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The Question about Equity?

Some background:
  • Idea is my own. Registered as a patent pending.
  • I have been working on this full-time since Jan.2015
  • Completed
    • Business requirements
    • Software dependencies
    • Wireframes/Interactive Mockup
    • Websites, Profiles, and presence.
    • Feasibility test
    • Beta testers lined up
    • Starting to develop the prototype.
Leading up the my Question:
Good news, I am getting more and more traction on cofounders joining my firm.

The conversation after interested in joining, comes the inevitable equity question.

I am anticipating to have three to four cofounders.

Each with their unique skill set.
  • Technical CoFounder
    • Still searching
    • Found a technical advisor
    • This person will have the ability to lead technical teams or/and drive the vision from the technical viewpoint.
  • Investor CoFounder
    • Found
    • Person that has the network of investors
    • Person knows the appropriate steps in starting a business
  • Marketing CoFounder
    • Just Found!
    • Person with the branding skill set with a fashion forward undertone.
    • Able to articulate clearly, cleanly, and concise.
Question:
Knowing all this, what are the best practices in offering equity?

Option 1:
  • Founder - 51%
  • Tech CoFounder - 16.3%
  • Investor CoFounder - 16.3%
  • Marketing CoFounder - 16.3%
Option 2:
  • Founder - 25%
  • Tech CoFounder - 25%
  • Investor CoFounder - 25%
  • Marketing CoFounder - 25%
Additionally, what is been used in the past to make incentivized them to endure the startup growing pains?
  • Standard investment agreement?
    • Tiered percentage equity model that the ownership of the firm will increase over time?
  • Performance based agreement?
    • Increase of ownership as time and performance of engagement? To make sure they are pulling their weight?

Conclusion:
I know this is an interesting subject that can many ways depending on the situation. Hopefully, I had conveyed my story to shed some light on my current problem. Good problem to have, but, I want to be fair. Even thought its my own idea, there is tons and tons of work that needs to be done.

Thoughts?



10 Replies

Rohit Paliwal
1
0
Rohit Paliwal Advisor
COO @ Uvaca, Inc.
Some thoughts..

1) It's not clear what value other than connecting you to investors the "Investor Co-founder" is bringing, and if that person should rather be an Advisor/Investor. As an Advisor you can give him/her <2% equity, depending on the overall value that person is bringing.

2) Option 2 is an absolute no-no in my opinion. Option 1 is valuing all co-founders equally which doesn't seem right.
A 3rd option could be:
You (Founder): 40-45%
Tech Co-Founder: 25-30%
Marketing Co-Founder: 10%
Investor Co-Founder: 5-10% (if providing enough value), else 2% as Advisor
Option Pool: 10-15% for any other hires at this stage so that you're not diluting on day one (except for investments).

3) Everyone should vest over 4 years with 1 year cliff, except perhaps you since you've been working since Jan 2015 so you may start with a 5-6 month cliff and 3.5 year vesting.
Jake Carlson
2
0
Jake Carlson Entrepreneur • Advisor
Software Development Manager at Oracle
Neither. S-L-I-C-I-N-G P-I-E. I agree with Rohit though about NOT giving founder status to someone just because they know some people. It's all about continually bringing value (and hard work) to the table. The idea might be worth somethingin terms of a royalty in the Slicing Pie model (but not much), and everyone's connections might be worth somethingin terms of maybe awarding commission for deals that result (but again, not much).
Michael Masello
0
0
Michael Masello Entrepreneur
Digital Marketing Professional
Agree with both on the longer-term role for the investor function.

I'm glad you presented two disparate options. #1 is what a lot of founders seem to want, but for someone joining a business pre-launch with less than a year of research and development put in it's way too lop-sided.

Think of it this way: say you and your founding team stick this out for 7 years. They all join at month 6. You will have put in roughly 7% more time than them, but in scenario #1 are commanding 319% more equity.

I also recommend checking out Slicing Pie by Mike Moyer. You will likely find a balance between #1 and #2, much closer to #2.

The good news is you're putting together a team with a well balanced set of skills.

Best of luck.
Karl Schulmeisters
0
0
Karl Schulmeisters Entrepreneur
CTO ClearRoadmap

You aren't funded yet. Decide what percentage of the company you are willing to give up for what level of investment. Set that aside since that would be the initial dilution anyway.

Now split up the rest. That way the initial round of funding has them come in as partners rather than as dilution to everyone else

Rohit Paliwal
1
0
Rohit Paliwal Advisor
COO @ Uvaca, Inc.
@Karl regarding "Decide what percentage of the company you are willing to give up for what level of investment. Set that aside since that would be the initial dilution anyway."

In principal I totally agree with this, however I've seen a practical issue depending on whether or not the people you're working with are savvy/comfortable with concepts of equity/dilution/option pool/etc.

For example, with 2 people, with a 60-40 split and 30% investment there are two options:
1) Initially set aside 60%-40% and then on 30% investment dilute to result in 42%-28%-30%
2) Initially do 42%-28% and then when funding is raised then there is no dilution.

Most people seem to prefer the 1st option since it just seems easier to comprehend when the pie is full 100%. Of course if the co-founders are savvy enough then #2 works much better.
J William Moore
0
0
J William Moore Entrepreneur
Publisher: EV World. Founder & Interim CEO of QUIKBYKE
Similar question came up this week for my startup, Quikbyke. I am looking to raise $25K in five $5K increments. With that I hope to win a local 2:1 matching grant, which would give me $75K to build our first Qopod prototype e-bike rental popup shop (http://quikbyke.com). Because we're pre-revenue, the question is how much of the company do I give those five early investors? 5/25 or 5/75 or 5/X where X = projected (bluesky?) Year 3 revenues? My gut tells me it shouldn't be more than 2-5% per investor. I want to keep a lot of the outstanding value available for future employee shares based on my belief that they add as much to the value of the enterprise as the investors.
Mike Moyer
0
0
Mike Moyer Entrepreneur • Advisor
Managing Director at Lake Shark Ventures, LLC
Slicing Pie was already mentioned (thanks Jake!), it will solve 100% of your equity problem. The model will allow you to not only allocate exactly the right amount of equity, but also it will allow you determine exactly the right buyout price if someone leaves the company.

The options you listed will both cause problems. Not just because the amounts are wrong, but because the amounts are fixed. So, when something changes or someone doesn't do exactly what you think they are going to do you will be stuck with these allocations. Changing them means legal paperwork and painful renegotiation.

The Slicing Pie model is dynamic, meaning that it self-adjusts over time to make sure it's always perfectly fair.

Most models, such as the options you listed, are based on rules of thumb, industry "standards", guesses about future value and promises of future contributions. All of these things are impossible to predict with any level of accuracy.

The Slicing Pie model is based on relative risk. When a person contributes time, money, ideas, inventions or anything else to a startup they are essentially making a bet on the future outcome of the company. The value of that bet is equal to the fair market value of the contribution. The Slicing Pie model is a formula for understanding one person's bets relative to the other people's bets.

Vesting is a way to mitigate the damage caused by fixed splits. It is unnecessary in the Slicing Pie model.

I've written a book on how to implement the Slicing Pie model and you may have a copy if you contact me through www.SlicingPie.com

-Mike
Peter Johnston
0
0
Peter Johnston Advisor
Businesses are composed of pixels, bytes & atoms. All 3 change constantly. I make that change +ve.
"Writing a plan makes you feel in control of things you don't actually control" Jason Fried

We were trained in the industrial age to think in terms of fitting people to roles, not the other way round. This was based around factory jobs where a person had to interface with an inflexible machine.

Even in that age it was the wrong way to hire knowledge workers. The person who knew a lot about how to do X, but was hired to spend their life doing Y was likely to be unfulfilled and to produce a worse result for the company than someone who had a passion for Y. When you multiply that up to, say, 5 skills, you realise that 20% or more of most people's potential was wasted.

It most certainly has no place in a modern startup.

I liken it to internet dating.
There are people who create a complete checklist for the person they are looking for.
They've defined themselves and their ideal partner.
Those people fail - bigtime.

There is one thing which must unite the founding partners - passion.
There is a second thing which is vitally important - availability.
And a third - financial expectations.

Everything else must fit around these.

By deciding "I need a co-founder CTO or CMO with skills X, Y and Z" you set an impossible task.
By sharing your idea and attracting people who want to help, your chances for success are far higher. They will have passion and availability.

Then look at the skill sets and see who can run with what. How the skills overlap, where the gaps are (including yourself). Who could learn and grow into a role. Who has a passion for which area. And don't restrict yourself to four founders, or even to full-time partners. Take on mentors, advisors, people who'll help part or full time or even just pass your leads. And build a team with overlaps so when one drops out it doesn't kill the project. You're after a buzzing community of ideas and people who can make them happen, not an industrial corporation with fixed roles and a blame culture.

But don't forget the financial expectations. You are trying to trade off real time dollars today against a lottery ticket on the future. You are giving away a large portion of the money you can make because you want to attract the best people but can't afford to pay them.

So put funding higher up your agenda. Find a way to get enough money in to pay people, rather than give away equity. And certainly don't give it away on an arbitrary basis.

If you really need this person who is part CTO, part marketing and part whatever else, then offer what it takes to get them on board. Then fit the team around him/her.

If you really need an investor they are in charge. You don't dictate the equity - they do.

One last thing. John Cleese put his success down to rejecting the first funny thing he thought of and working toward finding the deeper one - the one others hadn't thought of. The same applies with startups.You are aiming to find the people who really make this fly. The difference between the best ones and the normal people you find everywhere is probably an order of magnitude on the bottom line - a billion v a million.

Are you really going to cut this super guy who will transform your startup off, just because you will only offer 16.3%? Are you really going to turn down several million in investment because they want 20% instead of your 16.3%? Of course not. So why create these rules for yourself in the first place - it will only make you dissatisfied and insecure (I gave away more than I should have so I'll have to make it back on the next hire).

My rule is simple. Leave 80% for investors (1st, 2nd and 3rd rounds). Share out 20% among co-founders. If they feel the company is going to be big, then that's still good enough to bring them in - 5% of a billion dollar company is still a lot. Only if the company is small, does 30% v 50% matter. And that's not what you're planning - right?
David Ellenbogen
0
0
David Ellenbogen Entrepreneur
President at Professional Decision Making and Owner, Professional Decision Making
In my opinion, the dynamic Slicing Pie model, developed by Mike Moyer, is the best way to go. And, although I am still attempting to redefine it for my unique purpose (Collaborative Adventures), I truly feel that he has engineered the noblest and fairest system for equity sharing. So, if you haven't already, I suggest that you pick up a copy of his book. In a very short period of time, he illuminates the who, what, when and how of Slicing Pie. It's an easy read and a great read.
J William Moore
0
0
J William Moore Entrepreneur
Publisher: EV World. Founder & Interim CEO of QUIKBYKE
Because of this discussion thread I bought the Kindle version of Slicing Pie and am thoroughly enjoying it. It's helping me answer a lot of questions I've had about equity and fund raising for Quikbyke. Thanks, Mike.
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