,000 from investors will likely purchase 20% (or a bit less) of this software venture.
  • An electronic component manufacturer uses rapid prototyping techniques to provide prototypes to potential customers, who indicate substantial interest in the product.  The entrepreneur recognizes injection molding is the only appropriate manufacturing technique for high volume production of this complex device.  Unfortunately, the price for an injection molding die to produce this component is estimated to cost $400,000.  Furthermore, the entrepreneur estimates sales and marketing startup costs at $200,000.  Since the manufacturing/technology risk has not been removed for this company, the $600,000 in angel investment is likely to purchase as much as 40% of the company.

 

As we have discussed previously, startup ventures are often valued at less than $1 million in today’s market.  A typical investment then, might be $400,000 in a company valued at $800,000, purchasing 1/3 (33.3%) of the company – mid-range to our discussions above. 

It’s a GREAT time to be an angel.  Find a group and jump in!

Bill Payne is the 2010 BNZ University of Auckland Business School Entrepreneur In Residence. www.billpayne.com

One Response to “How Much Ownership do Angels Require?”

  1. Vision says:

    Yesterday I thought that this would happen… Thanks a lot for sharing.