Investment Crowdfunding – Part 18 of 20+ Series – Valuation Disagreements
Karl Dakin
I help you overcome challenges to raising capital. Take advantage of my Motivated Money Method to identify those investor candidates that are most likely to invest. Top expert in fundraising.
Disagreements by entrepreneurs and investor candidates over valuation occur all the time. The entrepreneur started the business with a vision of all it can be and the investor candidate can only see what is in front of them. This disagreement typically results in no investment. To reduce the time and money of raising funding, small businesses should be prepared with different deal structures that specifically address this challenge.
?One of the most common deal structures to address disagreements in valuation is the SAFE (simple agreement for future equity). This structure is a contract between the business and the investor that states that the valuation will be determined if and when equity is sold in the future. In effect, the market sets the price at a later date. The entrepreneur must then prove their valuation by successfully growing the business in a manner that demonstrates higher value. This typically takes the form of achieving milestones that improve the likelihood of success and reduce the chance of failure. Milestones can include increased sales, greater profits, more customers, key customers, new products or services, new personnel, etc. Success is still defined by an investor, but a different investor than the one who purchased the SAFE. A simple SAFE states that the money paid by the investor will convert to an equity position with the price of the conversion discounted by a percentage of the price set in the second offering. For example, if the second offering is at a price of $100 per share, the holder of the SAFE will get shares at a price discount such as $80. From the investor’s perspective, at the time that they become an owner of the stock, they realized a 25% appreciation in value.
?I dislike SAFE’s for many reasons that have been described in a previous edition of this newsletter. Primarily, if finding an interested investor candidate is hard, finding one that will wait for a valuation to be assigned to their investment is harder. Secondarily, too many things can or do not happen after the SAFE is issued that may make its implementation difficult or impossible.
?Another common deal structure is to provide an option for the small business to buy back equity from the investor if the small business outperforms the investors expectation. This is called a ‘clawback’. The original price is set at the time of the investment. If the equity grows in value above a second price, the small business may buy back a portion of the equity at a nominal price. This enables the investor to gain an appreciation in the value of the equity they acquired and places the small business in the same or similar position they would have been in if the investor had agreed to a higher initial price.
?For example, a small business wants to price its equity at $200 per share and the investor does not want to pay more than $100 per share. An agreement is reached that the investor will only pay $100 per share. However, the small business retains an option to buy back some or all of the investor’s ownership position at a price of $120 per share. If the value of the small business rises to $200 as originally projected by the small business, it can sell shares at $200 per share and buy back the original shares at $120 per share. The investor makes money and the small business regains a greater percentage of ownership control.
?A third approach is to use a shifting profits allocation. Within this structure, a price is set based upon a price that the investor is willing to pay in order to achieve a set rate of return on their investment. Profits are distributed at this rate until the investor’s objective has been met. Then the ratio of profit distribution changes in favor of the small business.
?A simple example is that of an investor seeking an annualized rate of return of 15%. The investor invests $100 and receives an equity ownership position of 10% with profits distributed proportionately until the investor has received $115, when their ownership position reverts to the business. An alternative would be for 10% of the profits to be distributed to the investor each year until they receive $15, with all of the remainder of the profits distributed to the other owners. Yet another alternative would be for 10% of the profits to be distributed to the investor each year until they receive $15, with 2% of the profits distributed to the investor after that and all of the remainder of the profits distributed to the other owners. There are many variations in this structure in the timing and allocation of profit distributions.
?There are other types of investment deal structures that may be created that address disagreements in valuation. A small business should be open to negotiation of other deal structures and should not take a position of taking it or leaving it. Be creative.
Don Cohen
?I was a guest yesterday and will be a guest again tomorrow on Don Cohen’s show (Monday through Friday at 9 am MST) on at 9 am MST.? I engaged Don as a coach to help me set up the Successful Funding show on LinkedIn Live. He has been assisted by Kelle Steinecke (The Awesome Journey Show) and Harvey Tuck (The Franchise Show) who have been mentoring on the use of LinkedIn, the publication of the Instant Funding newsletter, Restream, and guest management.
?You may go to his LinkedIn profile at the time of the show and click on the talking heads to enter the program. ?
?Or go to the Event on LinkedIn and add it to your calendar
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?Thursday, February 29 -? 9 am to 1 pm MST - Zoom Online
?The workshop will instruct on the Motivated Money Method of raising capital that targets investor candidates who are 'most motivated' to provide needed capital. Attendees will receive a workbook, templates, and a video recording of the workshop. A single organization may have up to three representatives participate in the workshop for a single registration fee.
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??Successful Funding Show
?Michael Podolny will be the guest on the next Successful Funding show on Tuesday, February 16 at 8 am MST. Michael is the Founder and CEO of Theodora Africa – a nonprofit that trains women in Africa to be virtual assistants and then arranges the sale of their services to small businesses in the United States. The availability of these services can be a great help in filling the gap in support personnel while having a positive impact on the lives of these women in Africa.
?Devin Thorpe was my guest on my Successful Funding show last Tuesday. We had a very energetic discussion on impact investing and crowdfunding. Devin was very clear that it is possible to build wealth by investing in small businesses through crowdfunding. And, each operating small business has a major impact on the community in which it operates. ? You may view the show in the posts on my LinkedIn profile at:
?The Successful Funding show will repeat weekly at 8 am MST on Tuesdays on my LinkedIn profile.
?Founded in FOCO
?I will be presenting a workshop on the topic of What is Your Funding Potential? on March 8 from 11:00 am to 12:30 pm in Fort Collins, Colorado at the Founded in FOCO event.
?SuperCrowd 2024
?I will be co-hosting the SuperCrowd 2024 event: “The Impact Crowdfunding Event of the Year” which will be held April 17th and 18th online.
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Karl Dakin, the Capital Coach
Dakin Capital LLC
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Absolutely, exploring creative solutions is key! ?? As Henry Ford once said - Whether you think you can, or you think you can't – you're right. Stay positive and innovative in your journey. ???? #entrepreneurmindset #innovation #smallbusinessgrowth
I help you overcome challenges to raising capital. Take advantage of my Motivated Money Method to identify those investor candidates that are most likely to invest. Top expert in fundraising.
9 个月One size does not fit all where every investment deal may require customization.