“Give a man a fish and you feed him a day; teach a man to fish and you feed him for a lifetime.”
Uncle Jet’s Fishing Journey is all about business, entrepreneurship, share investment and personal finance. Through Newswav, Uncle Jet hopes to share and learn together with all readers, creating a more financial-literate Malaysia together.
Journey 1: New Investor investing into your company? Yay or Nay?
Whether your company is currently (a) idealisation stage (b) startup (c) traditional growth stage company (d) matured company looking for exit, you will always encounter opportunities for third party investor to invest in your company.
If you are at idealisation stage, looking for your friends/families to invest in your idea. Make sure the expectations are set clearly in the beginning. If your partner is merely investing as a passive shareholder, don’t be upset when he/she is not contributing to the growth of the company while you are working your head off, sacrificing your social time, family time and health. If you are expected to run the show alone, make sure the compensation package is agreed in the first place, and built into the cost structure. You could also structure some form of sweat equity upon achieving certain KPIs.
Most of these friend/family funded companies will not have a Shareholder Agreement. When thing turns sour, remember not to do anything harmful to a friend/family/investor who trusted you in the beginning. You are responsible for your investor. If you have to resort to buying your investor out, make sure he/she will get his fair share of upside (if the company is doing well).
A good reputation goes a long way.
For most startups, the valuations are normally based on future prospects, rather than actual profitability.
At this stage, most valuations are crafted based on how much you want to raise in relation to how much equity you are willing to give. IE: if you willing to give out 10% of your equity, in change of RM1m, you are effectively valueing your company at RM10m.
However, this may not add up.
Even if the company may turn profitable in the future, the investor may not be able to reap good returns if the entry valuation is too demanding. If you expect your company to worth RM10m in 5 years, don’t ask your investor to invest at RM10m valuation today. It doesn’t justify for all the risks and hardwork, just to exit at his entry valuation 5 years later.
Most of the exit will be based on profitability ( rather than story telling ), unless you are selling to strategic buyers or your company is a unicorn with billion dollars revenue set to list on NASDAQ (on revenue multiple). The former, generally, knows what to do with your business and how your business can be integrated into the existing business verticals. Even then, the purchase price will also be based on traditional EV/EBITDA or PER ratio (but may be higher than typical financial investors). The latter can be far-fetched and is also proven to be unsustainable.
Don’t be delusional by all the deals happening around you (Company X has raised Y in its series A funding at USD Z valuation), you don’t know the actual details behind. Higher valuations may come with strings attached.
As a startup founder, be realistic with your valuations. Be genuine on your expectations and also be accountable to your projections. Make sure you have proper plan to achieve the promised projections.
If you are unable to attach a valuation to your company, one way to do it is to structure as a convertible loan, where the loan is convertible based on future performance (x% discount on future valuation).
It is pointless to have a good future prospects, without a good business model and cost structure generating cash flow and profitability. Your company is better off surviving on profitability and cash flow as compared to relying on fund raising. What if you are down with 3 months runaway, and your VC who has been supporting your growth strategies stopped funding you. I guarantee you will have sleepless nights, thinking about cutting OPEX, losing your company, your employees losing job, etc.
If you have raised your fund, work towards the projections you promised to your investors while looking closely to your cost budget. You can still grow your company while maintaining a healthy EBITDA! If you have to raise funds, raise it early. It normally takes 6-12 months to close a deal (sourcing, negotiation, due diligence, legal drafting and closing).
If you are the lucky fews, currently preparing to exit your existing established and profitable business, be realistic on your valuations and most importantly, start to adopt an exit mindset.
When you are exiting your business, your buyer will normally require you to stay as a minority founder for atleast 2-3 years (unless it is a strategic buyer). It may be hard because you have been your own boss for your whole life. Suddenly, you are required to do monthly reporting and also reporting to the new shareholders (whose representatives may be younger and less experienced than you).
If you are left with minority stake in the company, respect the exit terms, be genuine and work together with your new shareholder toward the final exit/pay-day on your minority portion.
If you have exited completely, (good job!) respect the exit terms and work on the knowledge transfer while enjoying your big pay day!
Again, a good reputation goes a long way!
Above all, all companies with multiple shareholders should always have a Shareholder Agreement. You can get it at less than RM10k for a simple one. It is essential in protecting the interest as a founder, as well as the minority shareholders. Under normal circumstances, the Shareholder Agreement is practically a piece of paper kept in your drawer. It becomes important when thing turns sour.
A good Shareholder Agreement should always include reserved matters, exit options, pre-emptive rights, right of first refusals, liquidation preference, tag-along, drag-along, priority-rights, veto-rights (if any), etc.
An example: if you and your shareholders are exiting your company, your minority shareholders are comfortable with the exit price, but you, on the other hand, think your company is worth much more. You want to negotiate and you are ready to walk away from the deal if you don’t get the price you want, but your partner wants the current price, without jeopardising the deal on the table. This may result in a potential deadlock. A good Shareholder Agreement can mitigate this.
If you do not existing have an Shareholder Agreement, and if your financial permits, get it done.
If you already have one, I hope that you will never have to bring it out, until you are selling majority of your company for a big buck!
Lim Jet Liang is currently with 5X Capital, a Securities Commission licensed Private Equity Fund based in Malaysia.