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Financial Adviser: How to raise funds by selling equity

Know the factors you need to consider in selling shares to outsiders.
By Henry Ong |



Q: I‘m looking to raise funds for my startup. I needed the additional funding for liquidity as cash flows have been very tight lately. I was able to talk to some angel investors, but they’re asking for 40% of the business. I’m not sure if the offer is reasonable, but I need some guidance in my decision-making. What are the factors I need to consider in selling my shares to outsiders? – John Christopher, by email

 


A: If your intention is to raise cash to boost your working capital, you may choose to borrow money from relatives and friends who can help you finance on a short-term basis. But if your plan is something that will require long-term resources—such as hiring more people, setting up new offices, and investing in high-end computers—then you may have to raise funds by selling equity rather than borrowing.

 

 

Risks and benefits
Raising capital by selling shares allows you to match your long-term financing needs by sharing the risks with other investors, without draining your cash flows regularly from paying interest and debt obligations.

 

But having outside investors as shareholders in your company also means that you will have a partner in the business who may not necessarily understand your operations or your industry. You may need to get approval from your shareholders for all your major decisions, which may affect the future of your company.

 

But having partners can be helpful too, as they can be your sounding board when you want an idea to be evaluated. They can also help promote your business and refer valuable clients to you. You can tap into their networks and leverage on their contacts to negotiate for better deals. Getting business partners as your financial investors must not only be about money but also about strategy, considering the overall business synergy that they can provide you.

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Giving up ownership

If you are ready to get investors, the first thing you need to decide on is the percentage of ownership in your company you are willing to sell. The larger the ownership you give up, the less control you will have in your company.

 

Ideally, the maximum ownership you can sell to outside investors is 33%, because the remaining 67% will still enable you to have absolute control. When you have absolute control, you can still do anything in the business, including selling some assets and investing in a new venture, for example, without necessarily getting approval from your investors.

 

 

How much to sell
The next question is: how much do you want to sell your shares to outside investors? The amount of money you need to raise from investors is relative to the amount of shares you are willing to sell and the valuation of your company. The higher the valuation, the less amount of ownership you may have to give up. If your valuation is low, you may have to sell a bigger stake in your company in order to raise the same amount of money you need.

 

 

Valuing your company
For some people, valuation is simply the net worth of the company, which is computed by adding all the assets of the company at book value minus all liabilities. But, if you follow this, you may not be able to raise the money you need because your valuation will definitely be low.

 

The other way is to value your company based on its ability to generate cash flows in the future. Normally, you will need its historical earnings data for the past many years in order to project your future cash flows. The higher your future cash flows, the higher your valuation. But this may be difficult for you because your company is just a startup with less than one year of operations. It will be difficult for you to convince your investors that you have a solid track record of earnings to make your forecast highly reliable.

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So, how do you support this? Remember that the most important asset in your company is not your office or your expensive laptop or anything that you can find in your balance sheet; it is your people and yourself.

 

When you value your company, you need to sell your ability to manage the business, your experience, your knowledge, your managerial skills, and your passion to succeed. You need to convince your investors that you and your team can bring the business to higher levels given the opportunity to expand. How you convince your investors with your ability to lead the business will support the credibility of your financial forecasts.

 

 

Accepting an offer
Before you accept any investment offers from the outside, it is important that you already have an idea of the worth of your company. It may not be accurate, but this will definitely help you in the negotiation. The final offer can turn out to be higher than what you have estimated, which could mean that they like you so much that they are willing to pay a premium. Or, it can be lower, which could mean that they may only need your business for their own convenience. Either way, having an idea of how much your business is worth can help you in decision-making.



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Henry Ong, CMC, is president of Business Sense Financial Advisors. You can follow him at @henryong888 or email hong[at]businesssense.com.ph

 

Photos from Thinkstock


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