equity, founder, co-founder, profit-sharingWe are a startup company with 3 founders, and almost 2 years of activities, and now we want to split the shares/equity.
The activities that have been done can be categorized:
These activities are all done by the 3 founders up to now. The shopping person, for example, might be the CEO as well! The man-hours spent on each category, and each work is recorded. Also, the regular daily hours spent by each founder is like this:
(However, it will change in the next year. Also it was different at the beginning.)
Now, here are the questions:
Thanks for your time and help.
P.S. I studied the Joel’s guide here. It was well-written and truly helpful; but I felt like I haven’t got all my answers yet!
In my answer, I am assuming that you do not have any revenue yet or “actual value” yet. That means that any value, or equity, is theoretical in nature.
You’ve done a good job splitting up duties, and it sounds like you know how many hours each founder has worked. Question 1 can be answered pretty cleanly. Based on what you’ve stated, a clean split of 33% does not seem practical. To answer question 2, yes, you must assign a theoretical value to each of those categories.
How? Think in terms of each category’s contribution to the “material value” of the product/service you are creating. If you do not assign values to those categories, it is not truly weighted. I think this is a fair method, but doing so can become very arbitrary. Such values can more easily be agreed upon and assigned while the work is being done.
Contextually, it is difficult to answer your 3rd question. I would say shares/equity over salaries. This really depends on whether all of you are continuing forward with the business, or if some of you are moving on to other things.
To answer question 4, your weighted measurement for what each founder’s contributions are worth should look in terms of time, money, effort, opportunity cost, and value creation. So, effort, opportunity cost and value creation are metrics I would add to your list. In economics, opportunity cost is any foregone opportunity given up to pursue A over B. That means money and time invested, but also what they could’ve made working or otherwise produced with the time spent.
How do I measure value creation? Think of the work that was done through qualitative and quantitative lenses. What work could’ve been done by anyone, and what could not have? My advice is to rate the categories on the following qualifiers:
If you can hire a man on the street to go shopping, for example, that is lowest in terms of value creation. Such work would be dollar for dollar, hour for hour.
The tougher question comes in valuing the idea, your question #5, and whether that person deserves an ‘X’ factor value for bringing it to the group. I would rate the idea on its value, and whether you believe it is inconceivable by the majority of the population. Measure the value of an idea like this:
In my opinion, there is a trite belief that “an idea is just an idea”. Some ideas are half-baked, but a small percentage of ideas come from highly creative visionaries. Creative expertise is one of the hardest skills to place a value on. If you’ve got a visionary, make sure to treat them appropriately. They might just be a secret leader. It sounds like you might have a good thing going, so just try to be fair and humble.
I propose the following.
Set an arbitrary target value for the company. It doesn’t matter what number you pick, the market will eventually correct any undervaluation or overvaluation. For this example, let’s choose $3 million since that is the market value benchmark I am familiar with. So let’s say the company has a target future value of $3 million.
Select a Full Time Equivalent (FTE) level of compensation for each co-founder. For the sake of this example, let’s say the FTE compensation for each co-founder is reflected by the following table.
Founder Compensation
------- ------------
A $ 100,000
B 75,000
C 50,000
Figure out the actual hours of contribution for each member. This can be tricky. I propose using the honor system with a shared spreadsheet (like Google Sheets) for transparency. Each co-founder logs their hours each week. And every other co-founder can see how many hours each logs. Compare that to their contributed work product to the company for the past week and you have a checked and balanced system. (Within reason).
Multiply the FTE hours actually worked (and logged) times the agreed compensation level in Fig. 1. to determine the dollar value of the compensation owed to each co-founder.
Authorize a certain number of shares to be allocated (but not yet issued). In this case, since the target future value is $3M, let’s say you authorize 3 million shares. So the share price works out to be one dollar per share. (Again, your choice for the number of shares to authorize is arbitrary in the sense that it doesn’t matter how many shares you authorize because the market will self-correct the share price later.)
Issue the shares. Now that you have a dollar value for the share price and a dollar value for the amount of compensation owed to each co-founder, simply allocate to each co-founder every week the number of shares that makes the dollar value of their shares equal the dollar value of the compensation owed. You can do this each week and fully transparently on the same Google Sheet described in the above step numbered 3.
Continue with this method until you get a professional investor to invest real money. At that point, you will have a pre-money valuation that you can use to self-correct and adjust your cap table to the pre-money market valuation you will receive at he time of or just prior to funding.
Note this method can be used to compensate anyone who invests cash prior to a professional investor making an arms-length investment and valuation. However, there is a hazard in so doing in that anyone making a cash investment will bear the risk of an overvalued company in step one. And the company will bear the risk of an undervalued company in step one. So everyone should be aware of this and, if stock will be traded for cash prior to a professional valuation, care should be taken to determine the company’s value as accurately as possible at that time. That’s why I chose $3 million for the example. At the time of early state financing, that is a typical benchmark. However, prior to that time the company would naturally be worth less since it is presumably gaining value with each passing week as the co-founders work on developing the company’s ideas and products.
All content is licensed under CC BY-SA 3.0.