tech-company, valuationI have been working on my start up in the enterprise HR tech area for the last two 2 years. We have a citizen integration inspired middleware that makes SAP integrations super easy. We have a cloud version as well as an installable version.
We don’t have any customers insofar. But that’s looking to change with 3 big ($6 bill+) companies looking to buy our subscription. Since we’re in HR Tech, our subscription is based on the number of employees a company has.
One of the companies has 70+k employees and they’re looking to start with 20k employees (a few of their subsidiaries) for this year. Per Employee per month is 30 cents: revenue is approx $7.2k/year and can increase based on employees at the customer to as much as $25k/year. Another customer on a similar note can bring in 20k more in revenue.
Now, by the end of last year, I met a very successful sales/business development guy. We worked together on a pitch for a really big software vendor. A deal with them can open up atleast 20+ such aforementioned customers in the next 3-4 years. Of course, that also means that we have to increase our man power and other capacities. End of 3years, we project : ///Realistic scenario: Revenue $400k | Profit -$280k(loss) ///Optimistic scenario: Revenue $700k | Profit -$44k(loss). Overall: Revenue $500k | Profit -$150k | trend + But if we manage upsell other products/consulting, then we start looking good on the profit front too.
Now, the new guy wants to pick up a stake in the company. He wants to put in $200k for a stake of 35%.
His take: Without him, the company had no value and therefore he gets the first mover advantage.
This I believe is too high. What are the repercussions of accepting this? What are my arguments to counter this and lower his stake to, say, 15-20%?
After discussion with Lonelymo it came to light a miss understanding between themselves and their investor as to how investment works.
It may be that this is the way that some people do investment, however I am yet to come across it.
The company had 70% of it's equity issued to the founders and had reserved 30% of it's equity unissued to be sold to investors.
The investor believed that in this case, if they wanted 35% of the company then they would have to buy 5% of the shares from the founders themselves which would of course incur capital gains tax, as they had sold capital.
In the above model there would always be a fixed number of shares which would get traded around. No one would become 'diluted' as such, just simply sell their shares until they had none and clauses in agreements around the sale of shares would be invoked all of the time. It would get messy as far as I can see.
what actually happens when you raise investment is that the founders keep their shares. So, in the above case Lonelyme has 35,000 shares. They will always keep this number of shares unless they buy more (or end up with some from a reserved employee pool). Instead you create new shares.
So, if an investor is issued with 35,000 shares then the total number of shares go up. Meaning Lonelymo still has the same number of shares but their percentage of the pot has dropped (dilution) and hopefully the value per share has increased and so lonelymo's value on paper at least has increased. No shares change hands, no capital is gained from and so no tax is incurred (until you exit the company and sell your shares).
This happens with every round of investment. Investment is sought, a valuation is negotiated and the number of shares is created and issued diluting everyone in the pot.
I threw together a quick cap table to hopefully highlight the process.
so my advice to lonelymo has been to issue the reserve shares (and look into the legal ramifications of doing so) so that both founders have 50% and then treat the new person as an investor in the above model issuing new shares to them diluting the two of them.
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