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
Expectations for return from the stock market
What is the expected return for investors? ›
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 rate of return required by investors? ›
The required rate of return (RRR) is the minimum amount an investor or company seeks, or will receive, when they embark on an investment or project. The RRR can be used to determine an investment's return on investment (ROI). The RRR for every investor differs due to the differing tolerance for risk.
Is 7% a good rate of return? ›
Return on Stocks: On average, a ROI of 7% after inflation is often considered good, based on the historical returns of the market. Return on Bonds: For bonds, a good ROI is typically around 4-6%. Return on Gold: For gold investments, a ROI of more than 5% is seen as favorable.
What return should investors expect? ›
Most investors would view an average annual rate of return of 10% or more as a good ROI for long-term investments in the stock market. However, keep in mind that this is an average.
What is a good expected rate of return? ›
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.
What is a reasonable return to expect on investments? ›
There's a reason that 12% tends to be used as a benchmark, according to Blanchett. The average historical return from 1926 to 2023 is 12.2%, according to a monthly data set called stocks, bonds, bills and inflation, or SBBI.
How much should an investor get in return? ›
However , a common range is between 20 - 30 % of the company 's profits . This means that for every dollar of profit the business makes , the investor would receive 20 - 30 cents . This may seem like a small percentage , but it can result in significant returns if the business is successful .
What is the expected value of an investor? ›
Expected value is a commonly used financial concept. In finance, it indicates the anticipated value of an investment in the future. By determining the probabilities of possible scenarios, one can determine the EV of the scenarios. The concept is frequently used with multivariate models and scenario analysis.
What is a realistic rate of return? ›
As a result, keeping a realistic rate of return in mind can help you aim for a defined target. Many consider a conservative rate of return in retirement 10% or less because of historical returns.
Most companies use a 12% hurdle rate, which is based on the fact that the S&P 500 typically yields returns somewhere between 8% and 11% (annualized). Companies operating in industries with more volatile markets might use a slightly higher rate in order to offset risk and attract investors.
What is a good overall rate of return? ›
A good return on investment is generally considered to be about 7% per year, which is also the average annual return of the S&P 500, adjusting for inflation.
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.
What rate of return should I expect from S&P 500? ›
Bottom Line. Since 1957, the S&P 500's average annual rate of return has been approximately 10.5% (through March 2023) and around 6.6% after adjusting for inflation.
Is a 7% return realistic? ›
While quite a few personal finance pundits have suggested that a stock investor can expect a 12% annual return, when you incorporate the impact of volatility and inflation, 7% is a more accurate historical estimate for an aggressive investor (someone primarily invested in stocks), and 5% would be more appropriate for ...
Is an 8% return realistic? ›
As a result, the 8% rate of return is a surface-level indicator of the investment's performance. In an environment with high inflation and taxes, your real return could be next to nothing. That said, investments can still be an excellent source of retirement income.
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.
