Entrepreneurship · Valuation

How to value a company pre-revenue to give out equity for partners?

Anonymous

January 16th, 2016

I am building a new mobile platform and in the process of bringing on partners.. i am trying to figure out how much equity to share and at what value .. and trying to figure out a way to create valuation.

Mike Moyer

January 16th, 2016

Hi Sathish, Trying to value a pre-revenue company is futile and pointless. An equity split based on a made-up valuation is just a random guess and is guaranteed to backfire when people realize it's unfair. The only way to ensure a fair split is to use the Slicing Pie model which is based on a simple principle: a person's share (%) of the reward should equal their share (%) of the risk. When someone contributes time, money, ideas or anything else to a startup company they are taking a risk that they will never get paid. The amount of that risk is equal to the fair market value of the contribution. Fair market value, unlike future value, is easy to observe and measure. The fair market value of a person's time, for instance, is equal to the salary they could get if they took a job. It's only fair that a person's portion of the future profits or sale of a company should reflect their portion of the risk. Think about it this way: if you and I each bet $1 on the same hand of Blackjack we would each deserve 50% of the winnings because we each bet 50% of the total bet. If we were dealt two aces and we split the aces and YOU put down $2 more, you would now deserve 75% of the winnings because you made 75% of the bet. You don't have to know the "value" of the winnings to know this. You just have to know the bets. It's the same for a startup. Simple measure each person's bet and allocate equity by dividing their risk by everyone's risk. I've written a book on this topic. You may have a copy if you contact me through SlicingPie.com -Mike

Jessie Harris Strategy | Operations | Program Development

January 16th, 2016

This addresses only half of your question, but here's a helpful article re: placing a $ value on "sweat equity" -- written by someone I really trust: http://www.entrepreneur.com/article/182440

Dimitry Rotstein Founder at Miranor

January 16th, 2016

Normally, at such an early stage it is not about valuation, but rather about contribution. Each partner should get percentage that reflects their contribution to the project (say, in terms of time, skill set, contacts, and/or self-financing). There are various formulas that try to do that, but they often give different results and contain subjective factors.
In my experience, in the end it always comes down to negotiations - all potential partners decide what percentage they will feel good about.
In any case, I would suggest not to get cheap on this - good partners are hard to find. Remember that there is a ~90% chance that you will fail and these percentages will become meaningless, and if you do succeed and get millions, then does it really matter if it's one million more or less?

Steve Jones Founder & Principal at Cayoosh Consulting

January 16th, 2016

Check out http://slicingpie.com/

Dimitry Rotstein Founder at Miranor

January 16th, 2016

@Chuck Blakeman,

You're right - the amount of time dedicated to the startup is a poor indicator of contribution. Unfortunately, everything else is even worse.

Splitting equity according to actual results is fatally dangerous, because you can't possibly know these results in advance, and trying to split the equity after the fact will create a conflict in 99.9% of cases, with a 99% probability of breaking up the team and 90% of killing the startup (the figures are guestimates, but that's the order of magnitude). The whole point of the founders agreement is to agree on everything in advance so as to avoid the conflict situations.

And trying to estimate the contribution of each member in advance, based on their resumes or something is even harder than trying to valuate a pre-revenue startup. Besides, how exactly can you compare different contributions? Suppose, co-founder A wrote 500 lines of code per day, co-founder B generated 50 leads per day, and co-founder C raised the seed round. Who's contributed more? By how much? I have no clue.

Like it or not, the time dedicated to the project is the only objectively measurable parameter (at least in most cases). I learned that after trying other things and having them exploding in my face. Besides, if one co-founder clearly produces much less useful results than the others, then the solution is not to give him/her less equity, but to kick him/her out and find someone better. That's why we have vestings and cliffs and all that.

Ballard Pritchett I help owners build the overall value of their enterprise and stay relevant in the digital economy

January 16th, 2016

It is vital to consider valuation in larger than balance sheet terms.  Treat the balance sheet as if it only held 20-25% of the information about overall enterprise value.  Evaluate each contributor's value creation portion of the whole picture.  Relationship with market environment, product and service offering innovations, operations, ability to attract talent, and personal and team leadership all create value.  Also, expect it to take five years to build the firm, so don't give out all the participant portions in year one.

Goran CFA Finance and Consulting professional

January 17th, 2016

Hi Satish,


Congratulations on reaching this stage in your business plan.


First, I recommend you to follow the steps described by Scott McGregor (few posts above) to get to the initial valuation of what the company can sell for / it's value in the next financing round - call this value post-money ("POST").*


If your partner agrees with the POST value, his ownership share ("SHARE") after he made the investment ("INV") can be calculated as follows:


SHARE = INV / POST


Below are a few things you should consider already at this moment:

1. How much money do you need until the next investment round / next stage of company's development? When will you need another investment (second investment round)?

2. At each round of investment your share will get dilluted. How many investment rounds are you potentially looking at? What stake (and operational control) would you like to keep? Now / at the time of exit?


* In the absence of a business plan and financial projections, this is the best advice I can give about valuation - if you need help with any of those, let me know, I enjoy doing this.

Christopher Boucher Co Founder at Benefactor

January 17th, 2016

We're using a Grunt Fund and it's fantastic - but, you have to trust everyone on your team. Highly recommend if you're the ethical type. Google it.

N Sherman Management Consultant

January 17th, 2016

Hi Satish. Valuation is based on multiple parameters and requires a detailed business plan. I can help you with both.. Sherman 9845622800

William Agush Founder and CEO at Shuttersong Incorporated

January 16th, 2016

Not sure why you need to establish a valuation as they aren't making an investment. The value is just the par value of the shares. You need to decide what % of the founders common you want to give them. Make sure you document this equity properly as RSUs so they can exercise at par value and file their 83b election. Get advice from a lawyer.