Equity Splitting for Startups

I wanted to talk about that topic give you some practically practical stuff you can use straight away that isn't in textbooks actually a lot of stuff isn't in textbooks this is stuff I've learned from Investment Banking and I guess it's picked up through learning how to model what companies are worth than how they should sort of develop the crowd capital strategies and so on so the startup dream this is the most important slide of the presentation and that's because everyone is really excited at the start with a start-up and it's super exciting because you've got this huge possibility out in front of you and what happens is you will start to hit things that feel like roadblocks or problems or lack of money and it'll suck the energy out of it and you may lose the passion for it so what I wanted to say is don't feel that that you're not actually in control of that you can take actions with simple modeling techniques and decisions about what you really want out of the business and having a different perspective of what you're doing in your startup to avoid getting into that situation how to handle initial equity stage now this is this one's really important everyone gets into a problem with this in my view you saw what happened if you saw the Facebook movie you saw the drama that core is not getting initial equity locked down properly and we have thousands of startups on our product and I've met lots of the young startups because I'm as part of our futures program we do things like this and we meet startups all the time and it's a really common thing they didn't get the equity right at the start and you get what's called a greedy bone effect so the greedy bone effect is it's all cool at the start when there's no value but you get six months down the track and the business is starting to get some traction and some success and all of a sudden one guy's going on why did I say 20% you know the other guy's got 80% on doing all the work and you're just getting this full-on resentment and before you know the things busted up and it's all over so you want to try to avoid that if you can so the way I'm going to give you the way to do that this is one way this you know I'm sure a guy from Harvard will give you another way in a Gotham City we'll give you another way this is my way I'm not a finance dude even I've spent my life in finance so this is the experience of equity splitting it's unfair it's incomplete it's unstructured there's legal paperwork there's changed contributions over time people put in different levels of work into the venture and unaccounted for contribution so you might leave your job and work in the business but you don't change the amount of equity you got in the business with your partner and it's unfair and you can get resentment and all kinds of stuff comes up so what that looks like is people come to the conclusion that this is what an equity split situation is in a business it's basically work out who's putting in the ideas who's putting in the time and who's putting in the cash and you'll absolutely get the wrong answer if you use this method but absolutely 95% of people use this method so that's why most equity splits are incorrect in my view or aren't as accurate as that could be it's impossible to get it completely accurate to be honest but you can get it close get to a reasonable level where reasonable people will stay in partnership in a vest a group or a syndicate or even if it's just two founders without getting in a whole lot of fights legal or otherwise so people tend to do it on the back of a napkin they start they've got their ideas and they classic thing is Cafe napkin domain names how much money each person's putting in they start working out a few things some people are putting the business idea as my ideas so I should get more for that all this kind of stuff comes up and you might get an answer but it's a pretty much a hack job to getting an answer as to how you split your equity now even if you're going to do this by yourself this stuff is really important because you're going to end up getting an investor at some stage unless you're planning to do a completely organic approaching it on a hundred percent never give any to your staff never invite any other investors all the way to the end and exit which just never happens so good luck with that or you might you might know the big business that doesn't list like this people would have done that to be honest to be fair and a very successful never sold their businesses so I shouldn't say that there's definitely situations and a check actually if you want a stress-free lifestyle it might be a better way so I you know do some stuff on the napkin first to get the thought process going but you've really got to switch into logic and maths and you and the only way to do that is to start dissecting what it is that makes up the equity value of a business and having a spock-like approach to it and I think this is I like this because of like Star Trek I'm not a Star Trek I'm not a Trekkie at all but I like the whole space thing but a very logical person probably a product guy and thinker sales guy you know strategist and that's a classic startup two founders one product one sales to end up in that sort of scenario so what you've got to do is look at a bunch of there's probably ten things to think about the makeup equity value at the start and down the track - in terms of the people you bring in and what you should give them say you meet someone is really good had lots of successes with startups you're sitting there with your other founders saying what do we need to give this guy for equity you know what's he worth that's a really hard question to answer but there's actually an easy way to work it out I'll show in a second so value execution and focus skills much more than ideas that's the first thing to do everyone go straight to the ideas are worth the money but I guarantee someone else's thought it up or come up with some variation of that idea and it's not as valuable as people think and actually the idea you can get in a lot of trouble because if you claim the ideas worth all the money and someone already has a patent on it you go and build out that idea it's actually a liability to the business because you built something someone else has already owned and all of a sudden actually the guy that owns all the equity has got the idea that you're in court about so you can't really look at idea ideas as a value in an outright sense it's okay to attribute value to it but I just think execution is way more important actually winning it the game of the startup is much more about getting stuff done the officer at risk now what this means is that the way we have our society set up is that there is someone who is a risk taker and illegal and tax and privacy and yeah there's a whole ball pile of stuff someone's taking that risk and you can have all the founders be directors and share the risk equally well you might have a senior founder or who owns 80 or 90 percent of the company and you agree that that person is going to be the director and the public officer you've got to attribute some value to that and they should get some equity for taking on that risk because it's hard dollars if you think about it so no way I would go and be the public officer of a company ie I'm the guy the ATO comes after bla bla bla it's no way I'd take that risk on not knowing I'm not getting some reward back for that they're just being saying plenty of small startups do this is one guy taking all the risk is a director public officer company secretary you name it they've got 50 50 shares the other guys so much safer and it's a crazy situation of being so you've got also present value your future time and cash flows so what this means is if you're if you have committed one founder might commit to two years of working for nothing because it'd been in a job and they've got some savings and they paid off their house the other founder might be as a younger person hasn't done any of that can only afford to really do this for six months and then it's got to start paying that person the person that's giving up the two years has to be given some valuation for that in the equity split and think of it also to like it's different earning two hundred thousand and missing and missing out on that because you're going to start up over two years so that's 100 grand a year or fifty grand a year it's very different missing out on that to saving up that amount of money so people make that mistake too people will say I'm not going to earn my 50 grand a year for the next two years so I'm putting a hundred grand in the business no because to put a hundred grand in the business and save a hundred grand you've probably got to work five hundred thousand or eight hundred thousand dollars of value to get that so you've got to kind of Lao for that so that's the foregone salary opportunity costs essentially so the thing to do to at the start of the process is benchmark your ideas versus competitor's IP values so that's about being realistic about what your IP is worth everyone thinks it's pretty much thinks it's worth more than it really is because they're their mind will find ways to say special or different because they're in a state of excitement around the idea which is fair enough but you've got to be realistic about it and go okay another competitors product idea is not as good Minds up here but the reality is for them to get from here to here with a running business and everything in the machine going is probably not a lot of money so you don't want the difference there is actually really the IP value it's not the difference for that competitor to get to there is really the IP value it's not you can't just look at it this and its outright sense so I think of it like another good example is people classic mistake people make around the stock market is that they go they say stuff like Oh stock market's going to sell off because the this huge inflation and it's going to crash and so people get really fearful about stock markets but what they don't realize is stock like us often rally really hard and inflationary environments because when you benchmark the value of your business against another business and it's it's R&D and its assets and so on the opportunity cost of starting business from scratch and buying all the all the stuff at high inflation prices to start their business has to be at parity to the business that's listed in trading so you have to look at them in a similar way and IP is the same you finally go and create that IP in a high inflation environment and it's expensive to do like IT people might cost 200 grand a really good person not a hundred grand the business that's listed has gone up in value by that amount because to redo that is now cost 200 grand so inflation is your friend in IP and we're thinking about relationships and health preconditions this one is nearly always forgotten about say a marriage in a dangerous situation can be just a problem waiting to explode if you're in a found founder to founders or group of investors because all of a sudden people split up they've got to sell their shares that means it gets a bit public you're getting out of the company stuff can happen it gets a bit messy someone dies because they've got bad health and they've had heart problems and all of a sudden you're a partner with their partner who you may not want to be in partnership with so you've got to kind of think of that and look at each person and say okay we all healthy is a good chance we're going to be okay you never know anyone got a divorce they haven't mentioned coming up you know all that kind of stuff I know it sounds if it's stupid for the amazed how many people go into big financial decisions without having talked about that stuff also that the partner of people is happy with the other person not working for a year or two and being involved in a start-up and the lifestyle change around that there's often resentment there and that hasn't been talked about in the group so personal brand wash applied to a business so you have a personal brand like the the cheaper nasty way to describe it is how many Facebook Likes you've got that's not true or you know your presence in an industry or in a social or a networking sense just your contact Network in general stuff like that creates a personal brand some people can bring really massive personal brand into a business and that's worth money and they should get equity for that and it's often a case one found it gets a bit of resentment towards the other founder around that issue but you've got to recognize that like people build up personal brand through effort it just doesn't happen accidentally unless you're a movie star but it's it's real and worth money so you've got to kind of agree a probability of cash flows on things so a good example here is you get a founder who's wealthy and the other one isn't and the founder says look if things are going bad knees time I'm going to put an extra 50 100 grand into the business and we'll keep it going and we'll be okay like a promise now that person's promise is probably pretty good if they've got 100 million bucks in the bank and got a whole lot of properties and they're trustworthy that's great if that person's got a million-dollar mortgage the markets about to collapse that's not worth the same amount of money as one hundred thousand dollars so you need to look at it from a risky perspective so promises made about money coming in the business down the track or people bringing in investors when we get to a certain size all those promises need to be discounted a bit so applying some probability of those things happening when you're working out the equity split is really important now I'm going to show in a second how to do this anyway so I don't if you're wondering what is the calculation for that don't worry about it I'll show in a second valuing experience and youth so experience is excellent obviously because you've learned to fight you've learned from a lot of failure you've probably worked out how to be pretty efficient in terms of getting stuff done but you may or may not be willing to work out in hours a day so this pros and cons of each and youth same thing doesn't have rituals and habits in place that have bad habits so thinking outside the box is benefits around that but there's always like a flip side to it so you know a youthful person might be more of an explorer and less of an action orientated person or I'm snake generalizations but what I'm saying is dangers bucket people into young versus old as good and bad because it doesn't work that way I found in hiring people over the years I get really shocked at both ends of the spectrum really shocked so I've learned not to even think about that for a second so the real starting point for the equity split port part of a start-up in terms of modeling it is to actually look at it a bit more detail so ideas do have value and IP has value we've talked about execution as being really important as part of that there is capital going into the business the physical capital or cash capital there's costs that have already happened like people forget about that one someone could have been working on a project for a while and might have been paying web-hosting bills and what have been buying wood to make their chairs that they're going to sell online or whatever it is they're doing there's risk taking that's worth money in the split and there's the brand that you bring into the business so you might bring brand in a personal brand sense but you might also bring in brand in your concepts and ideas and I saw that with one startup in our a customer of ours who the guy came from a he was head of digital marketing at Saatchi he was really by in terms of understanding data and branding he created an amazing brand and just came into the business with another founder with that as very high value I thought because he had nailed it straight away from his background and that's worth money because that company didn't have to go off and spend 200 grand with Sachi to get it so you kind of got to view the value of that stuff as well so that this is a this is one way you can do this so they treated as gospel but I think it works well to get a more accurate method than the napkin there's other models you can use but the thing is to look at the initial capital breakdown first what stuff is each founder just imagine this is a spreadsheet with lots of columns for the different initial investors and founders what money has been spent in different areas to start off with so there's you know cash might be put into the bank account to start the company someone might have spent some money on some website development already with a friend or something and got some business cards printed the other founders even came in a bit later so didn't hadn't done any of that there's just lists down all the stuff that there's been spent today's and you'll get a number and so this this person has spent 38 grand today cashing the in the savings account for the business all the other stuff 38 grand this person is put in 11 grand so far so put some money ends coming in the business late I've got a thousand bucks of miscellaneous stuff that relates to getting this happening maybe some legal fees for a shareholders agreement between these two and you get a you're starting to get the first number you need in terms of the initial investment split but it's only the first bit so so that's one line think of that as one model what I just did in a proper in a proper model where you're splitting startup equity if you really believe you're going to do this for lots of money you want to go through this process and it's you can do in one spreadsheet but that's one part of initial capital and I've transpose those numbers up into there 38 grand and 11 grand then you start going through different areas like contracted future capital that one is the for example one founder says I'm putting 150 grand in in the year's time and the other founder says okay in a year's time we'll put another hundred grand in and they agree that upfront opportunity costs so one founders left a job for two years at 75 grand a year the other ones left a job for two years at a 50 grand a year so there's 150 and 100 grand split there if you wanted to be obviously I'm not discounting this or present valuing it but if you want to be really accurate if you'd start doing that because that cash flows in the future so if you're a finance background you know what I'm talking about you've got a money in the future is worth less today so 100 grand the future is probably you know 90 grand roughly 90 grand today if it's four percent interest rate five percent interest rate so you start working through this and you'll start to see some stuff that I've talked about earlier being the public officer facing the ATO okay 50 grand risk there I'll take that on happy to do that job but I want some value for it because if I'm to go out and do that as a CFO and a company I'm going to get a hundred 50 grand because I'm taking that risk and 50 grand at 150 grand is for taking that risk so it's real company secretary role that provision so things like that guarantees one director might write the guarantee on the lease for the property for example that's a $40,000 investment that's just capital sitting aside now I haven't got that right because you get that money back in the future so it should be the difference between it should be the interest value taking on the director role that's risky too that's the asset facing risk you take non-financial resources if one person putting computers and desks and stuff like that free resources acquired maybe maybe this founder got his wife to agree to help for a year and she's a sales exec and she's coming in the business and she's just going to help out for you because they've got some savings behind them so it could be something like that so while she's not getting paid it's worth money so it should go in here and so eventually get through this list and you look at stuff like pre-existing IP key relationships so if someone had a relationship with say Richard Branson and could really call on that guided through something I mean that's got to be worth some money so you've got a it's hard to put a value on that stuff but you can't almost notionally want to do that like and hope to be honest that one's really tough to put a number in there it is a guess there's no right or wrong about that one business and strategic planning what someone might be financially savvy and the other person might be sales and marketing orientated but if that person is financially savvy has a banking or finance background safety going to accounting firm to do that that's a 15 grand bill so it's worth some money so you get like a day one intrinsic value and then you can work out your equity split pretty well from that this is a good way to do it and you can do it across multiple founders it's one model there's other models but we don't really have time to go through them all tonight as companies doing bigger startup projects that are putting millions of dollars of capital in right from the word dot they'll have a project sort of spreadsheet modeling system that looks at present valuing all these cash flows and putting risks against them and looking at IP norm or valued sense by getting accountants to work out what IP is worth and goodwill or anything that's coming into the business before they split it but that's for like really big startup sort of backed by players looking to move companies from initial values of millions to hundreds or millions or billions of dollars so we talked about the split there so I've left this in the presentation so you guys can use it this is just like an infographic we did that we give our customers who are startups trying to work out this equity splitting thing just giving them some ideas the stuff they can think about to put in their spreadsheet to come out of these different areas so under risk for example relationship complexity public officer company secretary liquidity provider debt bank guarantee provider director so there are risks that are worth money costs like initial travel devices that people have been using or buying for the business company formation costs capital so future capital personal guarantees initial time invested initial capital so you work out what all those components are and you work out for these five categories what percentage each person does like one purses invested 275 grand the other person has got nothing in capital one person put 75 grand a type in other 150 grand and you can work out your split from that and the top ten tips are in there they're probably not the literal top ten tips there's probably 30 or 40 things I could have in there but they're the ones I think of important you

Channel: Saasu

Views: 82,810

Rating: 4.8639174 out of 5

Keywords: equity, capital raising, co-founders, capital structure, startups, genesis, business, equity split, equity share, saasu

Id: tk7Q4mWnyIw

Length: 22min 41sec (1361 seconds)

Published: Thu May 01 2014