The Founders’ Pie Calculator

Elements of the Decision Making Process

Let’s revisit the factors that should be considered.

Idea

The company wouldn’t exist if it weren’t for the original idea, and that is certainly worth something, BUT there’s a lot of truth in the saying, “A successful business is 1% inspiration, and 99% perspiration.”

Business Plan Preparation

The development of an initial business plan is a surprisingly difficult and time-consuming effort. To pull together and organize all the thoughts of the founding team, filling in the blanks, identifying and reconciling the differences, and producing a document that captures the essence of the business and helps persuade banks, investors, board members, and others to support the company is a mammoth undertaking, as anyone who has done it will attest.

Again, the plan is a necessary element of starting the business, BUT execution against the plan is where the real value lies.

Domain Expertise

To what degree do you and your partners have meaningful experience in the business of your business? Knowing the industry, having relevant experience, and having a Rolodex full of accessible contacts can greatly improve the company’s probability of success and speed its growth rate. Otherwise, it will take longer to get commercial traction and you’ll have to pay for these assets, usually by hiring someone and including equity in their compensation package.

Commitment and Risk

You’ve probably heard the old saying that “a chicken is involved with breakfast, but a pig is committed.” Similarly, the founders who join the company full time and are committed to making it a success are much more valuable than founders who are going to sit on the sideline and be cheerleaders. In addition, the opportunity cost for those who join the company instead of pursuing a career is not trivial.

Responsibilities

Who is going to do what? Who is going to go stay up at night when you can’t make tomorrow’s payroll? Where does the “buck stop”?

Relative Importance of the Elements

For each company, the relative importance of these elements is likely to be very different than that for another company.  A company based upon new technology is highly dependent upon the “idea.”  On the other hand, a new restaurant is not likely to be so unique that the “idea” is a major contributor to the restaurant’s ultimate success. If we were to evaluate the ideas on a scale of 0-to-10, the technology company’s idea might be a 7 or 8,  while the restaurant may be only 2 or 3.

Similarly, the relative importance of the business plan will vary.  A company that has to raise external financing will need a plan that will assist fund raising efforts.  If the founders are providing the start up capital, then the plan will be relatively less important.

I believe the same analysis can be productively applied to the other elements.  Not only can the absolute evaluations be made (0-to-10), but they can be compared to one another for make sure that their relative values are reasonable as well.

Relative Contributions of the Founders

Each of the founders can be evaluated on these elements as well.  Who did what to come up with the idea? Who contributed what to the business plan? Who has the industry connections? Who is joining the company? Who is accepting responsibility for raising investment capital? Who is responsible for bringing the product to market?

An Example

Let’s look at a hypothetical example. Assume that we have a high technology start up spinning out of a university with four members of the founding team.

1. The inventor who is recognized as the technology leader in his domain.
2. The “business guy” who is bringing business and industry knowledge to the company.
3. The technologist who has been the inventor’s “right hand man.”
4. The research team member who happened to be at the right place at the right time, but hasn’t and won’t contribute much to the technology or the company.

If these were all first-time entrepreneurs, it’s likely that they would each get 25% of the company’s stock, because “it’s fair.”

Let’s take a look at what the Founders’ Pie Calculator says. First we evaluate each of the factors on their relative importance and each of the founding team members contribution to each on a scale of 0-to-10.

Next, we multiply each of the founder’s values by the factor’s value to calculate weighted scores. Add up the numbers for each founder, sum those totals and determine the relative percentages. Do a sanity check to see if those numbers seem to make sense, and adjust them accordingly.

Advice to entrepreneurs

• Splitting up the founders’ pie is not a trivial undertaking.
• Rarely should it be split evenly, even though that’s what many start-ups do.
• Consider the past, current, and future relative contributions of the founding team members to the ultimate success of the company.
• Employ the Founders’ Pie Calculator to create a quantified scenario of how the pie might be divided based upon these elements.
• Caution: while I have convinced myself that this is brilliant tool, and that the scenarios that I’ve run through it have had logical outcomes, use this tool for guidance only.  Do not depend upon it exclusively.

Soruce: HERE

Start-up dilemma: How to divide up the founder’s equity?

Here’s how the question is typically posed to me: “I’m in the process of starting a new business. I’ve developed some new technology — with patents pending. But I have no experience commercializing new business ideas. So I was able to find a veteran CEO who wants to be a part of the venture. How much equity should I grant?”

There’s no easy answer. And there is no rule book. You may be tempted to hand out a lot of your equity to hire the talent you need. But what if your start-up turns into the next Google (NASDAQ: GOOG), eBay (NASDAQ: EBAY), or the latest hot IPO, like VMware (NYSE: VMW)? Might you risk giving away the store?

Over the years, I’ve talked about equity splits with many pros. For example, last week I discussed the topic with Todd Dagres, a founder and general partner of Spark Capital.

Here’s the easy part: In the beginning, go for an equal split among the original founders. After all, in the early stages of a business, there is really not much value anyway.

Although, if a founder contributes hard cash, customers, partners, or technology, he or she deserves additional equity. But somehow there needs to be a way to value the contribution, which can be complex (except for cash) and may result in some heated exchanges.

It can also be complicated to decide who will be considered a founder. Include only those that will be critical for the success of the company in the first couple years. For all others, it’s probably a better idea to hire them or bring them on as consultants.

How then to treat early hires? It’s typical to set aside 5% to 10% of the company’s equity for employees. But it’s a good idea to have vesting. For example, you could set it up so an employee may vest 20% of the equity for each year with the company (for a term of five years). This can be helpful in attracting strong employees — and keeping them on board. Another benefit — if an employee leaves, there will be more equity available to give to new employees.

Now, let’s say you contribute technology, cash, or some other asset to the new venture. When you’re determining your equity stake, it’s also smart to provide a way to take back the asset in the event of a liquidation, dispute, or other problem. In the start-up world, the probability of survival is not good. So, make sure you don’t lose something that may still have value.

Finally, I highly recommend that you hire your own counsel. Many founders will hire an attorney to represent them as well as the company. While it may save some legal dollars, it could be expensive for your long-term financial interests.

Tom Taulli is the author of various books, including the Complete M&A Handbook and the EDGAR-Online Guide to Decoding Financial Statements. He also operates DealProfiles.com.

Source: HERE