“Recently technology entrepreneur Chris Mills posted a really interesting question on Facebook around whether or not he, as a potential investor in a business, should look at a profit share or an equity share in a start-up business. What followed was a string of really insightful comments around the pros and cons of each, plus an unconsidered third option which was certainly quite interesting.”
The key is revenue
Equity ownership is also a potential minefield. Apart from the awkward conversations about who gets what percentage, there are three other aspects which don’t receive a lot of attention until it’s too late:
- You don’t know what you don’t know. A few years back I made an equity investment at a price I thought was a steal. Literally 30 minutes after transferring money into the bank account of one of the founders, they started referring all their creditors to me and one of my business partners.
- Almost every early stage investment is going to be under-capitalised. At some point down the line you are going to need to inject more capital and whether you sell further equity or share of future profits, your investment is going to dilute at least once.
- If you have ever tried to sell a minority stake in a business, you will discover that your pool of buyers is relatively small and the most likely buyer is going to be the person who sold it to you in the first place. There is an above average chance that your fellow equity owner is already tight on cash having come to you for money in the first place and he / she will be looking to minimise the ‘value’ if they do try and take you out. No secondary market for your equity can be a killer.
The third model, which can work out quite nicely for an investor, is revenue share where the investor takes a percentage of revenue generated by the business.