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How to calculate the equity with a partner who came up with the initial idea before?

Hey guys, I joined my friend on his idea, he come up with it earlier, we agreed to pulley for a patent for it, it is still in the idea stage, but we will work together on the prototype to get the patent, and make the fund raising for it.
so my question is how to split the equity between me and him in a fair way.

Regards & Thanks

25 Replies

John Seiffer
10
0
John Seiffer Advisor
Business Advisor to growing companies
He won't want to hear this but I would split the equity based on the work you each do or have done, not value the idea at all.

Let me explain. There are 2 types of ideas. One where the expression of the idea is all you need. Things like "I have an idea of a facebook for cat lovers who also enjoy beer." Those ideas are most prevalent and are worth nothing. If you had that idea, so did 15,000 other beer/cat lovers. It's the execution of these ideas that brings value - if you can actually make the thing and (more importantly) get traction. Remember, Zuckerberg's idea was not novel. Harvard U did it on paper, myspace and others did it on the internet. But he executed so well and that's what made it valuable. So split the equity based on the work you each do to execute.

The second kind of idea is much more rare. That's an idea of the form "I have an idea how to launch payloads into orbit for 1/2 the cost of current technologies." This kind of idea needs a lot more than just the expression of it. In fact, already a whole lot of work has gone into it before you can even suggest it. If your partner's idea is of this type then indeed give him equity based on the work he's done to get the thing as far as it is and give each of you additional equity for the work you do going forward.

2 other points (though you didn't ask) 1) look up founder vesting and put a vesting schedule into place. 2) None of this including the prototype or patent will be worth much if no one wants to buy it. So put some effort into CUSTOMER DEVELOPMENT before you spend a lot of money or time on building the product.


Jackson Powell
0
0
Jackson Powell Advisor
UI/UX Designer & Front End Developer
Great thoughts and points from John. For more ideas on how to think about the equity question, you have taken a look at this blog article: http://www.thesmallbusinessforce.com/blog/2252/deciding-how-much-equity-to-give---how-much-is-less-important-than-what-its-worth/
Zvi Goldstein, CFA
3
1
Senior Quantitative Analyst | Data Scientist
Mohamad: Ideas are free, and are worth their cost: Nothing. Don't give anyone equity just for an idea. Equity isn't a reward for hard work, it's an incentive to participate going forward. The reason to give equity is because you'll need their thought leadership or dedication going forward. So, you want to split it based on the value that each of you will add going forward, and based how much equity it will take to get you motivated. A 50-50 split is typical and recommended for something in the idea stage. You both should be about equal. If you're not, the weaker of you should leave and a replacement should be found: Startups can't survive with a weak link from the get go. For reference, check out the Founder's Dilemma, by Wasserman. It's a great read on exactly these issues. z
R. Paul Singh
1
0
R. Paul Singh Advisor
Entrepreneur, Advisor, Get things done
John said it well and I would second with this thought - Ideas are dime a dozen and value is created in execution. However I do think if your partner is working on the execution just like you are, he or she deserves a slight edge on the equity - may be 51/49 or even 55/45 if the idea is worth that. This is also assuming that both of you will be vesting over the life of the company per the same plan.
Alex Baldocchi
0
0
Alex Baldocchi Entrepreneur
Brand and Digital Marketing Strategist
Hi Mohamad, Everyone can come up with an idea - the truly difficult part is the execution/marketing stage. You have to have a clear understanding of the "division of labour" with your partner if the equity is split evenly between the two of you. Good luck. Alex
Rohit Giri
0
0
Rohit Giri Advisor
Experienced Corporate Finance and M&A Professional
Mohamad, You can find many founder equity calculators online. I've had friends use them in the past to success. Rohit
Thomas Jay
1
3
Thomas Jay Entrepreneur
iOS / Server Architect / IoT / BLE / iBeacon / Apple Pay
I think its simple.

The idea is the most important part. He should keep 100% and pay you for all the time you put in.

If he wants you as a partner then you should get 50% as a partner, being a partner has nothing to do with the value of his idea which could be worth $1B, you really don't know. Has anyone offer him a suite case full of cash for the idea?

Most ideas that are worth lots can be sold, other ideas can be worked on and products made out of them, this can be called "Execution", this is where the partner adds their value. You try to get "Traction" which really just means getting paying or valued users to a level that the company is now worth money.

If the "Execution" has no value then you should not get any stock and you are not needed, he should just sell the idea and take the cash.

In over 40 years, I have never seen an idea that was sold without some level of "Proof of Concept" which means someone had to provide some level of execution. This can be done simply with money, pay someone to make the product and get the initial marketing / traction, then its all owned by one person.

If for some odd reason there is no money for this then the idea person needs to find a partner. The partners needs to have respect for each other. If one is at 10% and another is at 90%, this is not a partnership its an employment so if you are getting stock for work then its just another deferred payment scheme. There will be taxes on this as well.

I get contacted by over 100 "Idea" people every month, some have good ideas, some have great ideas. I have spent hundreds of hours working on projects for a 50/50 partner ship. When people ask me to work for stock and offer me 1%, I just walk away, if people do not value my skills then its not worth my time.

If you work for stock, you normally have some form of vesting, this is a cool way to not give you stock. If you have a one year cliff and then fully vest over 4 years that means you have to work there for 4 years (even if its without pay) befor eyou vest. If there is a 1 year cliff before you get 25% and you have to leave and get a job after 10 months, you get NOTHING. Pretty cool way to get free labor, I see this all the time, people try to take work they have done for someone else and say "They did not pay me" but when you look at the contracts you clearly see that the work is owned by the corporation and the person have no ownership writes, they had the option of stock based on the vesting agreement.

So to answer your question, if its just the two of you then I think it should be 50/50, no vesting, just do the corporation paper work or sign a letter of intent (get someone who knows more then me involved for all this).
Jacques de Cock
2
0
Jacques de Cock Entrepreneur
Partner at CQRS
Yes ideas are free, but a good idea is invaluable.

The key is what you both need to be able to go forward without spending too much time negotiating and bickering. So the key determinant I have found works is what both of you are comfortable and genuinely happy with.

A long time ago my Entrepreneurship lecturer during my MBA exchange at Berkley, who had generated for himself more than $100m of exits (in 1987!) said most venture fail because of greed and over evaluation of one's own contribution and under evaluation of the contribution of the other.

Just like an idea is worth nothing neither is a company if it does not succeed. The more you can look forward and develop together the more chances you have to succeed. Even then there is an 80% chance nothing worthwhile will be created. So go forward you can always adjust contributions through salaries, options, etc.
David Austin
0
0
David Austin Entrepreneur
Entrepreneur
Standard royalty rates for inventors is 5%. Depending on the product, volume, and market it can go down to as low as 2%. It rarely goes above 6%.
It's your idea too if you contribute to the patent if your contributions are essential to the proper functionality (which essentials you'll want to keep minimal and as generic as possible for the strength of the patent, but still new and novel enough to stand up in court). Be sure to factor in that contribution. Another thing to factor in is how committed was he to the project before you bought into it, if he was not too committed but with your help now he is, then you own again a larger portion of the idea. Have these discussions. A great idea without commitment really is hardly worth anything no matter how great. If he was already well invested into it, worked out most of the details (or knew how to do that, including finding the right people in that domain), and was intending on getting a patent ... then it's pretty much his totally, and depending on how good of an idea it's up to him to set that, and negotiate something that you agree with. Nobody here can tell you what the idea is worth, nobody. That's between you and him. Know that the execution is worth far more than the idea, and if he wants a serious part of this he needs to provide serious execution.

That's if he is earning royalties on the income. If he wants equity then you might want to base that on his execution. In that case his idea give him no advantage to the slicing pie scenario. That's what I recommend.

If he doesn't want royalties, but only equity, then things get tricky. Too many factors to tell without knowing more about the business. You can give him 5% of non-dilutable shares of the company for the idea. It doesn't sound like much, but if the company goes huge ... well 5% eventually becomes ridiculously huge if they are non-dilutable. To start with, the remaining 95% of the company you can split based on execution between you (say 47.5% each if you plan on giving equal parts). Might want to use a slicing-pie method for that. That 95% is the dilutable part of the company, as you will need that in order to grow and attract investment.
Matt Celuszak
0
0
Matt Celuszak Entrepreneur
Bringing Emotions to Life
Hi Mohamed - you need to understand the value of the IP contribution to understand your equity split.

I run a company in a VERY IP based industry and my suggestion here is to still build the prototype, get early adopter feedback and then ask the patent question. Then discuss equity. I did this specifically to set contribution metrics as well.

Starting a business is about taking a risk and if we failed early on, I held the risk. As we grow, my co-founders hold more risk so they go up in share options and I go down to a level out point. But all equity is earned.

For now, I don't think you are there yet as equity relates to contribution. IP contribution is unknown as the market value is unknown. So, you simply don't have enough information to answer this question.

Does the IP even solve a customer need? How big is the market? Is it replicable? How quickly can you prototype it? Who's prototyping it? Who's raising the cash? How many more people do you need as the core team? Do they need equity as an incentive? What's your plan with the IP? What's your plan with the business? How will you exit?

Until you map that out, you can't assess contributions of effort and IP.

+ Zvi - don't give equity away unless you have to, especially not for an "idea". The hard work hasn't even started yet, so map out targets to determine effort and risk which will support the equity discussion.
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