Last week I talked a bit about the SBA loan. This week I want to talk about one of the other early stage funding options – Friends and Family. It is exactly what it says. You get money from either Friends or Family or both. Sometimes this can be Debt, but I want to talk about it as Equity. This will give us a view into one of the biggest issues in Equity transactions: Valuation.
Valuation is pretty simple. How much is the company worth? The younger the company is the less likely there are lots of good ways of determining Valuation. But to start with there are 2 numbers that you need to understand: Pre-Money and Post-Money. This is pretty simple. A Pre-Money Valuation is the worth of the company before their is an investment. A Post-Money Valuation is the value after the investment. Think of it this way. If you created a company with 1,000 shares of stock and had invested $1,000. You then sell 100 shares of stock at $1 per share to a friend. The Pre-Money Valuation is $1,000 and Post-Money is $1,100. The Friend now own 100 out of 1,100 shares or about 9% of the company.
I hope you are beginning to see why Valuation is such a big deal. How much a company is worth is subjective, especially early on. That is because of what would be both Intangible Assets and Sweat Equity. Intangible Assets are the Intellectual Property that the Founders have. In other words, their brains. Sweat Equity is the effort that they put into the company without compensation. So a Founder will want to get value for all the work they have put in and the value of their Business ideas. Most investors will not be so generous about what that is and thus there is a significant amount of conflict about this topic. So, have your ducks in a row about Comparable Companies or Comps. This helps set the market for businesses.
I have one last thing to say about this. Put it in writing. I can not tell you how many people have broken relationships over business disagreements. It is not worth it. Put things down in writing and make sure everybody is clear.
Have a great day!
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