Ask HN: Are we giving away too much equity? | Hacker News Reader

Ask HN: Are we giving away too much equity?

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My (non-technical) co-founder, let's call him Mike, and I have been working on a startup for about a year now. I developed a pretty solid MVP last summer and we now have about 15 customers who have brought in approximately 50 users each that use our product as well. We started making a little bit of money through affiliate marketing, but have several revenue generating options planned for the future. Our business is somewhat seasonal, and the money we've made so far has been made in an off-season. But we see huge potential for growth and exponential increase in revenue as we get more customers.

We've been looking for angel investors to get us going, and through an acquaintance Mike found a group of 5 friends willing to invest. Unfortunately, Mike and I live in different cities (he's in SoCal, I'm in NorCal), so I wasn't there to pitch the investors. Anyways, they agreed to give us $100k for a 45% stake in our company. Originally we wanted to bring on a partner who would give us $80k for 33%, but the potential partner was dragging his feet too long so Mike approached this group of friends instead.

I was super excited to hear that we would get $100k, so I didn't say anything right away (which was probably stupid on my end), but 2-3 weeks have now passed and I'm starting to wonder if we're giving away too much equity. It's not that I am being greedy all of a sudden, but rather I'm worried that Mike and I would be left with 55% and if we needed/wanted to raise VC money later we would get diluted so much that we'd lose control of our company. On the other hand, it may be too late to convince the angels to give us 70k for 30% (though we haven't signed any agreements yet), because they would think we can't make up our minds (Mike had pitched them for 100k). Mike doesn't share this concern with me and he would rather have the extra 30k as a buffer, but if I insisted he would talk to the angels and see if they would be ok with the new terms (though that could hurt our credibility and they could change their minds entirely).

Do you think we're giving away too much equity? Should I insist on changing the terms? Or should I just let it go and worry about it later (if we ever even get to a point where we'd have to worry about it)?

Your advice is highly appreciated!

First off, congratulations on being funded, but a number of red flags popped into my head when I was reading your information, and the number you received for funding.

1. Did you have positive sales/user traction? 2. Is your product B2B? 3. Do you feel there are a number of products like yours already in the market that isn't big? 4. Was there a true need to involve investors that you couldn't make up in sales?

In my honest opinion, I think you gave away too much equity. 45% is a lot for only 100K, and with ideals for growth in mind as well. That means you increase your revenue exponentially to offset the need for additional funding in the future, or hope for the next round of investing that investors only want a small chunk. Slightly doubtful once they look at how much you initially gave up.

Thanks for your input. To answer your questions:

1. The money we've made so far is through affiliate links, because at this point we offer our product for free. We'll have a freemium service later on once we develop our premium features. The money we've made in one month so far is quite negligible, but it shows that we have potential to make a lot more once we get more customers.

2. Our product is not B2B. We're focusing on users in the higher education market.

3. Our product is not unique, but we've executed very well and offer a much better user experience than our big competitors. We are also trying to appeal to a different demographic than our competitors.

4. Unfortunately, yes. The money we've made so far is too low to pay for anything and it really just showed us that we CAN make money from this. We need the investment mostly to spend on marketing and scalability, and my co-founder would have rather not taken out a second mortgage.

While the valuation question is definitely important, there are a lot of other considerations when it comes to an angel investment. For example, what are the other terms of the deal? Is it for common stock or preferred? Even more importantly, with such a large equity stake by angels, it's important that you and your partner believe that the angels add far more value than just money. Do they have any connections and or experience in what you're doing so that they might add more value to the business. Will they be able to make meaningful introductions to follow-on funders? Are they capable of doing a follow-on round themselves, ideally at a higher valuation? In short, your question is hard to answer in isolation from these other considerations. I hope you find this helpful.

Thank you for your insights, that is indeed helpful.

$100k for 45% means that they value your company at $222k. $70k for 30% means they value your company at $233k. Your $80k for 33% investor valued your company at $250k.

YC puts roughly $20k for 8-10% giving a rough valuation of $200k-$250k.

I'll leave you to your own devices to figure out whether those percentages sound good.

To decrease the %, you would have to convince them to value your company for more than the ~$225k range they appear to have settled on.

You can negotiate and ask for a larger valuation, but, you risk losing the investment. Once you receive the investment, what happens to your risk? You get a salary for 6-12 months and they potentially could get $0 at the end.

I'm less worried about the valuation, but rather about the percentage my co-founder and I would own. I think we could get by with 70k, even if we had to give the angels 35% for it, but my co-founder likes that extra 30k just to make sure we have enough for a while.

You're right, we could renegotiate and risk losing the entire investment. I'm torn whether it's worth that risk. However, we would not get a salary from this investment. Our risk is the opportunity cost we invest through our time building the company, while the angels risk their investment.

Valuation is precisely what tells you how much the cash they have handed you is worth in terms of % in your company.

If you negotiate the company is worth $500k rather than $225k, their $100k becomes 20% rather than 45%. You get the same cash, you've just diluted your company less, allowing more room for your series A, B, C and successive rounds.

If you don't need the cash, are you trying to get an investment too early? Does $100k materially speed things up past your competition? If you've had two parties willing to invest already, would bootstrapping and building your valuation up put you in a stronger position? A few months building, getting more traction, establishing the business, working out monetization and getting a firmer plan of what you'll use the investment for might be a good 'breather'.

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