Paying a consultant to raise money for your startup

Besim wrote:

A consultant has offered to find an investment of $1 million for my startup. As a reward he is asking for an option expiring in five years to subscribe at par value for ordinary shares representing 5% of the capital of the company.  What does this mean?  Should this option be exercised, how much will I receive for 5% of the company considering that post money valuation would be $4 million.  However, current issued shere capital is 100 shares at $1 each.

The "Par Value" of a share of stock has nothing to do with the actual market value of the stock.  Par value refers to a price per share that is setup in the corporate charter, and it is usually near zero, often less than $0.01/share.  What he is asking for, I suspect, is an option to acquire the stock for, effectively, zero dollars.

 

It's unclear to me whether he is asking for 5% of the company, or if he is asking for 5% of the shares that are received from the $1 million investment.  I hope, and suspect, it's the latter.  It would be a typical arrangement for someone acting in this capactity to receive a commission on the money they helped to secure, and 5% is a pretty typical ask for the size of the investment you are looking for.

Sometimes they want to be paid in cash from the proceedes of the financing, meaning that if you raise $1 million, you would pay the finder 5%, or $50,000 when the financing is complete.  In your case, and in the case of many startups, that $50,000 is a lot of money that you were hoping to have put into the business, and so rather than pay $50,000 cash, I would rather you conver that to additional equity.  I believe this is what he is suggesting.

However, there may be no reason to structure this an an option.  More on that below.  I suggest you structure as follows:

The new investor(s) will purchase $1M worth of your stock at a price you mutually agree to.  It sounds like you are looking for $4M post-money which means they will be buying stock at price equal to $3M divided by the number of shares you currently have.  This gives you a price per share, indicating that your company is worth $3M today, then they will add $1M in cash, thus you will be worth $4M "post money" or after the investment.  I will point out that the $3M pre-money valuation is up for negotiation, but lets assume for now that this is the price.  

Also lets assume that you have 1 million shares of stock today.  This means your current price-per-share is ($3M pre-money valuation) / (1 million shares) = $3 per share.

The new investors will invest $1M, and they will be issued newly created shares.  Thus, their $1M dollars buys them 333,333 shares at a price of $3 per share.  Once issued, your company will now have 1,333,333 shares issued and outstanding, at a price of $3 per share, giving you a post money valuation of $4M.

What I suggest is that the agent who finds you the money be issued shares at this time, equal to 5% of the amount of money they helped to raise.   Issuing an exipring stock option seems compeletely unnecessary to me.  Thus, the agent should receive (5% * $1M) = $50,000 worth of shares at $3 per share = 16,667 shares.  
This then would give your company a total of 1,350,000 shares of stock, valued at $3 each, for a total post money of $4.05M.  You will receive $1M in capital to grow your business, the new investors bought 24.7% of the company, the agent would receive $50,000 worth of stock as valued at the price set by the investors.

I suspect that the reason the agent is looking for an option has to do with taxes.  The detail here depends on the tax structure wherever you live, and they don't want to pay taxes on the $50,000.  There are a number of options likely available to you, and you should have your attorneys draw up the right arrangement.  It could be that you pay some of that $50,000 in cash, such that they can pay the tax bill, or it could be that his shares are valued as common stock like yours (and thus have a market value far less than the preferred stock purchased by the investors), or it could be that the stock option is the best way to go.   

Again, the suggestion of the option is likely around taxes and there could be different paths available to deal with that.  In the end I would prefer that there be no lingering option because the cleaner you can keep your capitalization table, the better.  Work with your attorneys to find the best answer here, or at least reach an agreement with your agent that as a part of the closing of the financing, your attorneys will draw up language that makes everyone happy.

Can I sell stock before I've started making money?

Marco wrote:

I have a newly started honey farm that has very good prospects... It will take 3-6 months to realize our first profits because honey is seasonal, but we have lines of outlets agreed to buy our unique jamaican honey. Can I issue some shares now and collect a pool of funds from their sale, even though I have yet to make a sale? How freely can I use the funds?

Hi Marco.  Absolutely you can.  There have been thousands of companies which raised money and never got their products to market at all.  Obviously that's not your goal, but investing is risky and early stage investing is particularly risky.  Any investor putting money into your company should be well aware of this and it's expected.

As far as how you can use the funds, this will be determined by the investment agreement between you and your investors.  Generally these agreements will be very open and you can use the funds for any business purpose, but again, it's all in the specifics of that agreement.  You will want to consult with a lawyer on drawing up these agreements and complying with any securities laws in your area.

For your pariticular business, it may be possible to get a line of credit from a bank based on committed sales.  If you have customers committed to buying, then those commitments can sometimes be leveraged into bank financing especially with seasonal businesses.  If you do talk to a bank, be sure you have spent the time to put together a solid business plan, pitch, and financial projections.  Looking professional and prepared will go a long way.

Starting a company with no money

Paul wrote:

I'm trying to start a company with no funds of my own to speak of. My idea is sound and planned out for success but I have no money to my name... I have looked into government grants and it seems more likely to get money to put internet through the Congo than to receive funds to start a new business venture. I’m at a loss for where to go next and how to provide the early funding to get an investor or a loan to start my business. 

Hi Paul.  Unfortuantely there is no straight-forward answer to this because it depends on many factors unique to the business.  If you need money to buy inventory, equipment, facilities -- things with capital value -- then you could potentially get a bank loan, perhaps an SBA loan.  If you need money for operating capital, advertising, payroll, etc, then you need to look at getting equity financing (and sure, if you find a grant proposal you'd be a fit for, give it a shot, but you are correct in thinking that you need to look elsewhere).

Assuming that your capital need is not bank-fundable, then it depends on how much you are looking to raise and what the business model is.  If you needs millions, and you have a business model that supports it, you might look to venture capital.  If you need less, then you might look to angel financing -- or put another way, look to wealthy individuals.  

To find a list of wealthy individuals you need to network, ask around, make calls, get referrals, etc.  There's a lot of legwork invovled and it will take some time.  But this is the only way to do it -- don't expect to make any meaningful progress poking around on the interent for a list of angel investors.  Go to your local chamber of commerce meetings, see if there are any startup groups in your area, and just keep checking and asking, checking and asking.  Great investors might come from successful people in a related area to your business.  Asking doctors to be funders for a new medical device or medically oriented software/website business, for example.  

When you do compile a list, you need to be prepared to take them through your vision and pitch.  There's a lot of content written about this on this site already, and if you are serious you should look at the 8 slide investor pitch book I published earlier this year.  Those who invest will invest in you and your passion and your story.  The only way to convey that to them is to get out there, track them down, and ask them to listen.

Best of luck to you.

How much stock do I give a first investor?

Anna Wrote:

I am staring a fashion label specializing in high end womenswear, my line has a certain vision and is holistically represented, the designs and samples are ready, I have great reviews from industry professionals, my work has been featured in a few fashion magazines... I am now looking for investors ... Bank loan is not an option for me ... I need 50,000 GBP (pounds) at the moment and I don't know how much share to offer the investor? How much is too much?

Fortunately or unfortunately, there is no real formula or science behind this.  You will be selling stock in your company, and stock in your company is worth whatever the market is willing to pay, just like for a public company.  This is driven by things that make numerical sense, like revenues, future revenues and market size.  However, it's also, and very heavily, influenced by simple supply and demand.  The more people interested in investing, the higher the price of the stock -- in your case meaning you would sell less stock to get the same 50,000 GBP.

The demand for the stock goes up because of excitement and scarcity.  You have to get investors excited, and those investors need to be worried about other investors coming in and taking the deal away from them.

Many times I've seen companies try to raise money in a sort of one-off, ad hoc way, meaning that they find a potential investor, work with them only, and then try to strike a deal.  This is a mistake.  If a potential investor knows that they are the only one in the game there is no pressure for them to get done quickly or at a price you'd like.  To combat this, I suggest you dedicate yourself to a concerted effort to reach out to poential investors, starting first by making a contact list, networking, gathering names, etc.  Then reach out to them all at once, explaining the investment opportunity and letting them know that others are all starting to look at this potential investment at the same time.  Then try to keep the interested ones moving at about the same pace with a clear end-date in mind you can drive them toward a go/no-go decision.

If you haven't already, you should check out my book on the 8-slide investor pitch as this will outline the storytelling aspect of presenting your business concept to a potential investor.  Between now and the time you are ready to do that, you should be gathering names and working on your pitch.  Then when you start, you dedicate yourself fully to the fund raising effort until you have it completed.

I hope this helps.  Best of luck to you with what sounds like a promising business. 

Raising capital, search results, and is Google leading you astray?

I was just cleaning up a few old questions out of my McStartup inbox.  I reply to a lot more questions via direct email than I post on the site here, mostly because I get a lot of repeat questions.  I was laughing at myself in doing so because creating content which never goes online is a really lousy search engine strategy -- but it takes less time.  

I was talking to my friend and neighbor Jim Cockrum, a well known internet marketeter, about "SEO" stuff and we both are in complete agreement that an "SEO" strategy is really a "produce good content people want to read" strategy -- any "optimization" designed to trick the search engines is just one Google tweak away from being banished to the bottom of the pile.

This site is no exception.  I do zero SEO optimation, yet there are a few keyword searches for which McStartup will come up at or near the top of the list.  Maybe it's luck, but I'm assuming it's because I'm producing real content that isn't some kind of Google trickery, and the search algorithms are getting sophisticated enough so that the real content gets promoted past the spam content. 

While thinking about this, I did a quick search for "raising capital" to see what came up.  I was very surprised to see the top result was an article from a company which "takes small companies public" as a means of raising capital (supposedly).  This is surprising to me.  While going public is a means of raising capital, it's far from the easiest or most common way to get funding.  Certainly, most young businesses are in no position to even try to go public, no matter what this company might claim.

As such, I find it hard to believe that this particular article, the number one search result on Google, is so popular that Google must make it #1?  Very odd.  The danger here, in my opinion, is that in searching the phrase "raising capital" and then in seeing "let us take you public" as the theme of the number one result, it leads the uninitiated entrepreneur to think IPO is a real funding option for a small business.  I can envision a rat-hole of time and expense which gets the fledgling business nowhere. 

Most businesses need angel financing, venture capital, or bank financing to get started.  The art of raising capital is what my little book is all about. No where in it will you find a reference to making an IPO pitch to investment bankers.  Certainly this is a way to raise capital, but it's not the path a new business should go down.  

So strange to me that a link about tiny IPOs comes up ahead of things like venture capital.  There are thousands of articles about raising venture capital on the internet.  Likewise for angel funding, or bank financing.  How does this IPO method (dare I say, "scheme") come up first?  

Perhaps the search algorithms still have a long way to go.  Nevertheless, I believe good content is king. 

On the chance that you've come upon McStartup looking for info on raising capital, I'd suggest you take my book, The 8 Slide Investor Pitch for a test-drive.  And even if you don't, then please put the concept of this small time IPOs out of your head.  I've never seen one "work" and I hate to see people led that direction. 

Jeff