One problem founders and startups have is deciding what their company or startup is worth and how much of it they are willing to give up. In deciding how much equity companies should give up at the seed round and at whatever round in the growth of a company, there are a couple of things that you must consider.
A little mistake or an oversight can cost one a significant percentage of their company, and there won’t be a judicial process to help retrieve that share of the company.
It is crucial to be armed with the right knowledge of the company shares you are willing to let go of or comfortable without. The issue of equity arises when founders need to raise money fast, provide a valuation for their company, and sell a portion of the company’s shares to anyone willing to buy them.
This attempt at raising money is so that the company gets the funding it desires to move to the next phase of its development – only it is giving up its shares and allowing members of the general public to own a portion of the company.
Understanding the right amount for your company to give up at the seed round is quintessential to avoiding the woes of not completely controlling your company’s finances when the company scales. In this article, you will find all there is to know about how much equity companies should give up in seed rounds. Before going into the main point of this article, it is important to understand what equity and seed round means.
Mathematical Calculation to Determine How Much Equity to Give Up in Seed Round
Let’s assume that the pre-money valuation for your company is 250,000 naira, and the amount of money you want to raise during the seed round is 750,000 naira. Hence,
Pre-money (250,000) + seed round (1,000,000) = 1,250,000 post-money
Equity to investors = seed round/post-money that is 1,000,000/1,250,000 = 0.8%
The equity to someone who invests 250,000 naira would be ¼ of 0.8% = 0.2%.
This is an example of how you should calculate the amount of equity to give up in the seed round.
What is Equity?
Equity is the monetary value returned to a company’s investors, assuming all the resources were exchanged and the company’s debt obligations were paid off. It is the level of leftover proprietorship in an organization or resource after all obligations have been deducted. With equity, we are talking about the shareholder’s stake in a company, which is reflected on the company’s balance sheet.
What is a seed round?
A seed round, or seed funding, is the first official funding stage in a company’s lifecycle. During the seed round, the company raises the first set of funding for their business. In some cases, the money generated during this round is enough to get the company to a position where it can scale without external support. However, some companies opt for Series A, B, and C funding rounds after the seed round before they can scale.
It is essential to note that there is a funding round called the “pre-seed” round. Here, the funding comes in the early months of a startup, so it is not considered an official funding round. This round of funding sometimes occurs before the business is established. It is often carried out by the company’s founders and some of their friends.
Knowing what equity and seed round mean, let’s delve into details about how much equity a company should give up at a seed round.
How Much Equity Should Companies Give Up in a Seed Round?
Typically, 10–20% of equity is advised by financial experts as the percentage of the equity to give up during a seed round. Anything above 30% may be too much.
The amount of equity a company should give up in a seed round should be based on a couple of factors, which include the amount of money the company is earning, the value of the company years from now, the sum you want to raise at the moment, and so on.
There is no one-size-fits-all when determining how much equity you should give up in a seed round. What works for a company in the finance industry may not work for another in the home improvement niche.
Each industry has its perks, and the team behind each company’s growth may have a different approach to its operations. One company may become a large corporation in less than 10 years, while the other may struggle for 20 years before they break through.
On this note, it is difficult to peg the amount of equity to be given up. However, there is a template every business and founder can use to determine how much they can give up. To determine how much equity your company should give up at the seed round, you should consider the following:
- How much does the business make at the moment
- How much do you expect the business to be valued over the next period
- How much do you need to raise to reach a meaningful milestone in your business
- How much of your company are you willing to let go of
These four points, if duly considered and followed with the right calculations, are effective in helping to determine what every business should do when they are trying to give up equity for seed rounds. Some experts advise against giving a percentage of equity during the seed round because your company may not have grown sustainably at that point.
Others believe that since you will be giving up percentage equity every time you request funding, it is better to wait until your business reaches the Series A funding round before attaching percentages to the equity you give up.
Nonetheless, if you want to go by that school of thought or not, you would still need to consider the four points aforementioned to know how to go about the equity you would give up in the seed round. There is a mathematical presentation I will share after we discuss the four points I listed above. It is an interesting walk-through.
How Much The Business is Making
This is not going to be difficult to figure out. When it comes to business and finance, where you are present determines where you will be in the next five, ten, twenty years, etc. Suppose people coming to invest in your business know you are making an average of 5000 naira monthly, and you plan to make 500,000 naira monthly by the 2nd quarter of next year. In that case, they will not bother investing in your business because you are probably not sure how growing a business works.
How much your business is making at the moment will determine your projection for the future and the amount of money you should raise for the seed round or any other funding round.
How Much is Your Company Valued and Your Expectations Over a Period
How much is your company’s pre-money valuation? A company’s pre-money valuation is how much it is worth before it goes public or receives any form of external funding. Alongside your pre-money valuation, you would need projections for your company.
What should your business be worth in the next one, two, five, or ten years? Everyone knows it can be too abstract to determine how much a company will be worth from its seed round. Still, with concise and factual projections, you can make anyone believe the company would be worth a certain amount within a timeframe.
You should back up your projections with facts and stats. It should be clear how your business and the team will hit that milestone in the shortest time possible. Understand that the post-money valuation you give significantly determines how much you should raise. If your projections are concise, failing to come up with an accurate seed funding amount will impede your company’s growth.
How Much Do You Need to Reach a Meaningful Milestone
Most founders are unaware of how much it would take to move their business from one point to another. This inability makes it difficult for them to scale their business, and even with funding from several quarters, they still cannot make the most out of them.
To answer the question of how much you need to reach a meaningful milestone in the lifecycle of your business, ask yourself what it would take in terms of human and financial resources to get your business to a point where it can thrive.
Let’s say you are starting a food supply company and need up to 100,000 customers to patronize your business to generate a convenient income. Your projections will be how much it would take to market our business to achieve this customer base, the burn rate, and the company’s capital needs before we hit that milestone.
Your COO should know how these numbers work if they seem confusing to you.
How Much of your company are you willing to let go of
Mark Zuckerberg of Meta owns 29.3% of the company’s Class A shares. Jeff Bezos of Amazon is estimated to own just around 10% of Amazon’s shares.
However, these two men are comfortably in the class of the top 10 richest men in the world despite having what could be seen as a small number of shares in their own companies. The goal is to figure out how much of your company you are willing to let go of and how much you’d be comfortable with.
You and your team should work on the numbers to determine how much of your company’s shares can be given up as equity, which would not affect your place in the company or your ability to scale the company properly. It is important not to be desperate when trying to raise funds for your business. No judicial process can help you recover equities once they have been given.
Based on the above metrics, it would be easy to determine how much equity you can give out during the seed round.
Frequently Asked Questions
How Much Equity Should You Give Up in Pre-Seed Round?
There is no point in giving equity during the pre-seed round. At this point, it is difficult or probably too soon to get any value from investments made, and once you start giving equities from this point, you may end up without a company when you get to series B and C funding. The best you can do is to ask for favors. However, if the amount invested will significantly improve your company’s growth, then you can do the maths to determine how much equity to give.
How Much Equity Should I Give Up in Series A?
In a series A round, founders are advised to give up around 20-25% of equity to investors. These equity investments are often dependent on the kind of startup or business. Some businesses may give up more, while others must give out less equity.
How Much is a Good Seed Round?
A good seed round depends on the company and what they intend to achieve. Most seed rounds today often range from one to four million naira. Anything in that range is good enough to scale a company to the highest heights in its industry.
What Percentage do Seed Investors Take?
To determine the percentage of seed investors in your company, simply divide the amount of money you want by the company’s valuation. For instance, if your company is valued at 1,000,000 naira and you get 200,000 naira from a seed investor, then the percentage of equity would be 20%.
Equities and their calculations are crucial to financing a business or startup. If it is gotten wrongly, it could hamper the growth and development of a business. The best advice to any founder or startup is to consult a lawyer before agreeing to offer any amount as equity for any round.
After completing calculations on how you should give up much equity in the seed round, let a law firm handle the process to determine whether the company is on the right track or not.