We are three partners of an early-stage company with a revolutionary e-commerce product. We presume $3 million in revenue in our first year. We received an offer yesterday of $5 million for 15 percent of the company, with an initial public offering in the future. Could this be a good deal? We need to know because the investors want an answer ASAP. —F.B., Miami
Several aspects of your situation sound odd. First, there should not be extreme urgency to an offer like this. After all, if you truly have developed a breakthrough product, it will still be there in a couple of weeks or months, right?
When investment deals are floated, particularly of this size, it’s not unusual for that much time to pass in due diligence, negotiations, and meetings before contracts are drawn up and signed. When potential investors are pressing for a quick answer to something as big as this deal, that should tell you something is off.
Another concern is the size of the offer. These investors apparently believe that 15 percent of a startup company, with no actual revenues at this point, is worth $5 million. That means their valuation of your business is more than $33 million, although your projected first-year revenues are only $3 million.
While you may indeed have a revolutionary product, it’s unlikely that any legitimate investor would make such an offer before the product gets to the market and is tested in the real world.
Take your situation to a professional who can help you come up with an independent valuation for your company, suggests Larraine Segil, a former partner at consultant Vantage Partners and an expert on corporate governance and mergers and acquisitions. "Get a world-class accounting firm to work with you on your valuation," she says. "It depends on many factors, including comparable valuations in your industry, your current performance and past history, and the integrity and past experience of your management team."
While $5 million undoubtedly sounds attractive to a group of startup entrepreneurs, without a trusted, outside appraisal of what your company is worth, you may be selling yourselves short if you accept this $5 million offer. Even if the valuation is appropriate, you shouldn’t necessarily jump at the first deal that comes your way if the investors aren’t aligned with your goals.
On the other hand, this offer may be a front for a scam, says Steve Kaufer, president of Inter/Action Associates, a security consulting firm based in Palm Springs, Calif. The fact that this group is pressuring you to come up with a quick answer makes it particularly suspicious, he says.
"This just doesn’t make sense, giving $5 million for a small part of the company. There may be something else lurking here," he says.
Although Kaufer says he has not heard of this kind of scenario before, he speculates that it could be a variation on a so-called Nigerian scam, where individuals are trying to get access to your bank accounts, or want to get control of your domain name if you have a unique or valuable Internet address.
Talk to an attorney who can help you evaluate this investor group and the seriousness of their offer. If they are legitimate, they will welcome the due diligence and cooperate fully. If not, you’ll be glad you steered clear of them, whatever they were trying to accomplish.