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Is it OK for investors to demand an annual dividend on their investment?

A Question of the Day

By Services Founder, May 29, 2007  —  5 Comments

My privately-held software services company was offered $1.5 million by an investor for a straight percentage of the firm. It’s our first round of outside investment and it is designed to help us expand our marketing to really lock up the sectors we operate in and expand into some new ones.

We can grok most of the deal terms, but they’ve asked for a 10% annual dividend on their investment, meaning they want to be paid $150k annually.

The investment has a 5 year horizon, so it isn’t as if we’ll have to live with these terms forever, but I’ve never heard of such a requirement.

Is this usurious? It feels like it. Have you seen other deals like this?

Services Founder About Services Founder
I'm a first time entrepreneur who hit it big with my interactive services company. Operating in a niche outside of traditional marketing, we've grown to $10mm+ revenue annually, and over 60 people. We focus on online cause marketing and other traditional interactive services for non-product related campaigns.


Talk About This Story

Mads Kristensen Mads Kristensen
(2 points)
May 29, 02:05 pm

I think it sounds awkward. To me they’re basically asking to get a percentage of the company for half of what they’re willing to put up and let yourself pay them the other half in dividends. Furthermore I think a 10 % annual dividend is high, unless there’s some serious risk associated with investing in your company in which case it might be an ok premium.

Sean Byrnes Sean Byrnes
(9 points)
May 29, 04:05 pm

I’ve heard of similar dividends, but they were designed to be paid in equity. In essence, it is a mechanism to slowly increase the investor’s ownership stake in the company over time. It’s a tool by savvy investors to make the upfront seem low but to get a bigger stake later.

I would avoid a 10% dividend situation as it makes it more of a loan than an investment. If you’re paying it back over 10 years, perhaps there is other debt financing that gives you more flexibility with your cashflow over the next few years.

Carleen Hawn Carleen Hawn
(1715 points)
May 29, 04:05 pm

FROM THE OTHER SIDE OF THE WALL:
This comes from a well-known VC on Sand Hill Road, who can’t speak about such things publicly. I post it here for your information:

“10% is high, but dividends are fairly typical, although usually not paid in practice. There is often a ‘when and if’ clause declared by the board in preferred stock terms, but I’ve rarely seen the board actually declare a dividend.”

Babak Nivi Babak Nivi
(50 points)
May 29, 05:05 pm

Brad Feld has a good discussion of dividends here: http://www.feld.com/blog/archives/000328.html

My question to “Services Founder” would be what do the rest of the terms look like? Or who is the firm? That will tell you whether you are dealing with a legit firm or a “vulture capitalist”.

Carleen Hawn Carleen Hawn
(1715 points)
May 29, 11:05 pm

Thanks, Nivi, for the reference to Brad’s site. Perhaps we can get *him* to comment on the topic as he has previously published his views on it. Thanks for trying to keep our content sharp.

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