Minority investment: growth capital, founder liquidity and control

In short: A minority investment can put new money into the company (primary), pay the founder for existing shares (secondary) or mix the two, and the mix changes what the business and the founder each receive. Price is set by the pre-money valuation; dilution follows from it. Control is set by the governance terms, whatever the percentage: a 70 per cent owner with an investor holding reserved matters does not have unrestricted control. The investor arrives with a view on future funding, incentives, dividends and the route to exit, and alignment on those matters more than the headline valuation.

Primary, secondary and mixed

Primary capital is new shares issued by the company for cash that goes into the business: to hire, build product, acquire or fund working capital. The founder is diluted and the business is stronger.

Secondary proceeds are payments to the founder for existing shares. The business receives nothing; the founder receives liquidity, and the investor receives a stake in a business that is exactly as well funded as it was.

Mixed transactions combine the two, and the proportion is a negotiation. Investors generally prefer primary, because their money then works inside the business they have valued. Founders often want some secondary, because years of personal exposure are concentrated in one asset. Both are legitimate; the point is to be explicit about which is which, because they have different effects on the business and on the founder’s position afterwards.

Valuation, dilution and the terms that matter

• Valuation. The pre-money equity value is what the investor agrees the existing business is worth before its money arrives. The post-money value is pre-money plus the primary capital. The investor’s percentage is its total payment divided by post-money, which is why the primary and secondary split changes the pre-money for the same post-money and percentage, as the example shows.
• Dilution. The founder’s percentage falls by the primary issuance, and again if there are options, an incentive pool, anti-dilution rights or later rounds.
• Board composition. Who sits on the board, who chairs it, and whether the investor’s director or observer has a vote.
• Reserved matters. Decisions that need the investor’s consent regardless of its percentage: budgets, borrowing, acquisitions, senior hires, founder remuneration, new shares, a sale. This is where control lives.
• Information rights. What the investor receives and how often.
• Future funding. Whether the investor will fund further rounds, on what terms, and what happens if the plan needs more money than expected.
• Dividends. Whether the business can distribute, and whether the investor expects it to or expects everything reinvested.
• Management incentives. The option pool, who it is for and whether it dilutes the founder, the investor or both.
• The route to exit. The investor’s expected timing and form of exit, its drag rights and the founder’s position if the founder does not want to sell when the investor does.

Percentage ownership and governance rights are different things. A founder with 70 per cent and an investor with a standard set of reserved matters cannot borrow, acquire, issue shares, change their own pay or sell the company without consent. That is normal, and it should be understood for what it is before signing.

Two investments compared

One existing shareholder, an identical share price within each transaction, no options, no preference rights and no fees. Both investors pay £3 million for 30 per cent. The figures are hypothetical.

Why the pre-money values differ. Post-money is the same, £10 million, because in both cases £3 million buys 30 per cent. In A, all £3 million is new money, so £3 million of the £10 million is cash that just arrived and the existing business has been valued at £7 million. In B, only £1 million is new money, so the existing business has been valued at £9 million, and the investor has bought a further 20 per cent of it from the founder for £2 million at that price. Investor B is paying more for the business as it stands; Investor A is funding more of its future.

What the business receives. In A, £3 million to execute the plan. In B, £1 million. If the plan needs £3 million, B leaves the company £2 million short, and the founder has that £2 million personally, before tax. The founder in B has liquidity and a less well funded company; the founder in A has no liquidity and a company that can fund its plan.

What happens next. Suppose the business in B later needs the other £2 million and raises it from a new investor at a £12 million pre-money valuation. The post-money is £14 million, the new investor takes about 14 per cent, and the founder’s 70 per cent becomes about 60 per cent. The secondary proceeds taken at the first round have cost ten points of ownership at the second, and a second investor has arrived with its own reserved matters. Secondary can still be right. The arithmetic should sit beside the decision.

Neither investment has identical economics for the founder or the business. The right one depends on how much the plan needs, how much personal liquidity the founder needs, and what each investor brings beyond money.

Alignment, exit and restrictions

The investor is buying a return, and the return comes from an exit. Before signing, agree in writing what the investor expects: the timing it has in mind, the kind of buyer it expects to sell to, whether it would support the founder buying it out instead, and what happens if the founder wants to keep going when the investor wants to sell. Agree how further funding will be handled and whether the founder can take further secondary later. Understand the restrictions on the founder: service agreements, restrictive covenants, leaver provisions that can apply to a majority holder too, and consents required to sell shares. The specifics are a matter for legal advice in the relevant jurisdiction; the principle is that the terms should be read as a description of how decisions will be made for the next five years, because that is what they are.

What to do next

Decide what the business needs, what you need, and which kind of investor fits both. Then compare proposals on pre-money, primary and secondary split, governance and exit expectations, as well as on the headline. Rollover equity covers the related case of taking shares in a buyer’s group; building value covers what an investor will be looking at. We advise on investments as part of our strategic advisory work.

Written by Rick Palmer and Rob Reid, founding partners of Motion Advisory Partners. General guidance, not advice on any specific business or transaction. Legal and tax points vary by jurisdiction and should be checked with appropriate advisors.