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A Different Risk–Return Relationship

Author

Listed:
  • Aydin Selim Oksoy

    (Department of Management, Marketing & Entrepreneurship, Barney School of Business, University of Hartford, West Hartford, CT 06117, USA)

  • Matthew R. Farrell

    (Department of Management & Marketing, College of Business, Austin Peay State University, Clarksville, TN 37044, USA)

  • Shaomin Li

    (Department of Management, Strome College of Business, Old Dominion University, Norfolk, VA 23529, USA)

Abstract

We challenge the widely accepted premise that the valuation of an early-stage firm is simply the capital invested (USD) divided by the equity received (%). Instead, we argue that this calculation determines the break-even point for the investor; for example, investing USD 1.0 in exchange for a 10% equity sets a firm-level free cash flow target of USD 10.0, resulting in a 0% return for the investor. The design of our study is that of a descriptive analysis of the phenomenon, based on three assumptions: that angel investing is a two-issue negotiation, that negotiation positions are communicated sequentially from capital to equity, and that the capital is fixed to a strategic trajectory. We note that when pausing the negotiation once a strategic trajectory (and thus capital) has been defined, utilizing the break-even point as the main reference point provides a structure that can serve as a guiding barometer for negotiators, as they evaluate their options across the full range of equity greater than 0% and less than 100%. We draw attention to the diminishing benefit of the marginal equity percentage point [diminishing at a rate of (−1/x 2 )] for the investor to break even on their investment. This relationship tracks to the equation [value = 1/equity], which presents the full option set for any offer, once the capital is determined. Our study provides the practitioner with the subtle benefit of situational awareness and the scholar with a logical foundation for future research.

Suggested Citation

  • Aydin Selim Oksoy & Matthew R. Farrell & Shaomin Li, 2025. "A Different Risk–Return Relationship," Risks, MDPI, vol. 13(2), pages 1-27, January.
    • Handle: RePEc:gam:jrisks:v:13:y:2025:i:2:p:22-:d:1578435
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    References listed on IDEAS

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