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How to value a company pre-revenue to give out equity for partners?

I am building a new mobile platform and in the process of bringing on partners.. i am trying to figure out how much equity to share and at what value .. and trying to figure out a way to create valuation.

17 Replies

Steve Jones
2
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Steve Jones Entrepreneur
Founder & Principal at Cayoosh Consulting
Check outhttp://slicingpie.com/
Dimitry Rotstein
3
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Dimitry Rotstein Entrepreneur
Head of R&D at SafeZone
Normally, at such an early stage it is not about valuation, but rather about contribution. Each partner should get percentage that reflects their contribution to the project (say, in terms of time, skill set, contacts, and/or self-financing). There are various formulas that try to do that, but they often give different results and contain subjective factors.
In my experience, in the end it always comes down to negotiations - all potential partners decide what percentage they will feel good about.
In any case, I would suggest not to get cheap on this - good partners are hard to find. Remember that there is a ~90% chance that you will fail and these percentages will become meaningless, and if you do succeed and get millions, then does it really matter if it's one million more or less?
Chuck Blakeman
1
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Chuck Blakeman Entrepreneur
Founder, Chief Transformation Officer, Crankset Group
Steve's reference is to slicingpie.com - But I'm not sure it is useful, as it appears to put a big emphasis on how much time someone invests, which should be a minor or even non-factor. Equity splits should be based entirely on results driven. If one programmer can get stuff done in 2 hours that would take the next one 20 hrs, he/she's worth a lot more. In the emerging work world, results-based incentives should replace time-based incentives across the board, with Stakeholders as well as stockholders. bit.ly/1GH2GJ1
William Agush
0
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William Agush Advisor
Founder and CEO at Shuttersong Incorporated
Not sure why you need to establish a valuation as they aren't making an investment. The value is just the par value of the shares. You need to decide what % of the founders common you want to give them. Make sure you document this equity properly as RSUs so they can exercise at par value and file their 83b election. Get advice from a lawyer.
Jessica Alter
0
0
Jessica Alter Entrepreneur • Advisor
Entrepreneur & Advisor
Really important to do a search on FD before posting, there are a ton of good discussions on this already and you should follow the valuation topichttp://members.founderdating.com/discuss/topic/Valuation
Gray Holland
0
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Gray Holland Entrepreneur • Advisor
founder / director at UX-FLO
Ya, I just read Slicing Pie -- its a nice try at creating a fair value system for calculating "pie" dynamically. I'm sorry to say that its approach is too simplistic to be useful.

In the end you need to come up with a formulation that works for everyone involved -- it must be fair and openly agreed upon. One important note is that it is atheoreticagreement of valuecalculationto be executed in thefuture. It is not "real" value allocation (that would trigger taxation). And yes, you need a lawyer to be clear.
Mike Moyer
4
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Mike Moyer Entrepreneur • Advisor
Managing Director at Lake Shark Ventures, LLC
Hi Sathish, Trying to value a pre-revenue company is futile and pointless. An equity split based on a made-up valuation is just a random guess and is guaranteed to backfire when people realize it's unfair. The only way to ensure a fair split is to use the Slicing Pie model which is based on a simple principle: a person's share (%) of the reward should equal their share (%) of the risk. When someone contributes time, money, ideas or anything else to a startup company they are taking a risk that they will never get paid. The amount of that risk is equal to the fair market value of the contribution. Fair market value, unlike future value, is easy to observe and measure. The fair market value of a person's time, for instance, is equal to the salary they could get if they took a job. It's only fair that a person's portion of the future profits or sale of a company should reflect their portion of the risk. Think about it this way: if you and I each bet $1 on the same hand of Blackjack we would each deserve 50% of the winnings because we each bet 50% of the total bet. If we were dealt two aces and we split the aces and YOU put down $2 more, you would now deserve 75% of the winnings because you made 75% of the bet. You don't have to know the "value" of the winnings to know this. You just have to know the bets. It's the same for a startup. Simple measure each person's bet and allocate equity by dividing their risk by everyone's risk. I've written a book on this topic. You may have a copy if you contact me through SlicingPie.com -Mike
Jessie Harris
3
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Jessie Harris Entrepreneur
Strategy | Operations | Program Development
This addresses only half of your question, but here's a helpful article re: placing a $ value on "sweat equity" -- written by someone I really trust: http://www.entrepreneur.com/article/182440
Scott McGregor
0
0
Scott McGregor Entrepreneur • Advisor
Advisor, co-founder, consultant and part time executive to Tech Start-ups. Based in Silicon Valley.
Project your next month revenues. Get comps of similar public companies vs. their previous year's revenue (e.g. 3x). That's a reasonable guess about what your company will be worth next year if you are on target. There is some high probability you will fail and lose everything, some probability that you will sell less than forecast, and some probability that you will earn more. The expected value of your company is the weighted sum of all those probabilities times their values. For sake of illustration let's say that there is a 50% chance sales will be $0 and 50% chance the company will sell an average of $1M. Take the weighted average and you get an expected value of sales of $0.5M. Multiply that by the industry multiplier (e.g. 3x) and you get an expected valuation of $1.5M next year. Technically you should adjust this by the time value of money based on current interest rates. If the values of the payoffs were well known you definitely should adjust for that, in this case the errors in size of next year's sales, the probabilities, and next year's multiples probably swamp the interest rate corrections so we are only getting a stake in the sand estimate for a negotiation staring point. In the end you might adjust that estimate to get agreement between both parties. But at least you now know a way to find a starting point for negotiations. Scott McGregor, [removed to protect privacy], (408) 505-4123 Sent from my iPhone
Dimitry Rotstein
1
0
Dimitry Rotstein Entrepreneur
Head of R&D at SafeZone
@Chuck Blakeman,

You're right - the amount of time dedicated to the startup is a poor indicator of contribution.Unfortunately, everything else is even worse.

Splitting equity according to actual results is fatally dangerous, because you can't possibly know these results in advance, and trying to split the equity after the fact will create a conflict in 99.9% of cases, with a 99% probability of breaking up the team and 90% of killing the startup (the figures are guestimates, but that's the order of magnitude). The whole point of the founders agreement is to agree on everything in advance so as to avoid the conflict situations.

And trying to estimate the contribution of each member in advance, based on their resumes or something is even harder than trying to valuate a pre-revenue startup. Besides, how exactly can you compare different contributions? Suppose, co-founder A wrote 500 lines of code per day, co-founder B generated 50 leads per day, and co-founder C raised the seed round. Who's contributed more? By how much? I have no clue.

Like it or not, the time dedicated to the project is the only objectively measurable parameter (at least in most cases). I learned that after trying other things and having them exploding in my face. Besides, if one co-founder clearly produces much less useful results than the others, then the solution is not to give him/her less equity, but to kick him/her out and find someone better. That's why we have vestings and cliffs and all that.
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