There’s an old saying that “5 per cent of something is better than 100 per cent of nothing” and it’s an important factor to keep in mind when it comes to giving up equity in your firstborn start-up. At the same time, that 5 per cent can equal vastly different amounts of money, depending on the stage and size of a business.

Understanding how the different equity possibilities can play out is fundamental to good deal making.

Take Kim Huynh from online marketplace WeTeachMe who pitched on TEN’s Shark Tank last Sunday night. Still in its early stages, WeTeachMe has turned over $400,000 in revenue to date, but this did not stop Kim from giving the business an exorbitant valuation of $8 million.

Calling Kim out on his unrealistic offer of $200,000 cash in exchange for 2.5 per cent equity, Shark Andrew Banks made Kim a counter-offer of $200,000 for a 45 per cent stake. Andrew warned Kim that he wouldn’t be impressed by the offer but this still didn’t prepare Kim for the much larger equity percentage Andrew was after.

Standing in front of an investor with substantial revenue and an improving balance sheet puts an entrepreneur at a big advantage. But coming to the table with a more educated view of valuation and when to give up equity and how much to give up will help more entrepreneurs walk away with a deal they know they can be pleased with.

Here are a few guidelines around you valuation process and understanding your equity position:

1. BACK UP YOUR VALUATION: Help an investor understand why you think you are worth what you say you are. You need to believe your valuation number so be prepared to defend it and explain it. Don’t pull a number from thin air – there is always a methodical way of getting to a reasonable valuation. For example, if you are a tech start-up without a track record of revenue you may dispense with financial metrics and instead look at traction – how many users and how fast you are getting them, what it costs you to acquire and retain users, the size of market etc. You need to demonstrate this with solid numbers. A claim about your traction without evidence of numbers is a hypothetical few investors will be interested in.

2. FOUNDERS ARE FUNDAMENTAL: The “founder risk premium” factors into the way I value a majority of my potential investments. Founders matter to me – if I don’t like you then you don’t even get in the door. If you can’t demonstrate impressive skills in your space then the conversation ends. If you fail to articulate the problem and get me excited about the space, then I am out as well. As the entrepreneur you are the face of the business, if I’m not sold on you, I’m not interested in what you’re selling.

3. THINK THROUGH YOUR FUTURE CAPITAL REQUIREMENT: Investors want to understand where start-up founders want to take their business before collaborating with them on a potential future requirement for capital. This is where a well mapped business plan is key. You need to ensure subsequent capital raisings do not jeopardise the future of your business. A smart investor needs to know you’ll be in the business until it has its feet – so if future investment dilutes you past the point of caring, that’s a huge risk to the business.

The biggest rookie error an entrepreneur can make during the negotiation process with a potential investor is to offer to lower their cash requirement in order to maintain a certain level of equity for themselves. This is misguided. Your business timeline is dependent on your funding from the outset. Sacrificing your initial investment request only signals to an investor that you’ve failed to account for every step in your business plan and have not considered the bigger picture.

4. SWEAT FOR EQUITY? When you are starting out, one of the fastest and most obvious ways to grow your team is to offer people an equity position in your business. Whilst this can seem like cheap labour in the early stages of a start up, if not managed appropriately, it can quickly cause confusion and distress amongst the early-stage team – leading to walk-outs, legal battles and in extreme cases the collapse of the company. If you do go down the sweat-for-equity path, take advice on the appropriate amount to give away (usually in the 0.5-1.0 per cent range), and have a vesting scheme that ensures the work happens satisfactorily before the person walks away with their shares. Places like River City Labs in Brisbane or Fishburners in Sydney hold events around these sorts of topics all the time. Have a look around your city and see if you can attend a session that may offer some free advice on a rather thorny issue.

5. MAINTAIN CONTROL – BUT HOW MUCH? There’s no hard and fast rule for determining how much of the company you should retain. For me, it is basically about ensuring you as an entrepreneur have enough skin in the game to make the sacrifices worthwhile. I get nervous any time I see an entrepreneur within their first few rounds of funding with a less than 50 per cent equity holding. By the time founders are ready for an exit (when things have gone really well) you want them in for a collective equity percentage of between 20 per cent and 40 per cent. (Note to founders – fund your business from customers and you get to keep a lot more equity). Control does not have to be asserted via an equity holding but can be agreed as part of a shareholders agreement. Whilst under the Corporations Act there are some things you can’t do there are lots of things you can. Retaining effective control by agreement can be a way around an otherwise daunting dilution.

This article first appeared on Business Review Weekly. View the original here.

Every investor knows the best portfolios are built on solid, rational business choices, an in-depth understanding of the market, and more than a little bit of luck.

But, for those of us who have got the start-up bug, we often need to look beyond traditional methods. For early stage businesses, especially tech start-ups – you look at the founders, their skill and drive, the potential of the company, the problem they are solving, the market potential and the quality of the product and the intellectual property.

Many of the most successful start-up investors started their journey as entrepreneurs. Because we know what’s it’s like to risk everything to launch a company, and put in the hard yards to make it work, we understand where the people we are investing in are coming from. It also helps that we know the market, and the steps it takes for an entrepreneur to go from first hire to initial public offering. I’m a predominantly tech investor, I like big scalable businesses run by tech-savvy founders who want to take on the world.

Perhaps that’s why many people were surprised by the latest episode of TEN’s Shark Tank, which saw me and my fellow shark John McGrath invest in Hummingbirds, a childcare business for children with special needs.

I can understand this. If you told me a year ago that I would be investing in the childcare industry, I’d have laughed you out the door. However, when Leah James and Rebecca Glover entered the Shark Tank, they came not just with a moving personal story about what they’ve done to ensure a better future for their children, and other children effected by disabilities. They came with a sharp, well-thought and viable business proposition.

Hummingbirds are operating in a hugely under-serviced niche in their sector. They have a massive waiting list in their Queensland home area. The company founders are smart, articulate businesspeople who have in-depth expertise of what their customers are experiencing. And they have a fire and passion to succeed which reminds me of myself when I started SE Net and then PIPE Networks.

As a former entrepreneur myself, I let myself be swayed by the commitment, skill and passion of the founders I invest in. Then I look at the numbers behind the business, the quality of the product compared, and the size of the addressable market. But above and beyond that, it’s true to say that an entrepreneur’s authenticity and capability are the not-so-secret sauce of early stage investment.

This holds true for any sector, not just tech start-ups. In fact, Leah and Rebecca remind me of two other entrepreneurs who came to me with a big idea. They were ex-army personal and highly experienced skydivers. They had a passion to create a wholly new experience – and could show that people would pay for it. Four years later Indoor Skydive Australia (ASX:IDZ) is a reality with multi-million dollar facilities in operation in Penrith, and soon to open in Gold Coast, Adelaide and Perth.

As I said in Shark Tank, Hummingbirds was a deal too important not to be done. Leah and Rebecca’s vision is truly inspiring and as a father to a young daughter myself I could not help but be moved by the their personal stories. But as investors we are not here to give people money so that they can feel fulfilled. We’re here to help accelerate fast-growing companies, and create wealth and jobs for Australia. I’m not in the business of making charitable start-up investments.

But, with a little money and a lot of mentoring and guidance, I believe myself and John can help Hummingbirds transform the face of childcare in Australia for children with disabilities. I believe the business can become a viable and profitable enterprise, one that creates social good and decent profits. After all, why can’t a business be a good investment and help people at the same time? I may have moved out of my comfort zone and into the childcare industry, but I haven’t given up my investment principles.

This article first appeared on Business Review Weekly. View the original here.

As those who have been following TEN’s Shark Tank will appreciate, there are times in a pitch when the entrepreneur makes everyone feel a little nervous.

Whilst a degree of pitch anxiety is expected, this normally wears off after a few moments of conversation. When that feeling lasts the length of the pitch it can be deadly for a deal.

Take Kerry, the fast-talking inventor from Newcastle who pitched us the world’s brightest dynamo bicycle light combined with a USB.

A clever inventor who is passionate about the cycling market, this entrepreneur lost my confidence early on with some hyped up claims about his product that didn’t appear to stand up to scrutiny.

For example, after referencing a global market of over 100 million new bicycles per year, he went on to predict that this world-first invention, which costs well over $500 (compared to a regular bike light at $25) would find an enormous market. However, the panel felt a very niche percentage of this global market (the wealthy long-distance cyclists) would be tempted to spend that kind of money on his product.

It seemed Kerry had his pricing wrong, and whilst that’s a red flag, it’s not beyond correction if all the other elements are in place and someone is open to working with an investor to build more confidence in this area.

Kerry had enthusiasm in spades – which is great. But at times his demeanour and his responses were so over the top, he ran the risk of coming across as someone who could be challenging to work with – particularly for seasoned investors who are time-poor or prefer a more measured approach.

There are also times when an excellent pitch goes horribly, suddenly wrong. The feeling is palpable. Take the family from Evil Corp who blew us away with their awesome horror-themed presentation. When one of the presenters came at us with a bloodied chainsaw we definitely felt uncomfortable, but that was purely a demonstration of their ability to wow their customers with fear.

I loved their bold vision to fill a gap in the entertainment market with a scary theme park. And, of course they were from Queensland, which instantly got my attention.

Towards the closing moments of their pitch, I asked what was to become the deal-breaking question: what do you base your projected customer numbers on? They told us that Movie World in Queensland (a well established gigantic attraction) was the main competitor and that they aimed to match their performance.

Their exaggerated plans to take on Movie World saw this family business snatch defeat from the jaws of victory and sadly walk away without a deal. The answer, quite frankly, was scarier than their pitch for anyone thinking of going into an investment partnership with them.

There are many important things to do in a pitch – like communicating your vision and your expertise, being across your numbers and having an appropriate ask. And, of course, you need to come to the conversation with a great business idea and ideally some existing revenue. Assuming those fundamentals are in place, here are a few things to never do in a pitch environment.

1. DON’T OVERSELL – it makes people nervous: Investors want entrepreneurs to be persuasive and clear about their business, but they don’t respond well to someone putting on the fast and loud talking display of a stereotypical used car salesman. Let your great idea, solid plans and expert credentials do the selling for you. And remember, investors generally want you to succeed – otherwise they wouldn’t have you in the room.

2. DON’T OVER-CLAIM: Exaggerated, unsubstantiated claims from a young, untested business like “this will obliterate Facebook” or “we will make a million dollar profit in the first three months” will only undermine your credibility and shut down the conversation early. Investors are more likely to be persuaded by a calm and rational presentation of the sales projections, even if they are still small, with a vision for how you plan to scale the business. This signals they are dealing with someone they can trust, who is more likely to under-promise and over-deliver than the reverse.

3. DON’T BE INAUTHENTIC: getting into partnership with an investor is a marriage of sorts (albeit a shorter one). Bring yourself and your experiences into the room, not a hyped-up version of who you think you need to be to get the deal. Faking the first-date is a bad idea – it’s likely to instantly repel the experienced investor, who can smell inauthenticity a mile off. And, if you did end up with a deal, you may well find yourself poorly matched with a person who has very different expectations of who you are and how you will manage your business.

4. DON’T BE COCKY OR OVER-FAMILIAR: When Kerry called Shark Naomi Simson “darling” on last week’s show, it came across as patronizing and got the panel offside. Cheeky is fine, and can build rapport (example: the Bottlepops duo who offered us a beer) but if it distracts from your presentation or jars an investor into thinking you would be disrespectful in a business relationship, your chance at a deal is off to a rocky start. Demonstrating a willingness to listen bodes well for a long-term relationship with an investor. Talking over the top of an investor when they are trying to give you constructive feedback/criticism, signals someone who would be difficult to work with.

This article first appeared on Business Review Weekly. View the original here.