Evan Carmichael breaks down four ways to structure an investor deal: debt, equity, convertible debt, and royalties. Each has different tradeoffs for the entrepreneur and investor. He emphasizes picking investors who bring strategic value beyond just money, like connections and advice.
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How much should an investor get? So I got a great question from one of my YouTube viewers, Sergey, love you guys, who wrote in to say, I have a difficult question for me and for many people. One person, inventor, believed in me and put money in my business, for example, $1,000. The question is, how do I divide with him the profits? What percentage to give him and on what terms and what time frame possible and for how long? I run a business on 100%, he is only the investor. "Thank you, P.S. Would be great if you made a video response for all, how to make a relationship with investors." So, Sergey, here is your video. Now, this is a common question, and as entrepreneurs, you know, we want to often raise capital. We feel we can't do it ourselves. We need money to launch this thing and make it big time. There are 4 main ways to structure a deal with an investor, and each deal is different. So there's no easy way to say, "Hey, if he gives you $1,000, and here's how you want to pay it back." Each single deal, every deal is different, and this is coming from a background in angel and venture capital investing. So I'll give you the 4 options and you can see what feels right and how you want to match it up with your investor. The first is debt. So debt is a loan. They don't own any of your business, but they're giving you money that you have to pay back. If they give you $1,000, maybe you say it's a 10% interest rate and every year you have to pay that 10% plus some of the principal down, just like going to a bank and getting a loan. But often the rates are going to be a lot more favorable towards the investor than you. Obviously, often you would go when you can't get a loan from a bank because it's too risky, so you're going to have to pay a premium. But that's debt. Number 2 is equity. So equity is they're taking a piece of your company, so they don't— you don't have to pay them anything back. On a monthly basis or quarterly basis or whatever it is, but they own part of your company. So if they're giving you $1,000, maybe they get 10% of your company. Now that's, that's a pretty low, terrible valuation. But basically what you're deciding is, okay, our business is worth this amount of money. So if your business is worth $10,000, that's what we think our business is worth today, then by you giving us $1,000, then we're going to give you 10%. And how that person gets paid is when either you do a dividend from the company to the shareholders, and you know, you'll get 90% of the dividend and they'll get 10% of the dividend. Or ultimately, the goal is when you sell the company, right? When you sell the company, you get bought for $10 million, they get $1 million because they own 10%, and you get $9 million. So that's the exit strategy, but it's typically a lot longer play because you got to build up the company to get acquired. Number 3 is convertible debt. With convertible debt, it's a mix of the two. So this is favorable for the investors a lot more than the entrepreneur, but typically how it works is the investor gets a loan that they're getting paid, so you're making them monthly payments on the loan, but at any point the investor can convert that to equity. So if they feel like you're going to make a big deal, you're going to get sold, you're going to start paying dividends, then they can say, okay, you know what, I don't want that anymore, I'm going to convert that into equity. So it's a great way for investors to lower their risk, right? They're getting paid monthly from you for their debt, and then whenever they see an opportunity to get to equity because it's going to be favorable for them, they say, okay, we're going to convert our debt and turn it into equity. So not as great for the entrepreneur, but a great deal for investors, and it's super common for a lot of angel investors. Number 4 is royalties. And here the investor is not taking a piece of your company, you're not paying them back a certain fee every month on a loan, but they take a percentage of every sale that you make off the top. So whatever product you're selling, if it's a $100 product and they say, okay, I want a 5% royalty, so that I'm gonna give you this $1,000 and every time you make a sale I'm going to take 5% of that. So if you're selling it for $100, every time you make a sale you're paying them $5. But they don't own any of your business and you don't own any debt that you have to pay them back. So it's another common model to use. And often they'll still mix it up. They'll say, I want debt with a royalty, or I want equity with the royalty, or I want some debt and some equity. Every single deal is different, but those are the 4 main components. So just to recap again, number 1 is debt, number 2 is equity, number 3 is convertible debt, and number 4 is royalty. One last thing I want to remind you guys about is when you're bringing on an investor, you don't just want money, okay? You want somebody who can bring more to the table. You want somebody who can give you advice on how to grow business. You want somebody who's going to open doors and make connections for you. You want somebody who might help you get into the media or might bring on new customers to your company. You want more more than just the money. Because you have a limited amount of people who you can bring on board, right? You only have so much debt you can take on, you only have so much equity you can give away, you only have so much of a royalty you can give to somebody, and you want to make sure that the people you bring on are strategic and really want to help you instead of just giving you money. So always have that caveat in the back of your mind. Think about this person you're bringing in. It's like, great, I need the money, awesome, but what else can they bring to the table besides the money? Belief. For those of you watching, like the video. You can support me by clicking on the link in the description. Leave a comment, let me know what you think. Ask a question if you want me to make a video reply for you. And click on my face to subscribe to the channel. Thank you so much. I'll see you soon.
