Conversation: Talking about the fitting return limitation 

When setting a return cap, you might hear very different reactions. One person might look at the proposed cap and exclaim, “What? That’s way too high!” while another, reviewing the exact same terms, says, “That’s far too low – I wouldn’t even consider it.” We’ve experienced such mixed responses firsthand and they show just how subjective and open the concept of a “fair, risk-adequate return” is. So, the goal of the conversation around the right height and cap method of the return for investors is to see whether there is a return that works both for the investor’s and company’s needs. Ideally, you manage to actually have a conversation that doesn’t revolve around “how much is possible” but around “how much is needed, realistic and risk-adequate”.

 

Points that are crucial to get across here are: 

• What matters is not the company’s theoretical value, but what feels fair and proportionate to the risk for both company and investor. The return limitation where expectations meet is the return that the investors will receive. 

• The company as a whole cannot be speculatively sold anymore/ will not be sold speculatively so an exit where the return stems from selling the company as a whole is not on the table for discussion.

• Agreement in such a conversation can also manifest in defining a process how the valuation will be calculated and how company and the investor can end the investment relationship in the future.

To get there, the general concept of how investor returns will be structured in the investment structure ( → not unlimited, in some form capped, risk-adequate) should be clear to investors. This might be automatically so due to the financing instrument or return limitation you have already proposed in your pitch deck – or might be your starting point of the conversation.  

 

Possible conversation topics

• What return on the investment do the investors need to fulfill their own and their stakeholders needs? Why? 

• Which limitation would feel fair for the investors? For yourself? Why?

• What would be a great return outcome for the investors? For yourself? 

• For different return scenarios, discuss that the money will need to come out of the cashflow that the company generates (at some point in the future), to put the return for investors into perspective. Talk about the realism of the company being able to redeem a certain investment return in the future.

• Which cap mechanism would make sense and feel healthy and fair for both sides?

 

For some investors, the concept of multiples on investment is a great place to start understanding the investment potential; for investors talking about the interest rate on the investment might be more adequate. It can be helpful to try to bring your envisioned return into their language and talk about the relevant reference points for the investors. E.g.: Why is investing in you a better case than putting the money into the bank? How does an investment in your company compare to a typical VC or PE case in return height and risk?