A non-profit asks you to start a business using their idea...equity advice?

J David Product Development at Back to the Roots

August 5th, 2014

This is a bizarre situation, which I have found limited advice on how to approach. When someone comes to you(in my case a non-profit) with an idea, but no experience or funds to start a business, how should the two of you divide the equity. I want to be fair, but also given that they are just handing it to me, I'm not sure how to proceed. I'm hoping for guidelines on how to calculate what an idea+PoC is worth in equity against funding/sweat/knowledge/reputation.

Mike Moyer

August 5th, 2014

Hi David,

The short answer is that non profits don't have equity so it's a moot point.

However, if you were joining a for-profit company you would want to use a dynamic equity split like the one I outline in my book Slicing Pie (it's available on Amazon, but I'll send you a copy if you contact me through www.SlicingPie.com.

A dynamic equity split values each contribution using the item's fair market value and a risk premium. Contributions include time, ideas, cash, supplies, equipment or even relationships. A person's share is equal to the adjusted value of their contribution divided by the adjusted value of everyone's contributions. It self-adjusts over time to keep it fair.

The other part is a framework for the recovery of shares in the event of separation of an employee, partner or investor. Different separation situations give the company different rights in reclaiming equity.

Using a model like this is the only way to make it fair and keep it fair. All other models are guesses at best with little or no concrete structure. Most splits are fixed, meaning they don't adjust over time. This means that the split is wrong the second something changes in the company.

Dave R

August 5th, 2014

To clarify what was indicated by other commentators, you cannot get any equity in a non-profit organization, but a non-profit can own equity in a for-profit entity. So you can designate equity in a new company to go to the non-profit for their contribution of the idea.

Alternatively, you could offer the non-profit a royalty calculated on units sold . . . as is done with publishing (10 to 15%) or with licensed intellectual property such as a patent. Surely they understand that if they are only contributing the idea, they will get less than 50%, so don't hesitate to just ask them, "what percentage do you think is fair?" then negotiate from there, and if necessary, help them to understand that you are taking all the risk.

By the way, if the product/invention is one that is relevant to their non-profit work, they can invest in the development and can own the product in it's entirety, and instead they could pay you a royalty based on their sales. In that scenario, they may be able to approach their big donors and convince them to make donations to the project in order to develop the long term financial viability of the non-profit based on revenue from this project.

Kelly McIvor Product Commercialization | Mobile Strategy | Opportunity Developer

August 5th, 2014

Hey David, Interesting situation. While not exactly the same, I've been in a similar situation. I was part of a hackathon (while riding on a bus for three straight days!) and the agreement we all made with each other was that we would each own 1% of any business that might come of the effort and that we wouldn't start a competing business. It was general recognition that ideas are pretty easy to come by and the real value is created when the entrepreneur executes. In your situation I might put them on the advisory board and give them options that vest over time. If they've dome more than come up with an idea by doing some market research or other planning then I might give them a single-digit % equity. Kelly

David Crooke Serial entrepreneur and CTO

August 5th, 2014

A company in my industry did this, and we ended up acquiring them so I got to see all the gory details while reviewing legal documents. There was a team at a large non profit who had developed a then very unique web app which they saw could be used by other non-profits, and so they left and persuaded the non-profit to give them rights to the software they had developed in exchange for 10% of the company and a small royalty on product sales. This was working code so arguably more valuable than just a business idea. I recall some famous VC, maybe Viond Khosla, stating that ideas really don't have value, in the context that founders should get equal treatment even if one brings the idea to the table.

Ryan Rigterink Midwest Manager at Hematogenix Laboratory

August 5th, 2014

I would start with a very open and honest dialogue with the non-profit as to their expectations. They may or may not expect to participate in the equity of the business and simply want it developed for a benefit they derive from it. Or alternatively they may have in mind the equity percent they expect to retain. This conversation should begin to identify resources they can commit to the initiative. There are a lot of factors to consider with the goal focused on proactively identifying roles and expectations early. Ryan Sent from my iPhone

Michael Weickert ♦ Strategic & Entrepreneurial Executive ♦ Trail-blazing leadership in biotech, medical device & pharmaceutical business

August 5th, 2014

David, It might be easier to navigate this with a non-profit than it would be with an individual founder. Typically individual founders overestimate the value of the idea versus the value of the execution that brings it to a marketable state. A non-profit might be more susceptible to logic and precedents than individuals, and I guess you can do the experiment. I would start with the logical framework of what has to be done to bring an idea to fruition. Is there IP that is license-able? If not, then they really have very little actually. The typical license for IP goes for a small up front (scaled to size and maturity of product) and 3-5% royalty. That is the market value for an idea plus enough proof of concept to have filed IP to protect it. The cost of development and the risk of failure along the way, as well as the cost of capital, is far more valuable. But it also builds gradually - you don't take down all the development capital and do all the work on day 1. If the non-profit wants an equity stake, what are you providing and promising to provide? There will be dilution along the way. If, for example, you divide equity 50:50 today, but you are going to raise $1M in a month, your stakes could be diluted 50% or more in a short time. Before long they will be under 20% equity holders. Framework: 1. Define relative value of initial contributions 2. Define capital requirements and schedule 3. Describe fair and realistic equity schedule and starting point Good luck! P.S. - Make sure you have done your diligence and know this is a really good idea that you can run with. A non-profit with an idea of what is useful can end up being great or misguided and you need to sort that out first.

Paul Bostwick

August 5th, 2014

Along with talking to them and making sure they are rational about this sort of thing (good ideas elaborated in other answers.)

Consider writing them a check for exclusive access to the idea for a year. Then later on a check from them to you for a half-price license for them as soon as you have another paying customer (and if and only if the product is one they want at that point.) That way the price is not artificial - it is one somebody else would pay so it not a made up number by you or them or both of you. Why a paid license? Same reason you pay them: people do not value things they do not pay for. There are exceptions but in business they are few and far between. This keeps it up front and straightforward. The year means they can find some other person to make it go if you move on to some other shiny thing. It happens - this provides for that as well.

If you are pressed for cash you can chop it up over time - but paying for it (in both directions) means you identify what you are getting and giving which makes the exchange clean. Which is what you want - not some nonprofit folks sitting on your for profit board/investor meetings.

Also, except for some narrow cases, Non-Profits should not be in the investment management business as an adjunct to their stated purpose. Your payment is likely to be classified as unrelated income and be subject to tax.

Ben Sweat Director, Product at Idealab

August 5th, 2014

Almost nothing. Maybe give them adviser equity (less than 1%). Or something that could be dangled in front of them, if you bring in a customer, I'll give you ___. Or some option that allows them to participate in future rounds of funding. But an idea is worth essentially 0.

J David Product Development at Back to the Roots

August 5th, 2014

Thanks everyone for the feedback, I appreciate the diversity of points. To clarify, the idea is a method of adding value to agriculture that has been around for a while so in the IP sense this is public knowledge. The idea to do this in the United States is unusual, and the non-profit has already implemented this type of ag in one location to prove that it is possible. So in that sense they have contributed more value than I have at this point. That is subject to change, but the valuation of what they have already done is tough.

Mike & David R -The non-profit wants to start a business distinct from the non-profit, sorry if that wasn't clear. I know of cases where this has happened, but your feedback is still relevant, so thank you.

David C & Kelly- I appreciate you guys sharing your experiences that bare a resemblance to what I described.

Ryan & Michael- The advice is greatly appreciated and Michael, thank you for including that framework, I will definitely be referencing that.

Paul & Ben- I should have conveyed what I said at the top sooner. I don't need exclusive rights to the idea because it already exists. There is however minimal infrastructure and research already in place, which the non-profit should be compensated for. The question is how to go about doing that.

Anonymous

May 23rd, 2016

As far as structuring goes, it is possible for a non-profit to "own"/operate a for-profit subsidiary of which you can own or earn a percentage of equity for your services. This subsidiary can later be acquired by an outside investor if it gains significant traction, however, the key is that this idea/purpose of the for-profit subsidary ought to be connected in someway to the charitable mission of the nonprofit, otherwise issues such as unrelated business income will arise.

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