I love working with numbers and I hope you do too. After all, business does come down to numbers—increasing the number of customers served each year, reducing costs, improving gross profit margins and then counting up your profits.
Trust me, though. What you show as your projected revenue and earnings growth will not be the only numbers that investors consider about your business.
Since most investors get their money back from the sale of a company to another business, investors think a lot about how big a company’s valuation can grow to over time. The bigger the better.
In general, angel investors expect to get their money back within 5 to 7 years with an annualized internal rate of return (“IRR”) of 20% to 40%. Venture capital funds strive for the higher end of this range or more.
So how big does a company have to grow to in order to achieve a venture-friendly rate of return?
As the table demonstrates, the greater ownership percentage an investor has in a company, the less the company’s value has to grow to in order to achieve a venture-friendly return.
| Build Value on Purpose |
| % Ownership of a Company Required to Deliver 30% IRR |
| Investment Amount |
| $2M | $4M | $6M | $8M | $10M |
| Company Value | | | | | |
| $20 Million | 48% | 96% | <30% | <30% | <30% |
| $40 Million | 24% | 48% | 72% | 96% | <30% |
| $60 Million | 16% | 32% | 48% | 64% | 80% |
| $80 Million | 12% | 24% | 36% | 48% | 68% |
| $100 Million | 10% | 19% | 29% | 38% | 48% |
If, for example, a group of angels invest $2 million in a company, and own just 10% of the company at the time of exit, then the company would have to grow to be worth $100 million to deliver a 30% return over a six year period. That’s a big valuation gain in a short period of time!
Caveat: If the company was sold successfully in less than six years, then the IRR returns noted above would be higher than 30% because of the time value of money.
Investors know that building a company up to be worth $100 million is exceptional (and unusual) performance. It’s why most savvy investors ask for a larger percentage equity stake at the time of investment. The extra percentage ownership helps compensate them for risk plus gives them a better chance of reaching a 20% to 40% IRR.
Now that you know more about the relationship between a company’s valuation at the time of business sale and percentage ownership, you can evaluate your business strategies in a more purposeful way.
Consider, what is it about your business that other companies will want to buy in the future that will boost your company’s value. If you want some ideas on the factors that tend to boost a company’s value at the time of sale, read chapters 3, 7, 10 and 11 of Start on Purpose.
FAQs
While the term good is subjective, many professionals consider a good ROI to be 10.5% or greater for investments in stocks. This number is the standard because it's the average return of the S&P 500 , an index that serves as a benchmark of the overall performance of the U.S. stock market.
What is the expected rate of return on an investment? ›
What Is Expected Return? The expected return is the profit or loss that an investor anticipates on an investment that has known historical rates of return (RoR). It is calculated by multiplying potential outcomes by the chances of them occurring and then totaling these results.
What is a good expected return rate? ›
Financial advisors can help clarify this by considering individuals' risk tolerance, age, income and other factors. However, here are some general guidelines: General ROI: A positive ROI is generally considered good, with a normal ROI of 5-7% often seen as a reasonable expectation.
What percentage should an investor get in return? ›
A fair percentage for an investor will depend on a variety of factors, including the type of investment, the level of risk, and the expected return. For equity investments, a fair percentage for an investor is typically between 10% and 25%.
Is 20% a good rate of return? ›
A 20% return is possible, but it's a pretty significant return, so you either need to take risks on volatile investments or spend more time invested in safer investments.
Is 5% a good return? ›
So, if you earn 5% on yours, you're not only beating the national average savings account return by more than 10 times, but you're enjoying one of the most competitive rates on the leading high-yield savings account options.
What is a realistic real rate of return? ›
A realistic rate of return for retirement depends on your asset allocation, investment management fees, inflation, and taxes. As a result, calculating your real rate of return means accounting for these factors when assessing your investment gains.
What is normal average rate of return? ›
The average rate of return (ARR) is the average annual return (profit) from an investment. The ARR is calculated by dividing the average annual profit by the cost of investment and multiplying by 100 percent. The higher the value of the average rate of return, the greater the return on the investment.
What is the 1% rule for investors? ›
For a potential investment to pass the 1% rule, its monthly rent must equal at least 1% of the purchase price. If you want to buy an investment property, the 1% rule can be a helpful tool for finding the right property to achieve your investment goals.
What return should I expect from a financial advisor? ›
Investors who work with an advisor are generally more confident about reaching their goals. Industry studies estimate that professional financial advice can add up to 5.1% to portfolio returns over the long term, depending on the time period and how returns are calculated.
Basically, the rule says real estate investors should pay no more than 70% of a property's after-repair value (ARV) minus the cost of the repairs necessary to renovate the home. The ARV of a property is the amount a home could sell for after flippers renovate it.
Is 7% return on investment realistic? ›
A good return on investment is generally considered to be around 7% per year, based on the average historic return of the S&P 500 index, adjusted for inflation. The average return of the U.S. stock market is around 10% per year, adjusted for inflation, dating back to the late 1920s.
Is 10% return on investment realistic? ›
Usually the implication is that they can expect, over a long time, a 10% return. Fortunately some ask, with some doubt, "Is a 10% return really reasonable?" It is not. While the average growth or return in the market (e.g., the S&P 500) is about 10%*, investors over time do not see that.
How to get 15% return on investment? ›
Consider investing Rs 15,000 per month for 15 years and earning 15% returns. After 15 years, the total wealth will be Rs 1,00,27,601 (Rs. 1 crore). According to the compounding principle, if we implement these very same returns and contributions for another 15 years, the amount we accumulate grows enormously.
How to get a 10% return on investment? ›
Investments That Can Potentially Return 10% or More
- Stocks.
- Real Estate.
- Private Credit.
- Junk Bonds.
- Index Funds.
- Buying a Business.
- High-End Art or Other Collectables.
