Buying equity in a business, for dummies
Discussion
A company has an estimated value of £2m based on 10x EBITDA, which is typical of the industry. P&L is clean, I know the business and the people.
Company intends to raise funds (£m) over the next few months to invest in future growth. It's an exciting proposition that I'm interested in. I've been asked if I'm interested in a much smaller scale (sub 100k).
Let's say I wanted 2.5% of the business and agree the £2m valuation, I should expect to pay £50k, we shake hands and paper it all up. Company will hope to sell to PE within 5 years so I will forget about it until then (though will be as active as required).
What happens when the business then fundraises and injects another million or two? Is my 5% diluted (but still worth 50k as theoretically company valuation has increased).
Is it better to get in before the big investors or after?
I've only ever been given share options (with conditions), so all new to me. Would appreciate some tips on questions to ask etc
Company intends to raise funds (£m) over the next few months to invest in future growth. It's an exciting proposition that I'm interested in. I've been asked if I'm interested in a much smaller scale (sub 100k).
Let's say I wanted 2.5% of the business and agree the £2m valuation, I should expect to pay £50k, we shake hands and paper it all up. Company will hope to sell to PE within 5 years so I will forget about it until then (though will be as active as required).
What happens when the business then fundraises and injects another million or two? Is my 5% diluted (but still worth 50k as theoretically company valuation has increased).
Is it better to get in before the big investors or after?
I've only ever been given share options (with conditions), so all new to me. Would appreciate some tips on questions to ask etc
a lot depends on how investments take place...
at its simplest, a company worth £2million with 100 shares, each share will be worth £20,000 - to invest £100k you hand over the cash, they give you 5 shares.
However, all shares are not identical, there are different classes of share (so for example, one class may get a better dividend than another), some shares might not have voting rights, while others do, some shares may have preferential rights. Then there can also be shareholders agreements - commonly setup where there is investment, which can protect one class from dilution, can give a class of shares pull or push rights (i.e. if they sell their shares they can force others to sell them as well) etc. etc. It can get quite complicated...
I would take advice...
at its simplest, a company worth £2million with 100 shares, each share will be worth £20,000 - to invest £100k you hand over the cash, they give you 5 shares.
However, all shares are not identical, there are different classes of share (so for example, one class may get a better dividend than another), some shares might not have voting rights, while others do, some shares may have preferential rights. Then there can also be shareholders agreements - commonly setup where there is investment, which can protect one class from dilution, can give a class of shares pull or push rights (i.e. if they sell their shares they can force others to sell them as well) etc. etc. It can get quite complicated...
I would take advice...
Roughly, all down to the number of shares......
If the number of shares goes up, you will be diluted. If they stay the same then you still own x% of the business.
If the value of the business goes up, your shares are worth more, and if it goes down, you loose.
The board will generally be allowed to dilute to a certain level without asking the shareholders, otherwise it has to go to a general meeting.
If the number of shares goes up, you will be diluted. If they stay the same then you still own x% of the business.
If the value of the business goes up, your shares are worth more, and if it goes down, you loose.
The board will generally be allowed to dilute to a certain level without asking the shareholders, otherwise it has to go to a general meeting.
B9 said:
Company will hope to sell to PE within 5 years so I will forget about it until then (though will be as active as required).
What happens when the business then fundraises and injects another million or two? Is my 5% diluted (but still worth 50k as theoretically company valuation has increased).
Is it better to get in before the big investors or after?
Several general observations:What happens when the business then fundraises and injects another million or two? Is my 5% diluted (but still worth 50k as theoretically company valuation has increased).
Is it better to get in before the big investors or after?
Start with the business and the people that you know. Ideally you want to like them, but above all you need to be able to trust that they can deliver. Don't get likeability and competence mixed up! Ask a reasonable number of sensible questions.
It is not easy to get a PE sale. Make sure you diligence their ability to deliver whatever PE wants/expects to see for that sector. It could range from being a start-up with credible plans, through a fast growing business beating its peers, to already being a well formed, well run, mature business. Different things appeal to different PE houses and in different sectors.
Of course, PE is not the only (and perhaps not necessarily the most likely) exit. Worth thinking through what other options there might be in the event that PE isn't interested. MBO or trade sale would not be uncommon around that sort of business valuation (or higher).
Make sure you know who is going to get it from where it is now to your expected exit. Are incentives aligned? Are they fully committed/locked in?
You're right to see dilution as a concern. Will they need further money? Will they need to bring in/equity incentivise more staff? If so, expect dilution...
As for before vs after... with the sorts of sums you mention, you probably don't have an option to get in after PE.
The other biggie, is of course to risk weight you investment vs expected returns. Some investors will like the prospect of growth but not actually be able to tolerate much downside. Others might prefer to back 10 horses in search of a 100x winner (but be prepared to lose the lot). Check that this one fits your appetite on both sides.
Oh, and read the shareholders agreement carefully, ideally taking advice. You don't want to find yourself in a situation where you're trapped.
B9 said:
A company has an estimated value of £2m based on 10x EBITDA, which is typical of the industry. P&L is clean, I know the business and the people.
Company intends to raise funds (£m) over the next few months to invest in future growth. It's an exciting proposition that I'm interested in. I've been asked if I'm interested in a much smaller scale (sub 100k).
Let's say I wanted 2.5% of the business and agree the £2m valuation, I should expect to pay £50k, we shake hands and paper it all up. Company will hope to sell to PE within 5 years so I will forget about it until then (though will be as active as required).
What happens when the business then fundraises and injects another million or two? Is my 5% diluted (but still worth 50k as theoretically company valuation has increased).
Is it better to get in before the big investors or after?
I've only ever been given share options (with conditions), so all new to me. Would appreciate some tips on questions to ask etc
Do you have a day-to-day role in this company or is this just an investment opportunity? Small shareholders will generally not be involved in the business at all.Company intends to raise funds (£m) over the next few months to invest in future growth. It's an exciting proposition that I'm interested in. I've been asked if I'm interested in a much smaller scale (sub 100k).
Let's say I wanted 2.5% of the business and agree the £2m valuation, I should expect to pay £50k, we shake hands and paper it all up. Company will hope to sell to PE within 5 years so I will forget about it until then (though will be as active as required).
What happens when the business then fundraises and injects another million or two? Is my 5% diluted (but still worth 50k as theoretically company valuation has increased).
Is it better to get in before the big investors or after?
I've only ever been given share options (with conditions), so all new to me. Would appreciate some tips on questions to ask etc
If the company valuation increases, so too does your 2.5% - your investment is pegged to the shares you own, not the amount you put in. I'd be very wary of making this investment without advice given your basic knowledge.
Is anybody exiting using the funds being raised or are they creating more shares which you will then buy? Are all new investors investing at the same £/share or is there a discount for bigger tickets?
You'll generally only be allowed to invest alongside others, so in this fundraising round or the next, but if the business has made waves between this one and the next, the next round may all get swallowed up by a big investor or investors and you might not get the chance, generally the earlier the investment, the more chance or smaller players getting in (but the more risky it is).
Re dilution, the way this works (simplifying by setting aside complexities of different share classes etc) is that your %age holding goes down when new shareholders come in, but the total value of your equity stays exactly the same. This is because whilst more shares are issued, they are being bought at exactly the current share price, so the value of the existing shares stays exactly the same.
Of course the logic is that the injection of capital means the company can do new things and grow, the prospect and reality of which should raise the share price and value of holding for all the shareholders. But the act of issuing shares is only dilutive of %age, which really just matters for voting. What matters for the value of your stake is the number of shares and share price, not %age.
Of course the logic is that the injection of capital means the company can do new things and grow, the prospect and reality of which should raise the share price and value of holding for all the shareholders. But the act of issuing shares is only dilutive of %age, which really just matters for voting. What matters for the value of your stake is the number of shares and share price, not %age.
Once you invest it’s worth nothing until someone buys it off you and you’ll have little control of what happens in between these two experiences.. Therefore unless you have a pretty assured route and timescale to exit consider very carefully whether this is the best type of investment for you. Also be prepared to write it off. Explore the comparable gains of investing elsewhere too where you can readily withdraw your cash if required.
Thanks all, a few answers to questions!
I know the CEO and would consider him a friend. I worked for him many moons ago, he's successfully built and sold a few businesses (a couple to PE). He has a clear timeframe, which is a bit of a rinse and repeat of previous ventures.
I won't be working for him in this business. I'll introduce him to people who can help build a function I specialise in, along with advise - All pro-bono. I have options in the company I currently work for who will also be looking to roll-up within 24 months. I'll review options thereafter, but would be taking quite a risk as PAYE is ultimately what covers the bills.
In answer to where they'll be coming from - he's offered to transfer the percentage from his holding as this won't cause any issues with other shareholders.
All makes sense ref dilution, and that £ means more than %. Perhaps I'm focussing too much on ego of owning x%.
Ref timeframes and risk - Feels less risky than what I've put into crypto, and I'd have a little more visibility/control (albeit very very little) in comparison!
I know the CEO and would consider him a friend. I worked for him many moons ago, he's successfully built and sold a few businesses (a couple to PE). He has a clear timeframe, which is a bit of a rinse and repeat of previous ventures.
I won't be working for him in this business. I'll introduce him to people who can help build a function I specialise in, along with advise - All pro-bono. I have options in the company I currently work for who will also be looking to roll-up within 24 months. I'll review options thereafter, but would be taking quite a risk as PAYE is ultimately what covers the bills.
In answer to where they'll be coming from - he's offered to transfer the percentage from his holding as this won't cause any issues with other shareholders.
All makes sense ref dilution, and that £ means more than %. Perhaps I'm focussing too much on ego of owning x%.
Ref timeframes and risk - Feels less risky than what I've put into crypto, and I'd have a little more visibility/control (albeit very very little) in comparison!
I'm confused, is he raising funds, in which case all shareholders would be in agreement, or is he selling his shares to you and reducing the % he owns?
Why are you doing pro bono work to increase the value of his business? If your advice and contacts are worth paying for, he should either be giving you shares for free, or paying you for it - you're helping him to increase the value of his business.
Why are you doing pro bono work to increase the value of his business? If your advice and contacts are worth paying for, he should either be giving you shares for free, or paying you for it - you're helping him to increase the value of his business.
B9 said:
Ref timeframes and risk - Feels less risky than what I've put into crypto, and I'd have a little more visibility/control (albeit very very little) in comparison!
… but in exchange, no public mark to market, and a very illiquid investment. As others have said, time shouldn’t usually be given for free.
If friends are involved, what’s worth more to you, the money or the friendship?
B9 said:
...he's offered to transfer the percentage from his holding as this won't cause any issues with other shareholders...
That raises big red flags.You generally want the interests of employees and shareholders to be in alignment so that the better the company does, the greater the value to shareholders. That the CEO is offering to sell you his own shares suggests the opposite.
If he is also looking to sell shares to friends without other shareholders knowing it, it suggests potential bigger problems with him and/or the company.
Remember that he might be having similar conversations with other friends to sell his entire shareholding!
Ideally walk away. Or do a lot more homework / due diligence before you consider proceeding with this.
B9 said:
...he's offered to transfer the percentage from his holding as this won't cause any issues with other shareholders...
That raises big red flags.You generally want the interests of employees and shareholders to be in alignment so that the better the company does, the greater the value to shareholders. That the CEO is offering to sell you his own shares suggests the opposite.
If he is also looking to sell shares to friends without other shareholders knowing it, it suggests potential bigger problems with him and/or the company.
Remember that he might be having similar conversations with other friends to sell his entire shareholding!
Ideally walk away. Or do a lot more homework / due diligence before you consider proceeding with this.
sideways sid said:
You generally want the interests of employees and shareholders to be in alignment so that the better the company does, the greater the value to shareholders. That the CEO is offering to sell you his own shares suggests the opposite.
Or it could be benign. He might just need a bit of cash.The question I’d be asking is “why are you wanting to sell now, instead of waiting for the (presumably higher) valuation when others come in?”.
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