Angels and Control

by Alexander Muse

Tonight I was watching the Shark Tank and was struck by how focused the 'sharks' were on owning 51% of each of the companies.  More often than not angels I talk to are hung up on valuations.  The folks at NTAN will explain to me, "We love the deal, it is going to be a winner, but the entrepreneur's valuation expectations are crazy."  Control is almost always an illusion.

Why take away an entrepreneur's illusion of control by insisting on 51% ownership?  As an angel why not explain to the entrepreneur what sort of return on investment you are looking for.  Most entrepreneurs will respond positively if you present your case properly.

For example, an entrepreneur needs $250,000 to take his business to the next level.  You love it and think that $250,000 is exactly what he needs.  The entrepreneur has been working on the business for three years without a salary.  He thinks he has invested more than $1,250,000 in the business (mortgage on his house, lost income and so on).  He is willing to give up 10% of the company. 

You laugh at him.  In your mind his company is only worth $250,000 - after your investment it will be worth $500,000 and as a result you think you should own half of the company.  How do you close the deal if you are certain the entrepreneur won't give up more than 10% of the company?

Why not offer the entrepreneur this sort of deal.  In exchange for 10% of the company you will invest $250,000 under the following conditions.  You explain that your goal is to triple your investment.  To that end you ask him to agree to give you the first $250,000 the company generates.  Then you ask him to agree to give you 50% of each additional dollar the company generates until you have generated an additional $750,000.  After you have returned your original investment and an additional $750,000 you and the entrepreneur will be equal footing 90%/10%.  If you are concerned about control simply ask for board control until such time as you have tripled your money.

In this scenario if the business works you make a bundle.  If the business fails owning more of it won't help you.  Most entrepreneurs I talk to have no problem letting an angel guarantee some sort of return if they have some certainty that they will retain control if the business succeeds.