Startups · Equity

How much are you willing to give up in equity?

Jordan Zommick

February 18th, 2016

If you were given substantial money (over $150K) to develop an MVP, money to grow your business, great mentors/coaches, free workspace/food and a lean startup program curriculum, what sort of equity would you be willing to give up ? Now, suppose I give you the actual product idea that is validated by several fortune 500 companies who have hundreds of thousands of users committed to licensing your product when its complete and oh by the way they are part of the design, development, testing so they are validating with you every step of the way to ensure a successful outcome. Now what sort of equity would you give up since your chance of success is so high?

Based on the responses below, I've revised my question and provided further background in my response later in this thread. See below before posting a response. Thanks! 
A great idea is 1% of the work. Execution is the other 99%. In this course, we’ll teach you how to conduct market analysis, create an MVP and pivot (if needed), launch your business, survey customers, iterate your product/service based on feedback, and gain traction quickly.

Vijay MD Founder Chefalytics, Co-owner Bite Catering Couture, Independent consultant (ex-McKinsey)

February 18th, 2016

This sounds more like being an early employee prototyping something for an enterprise C-level champion or two than anything else.

Less of an issue here about equity and more about giving up the chance to do anything disruptive and selling into a top-down product development model (which may or may not have anything to do with what the actual end users want/ need).

You'd have to ask yourself if the idea was so great and obvious why the players with substantial budgets are looking to outsource this to an unproven startup and provide less resources than they would to a middle manager, top-tier developer, or custom dev shop.


Mike Moyer

February 18th, 2016

No matter how high the chances of success, the business is still a gamble and the actual odds are unknown. Most entrepreneurs think they have a sure thing, otherwise they wouldn't go for it.

Equity entitles people to reap the future rewards of a company. These rewards come in the form of profits and/or the proceeds of a sale. 

No matter what the situation, there is a universal answer: a person's % share of the rewards should always equal that person's % share of the risk taken to achieve those rewards.

If the game was Blackjack, instead of your company, and you and I each bet $1 we would each be entitled to 50% of the winnings, if any. We each took equal risk and deserve equal rewards. Things rarely go as planned, however. If the dealer deals two aces and we split, additional bets are placed. Let's say I'm broke and you put down $2 more. Now the 50/50 split is no longer fair. Your risked $3 and I only risked $1. It would be fair for you to take 75% of the winnings, if any, while I should take 25%.

When someone contributes time, ideas, relationships, supplies equipment or anything else to a startup and do not get paid, they are, in effect, betting on the outcome of the company. Just like in blackjack, they should receive a slice of the rewards that properly reflects their slice of the risk.

The amount people risk when they contribute is equal to the fair market value of the contribution they make. So, if a guy can make $100K doing marketing and works for you doing marketing for free, he is risking $100K.

So, to answer your question, you should disregard your level of confidence in the company (because all entrepreneurs are confident) and instead look at what people risk. No matter how confident you are, it would not be fair to take a slice of the rewards that was disproportionately high. It's not fair to benefit from someone else's risk. 

If you're sure you're going to succeed then pay everyone who helps you out of your own pocket. Empty your savings, mortgage your house, sell your cars. This gives you all the risk and entitles you to all the reward.

I've written a book about how this works. It's called Slicing Pie and you may have a copy if you contact me through SlicingPie.com

Good luck! Sounds exciting!

-Mike

Rob G

February 18th, 2016

.... this also begs the question 'why would you not simply build this and the team yourself?" 

Rob G

February 18th, 2016

@ Mike M; if i'm an expert blackjack player, have made a living over several years playing blackjack (or more likely, poker) and you are an occasional visitor to vegas, then the equation is not just related to risk, but also expertise. The $1 that i commit is worth more to our overall success than the $1 you commit. In fact your rookie mistakes could cost us more than the $1 you contributed.  Also, cash seems to have a different quality to it.  If our team needs a certain technical expertise, for example, and you and i don't have that expertise there is no amount of your time or mine that can solve our lack-of-expertise problem, but cash can solve that problem so cash takes precedence over forgone income or labor contribution. How much is up for debate. 

Joe Albano, PhD Using the business of entrepreneurialism to turn ideas into products and products into sustainable businesses.

February 18th, 2016

Ultimately your business and the equity others aquire in it is what all parties to the transaction agree to. 

I'm not exactly sure what you're pitching here. I kind of sounds like you want to develop an "idea factory" that works on your ideas with unpaid labor. 

Among the many challenges, here is a big one: ultimately the price of any resource (time, treasure, talent) is equal to what both parties to the transaction agree it is (cash, credit, or equity). These negotiations are best best agreed to BEFORE any work is done ... but FAR too often are not. The result of post hoc negotiations is reliably unpleasant.

The formulaic determination of contribution is appealing because of its simplicity, but it rarely survives contact with the real world. A common argument goes like this: "I could make $250K per year working in the industry and you want me to take on risk - so I want my contribution to be worth 2x" ... I worked for a full year so I "contributed" the equivalent of $500K. Now assume others contribute the equivalent of $2M in a combination of cash and sweat equity. 

So your total "investment pool" is $2.5M. Now the fun begins: 

  1. Starting an enterprise is different from getting a job. If you didn't want the risk and just wanted guaranteed reward you should have taken the $250K a year job. Theoretically being able to get a job and actually  having a job are two VERY different things. 

  2. Some people will show up, some will meet expectations, and some will overperform. We prefer performance-based vesting over time-based - YMMV.

  3. The monetary value assigned to contributions tends to get people confused. From our example above, it's easy to assume "I have a $500K interest in the company". But what happens if the total enterprise value of the company is only $350K? I've had to explain - in GREAT detail how it is impossible to take a $500K slice out of a $350K pie.  
Much of the drama around startups seems to come from the assumption that SMBs operate as miniature versions of traditional corporate entities. Starting with a clear understanding that includes expectations and risks is the best way to avoid unnecessary drama. Numeric calculations are a good basis for these understandings, but there no substitute for a frank and well-documented conversation. 

In our work we have developed a framework and process for these conversations. Unfortunately we have also found that many entrepreneurs don't want to engage in the conversation until the sparks start to fly. 

Michael Barnathan

February 18th, 2016

Your chance of success is still pretty low until you have consistent and growing cash flow, or a significant investment. That's when risk tapers. Not coincidentally, that's also when you tend to have the cash on hand to avoid giving too much equity out :)

The first scenario is an accelerator model (sort of), and I think it's customary for them to take something like 7% in exchange for that. The second model doesn't sound like entrepreneurship anymore, since someone is handing me an idea and saying "go do that", and I probably wouldn't give anything up for that specifically.

David Austin

February 18th, 2016

>Now what sort of equity would you give up since your chance of success is so high?

If it is indeed so high, I'd give up a very large amount, perhaps even the lion's share.  That said, I've been there.  It's easy to get fortune 500 companies verbally agree to buy a theoretical product ... another thing entirely to get them to sign a commitment.

I did a recent round of customer interviews for a product in development.  I talked to about 40 such customers one on one.  Compared to the competition on average they were willing to spend 50% more ... at least they said they would.  Then the golden question ... would they be willing to commit.  Few takers.  Even if the price were on 20% over the competition ... still few takers.  I had one prospective customer I interviewed who said he estimated the value 3X as much and when I asked if he were personally interested in buying it, or even just being notified when it was available the answer was no ... even when I said the cost was only a 20% increase instead of a 300%.

It really comes down to the customer interview to see if they are ready and willing to pre-order something like this.

Also need more details on the project / product / service scope.  How many developers and sales guys am I going to need? Operations / manufacturing?  Even though it's just an MVP ... some MVP's are harder than others.  Some industries are harder to change than others.  What are your connections, or do I have to develop all the channels myself?

Josh McCormack Owner, InteractiveQA - Marketing, Web Dev, Testing, Data & Market Analysis

February 19th, 2016

I'd rather own 1% of a million dollar company than 100% of a failure. What you're laying out sounds like a great combination of an incubator and a startup employee role. 

Peter Jackson CEO

February 18th, 2016

1. If you don't need money to develop It = none 2. Normal to factor a valuation based on a lot of what you have already express. Add in revenue or TAM. There is a present value range that all sides agree too If you need cash, you sell X percent at that value. 3. Employees and key hires can be part of an option pool. At this stage maybe you give up 20% to equity and 10% over 4 years in A vesting pool. 4. Maybe the answer is you get 70% 5. Other factors are: logical exit paths- multiples in that sector Barriers to entry TAM Your past

Andy Halliday COO LifeAID Beverage Co.

February 18th, 2016

this doesn't sound like “I” am starting with much equity to give up, as the idea, the capital, and the key resources are all being supplied by you. So being a non-founder, presumed without a claim on the intellectual property of your idea, the question is what equity are you willing to give up to get a committed leader of your venture?