Startup idea valuation – How much should your idea value and will it translate into more equity?

We at Founder Solutions (www.FounderSolutions.com) were figuring out the way to compute startup idea valuation to be used by our innovative algorithm for our upcoming PieChopper tool which allows startup founders to divide equity fairly. To put a price tag for your startup idea is very difficult and probably much more difficult than putting valuation to your startup before funding round as for valuing your company, you might have knowledge of some tangibles, investments, team expertize, pilot, sales forecast etc.

So how to value your ideas in numbers? You might need to do it so that it can be taken into account as an investment or contribution in some way to your startup and possibly will want some equity incentive based on that.

Idea Valuation

Idea Valuation

Our first assumption was to give “equity premium” to the founder who came up with the original idea in agreement with the other founders. Initially, it looked justifiable as the founders will get some credit for coming up with the idea which resulted in the startup to be founded in first place and get some agreed share of equity as a result. But as we did our user tests with real world founders, it became more and more clear the premium might sound justifiable initially but won’t be fair in the long run. For example, if a founder asks 5% of the equity premium for his idea. He will be reserving 5% of the equity irrespective of other contributions by him or his other co-founders. If the idea founder invests 1000€ but his co-founders are investing 50,000€ and doing most of the work in the startup, it won’t be fair to reserve 5% equity irrespective. Needless to say that the idea initially during the founding stage would be unproven and most probably will go through multiple iterations before it gets market adoption.

The second scenario we considered was to ask founders about the tangible value of the idea based on the possible IP (Intellectual Property) it brings. But that consideration was met with our own criticism after giving some more thought as most ideas can’t be translated into IP like patents etc. Also, even if they do, it won’t be possible to accurately measure the value of the generated IP.

idea patent

Idea IP value

Finally, we came up with the conclusion to solve the problem by:

  • Asking the relative contribution to the idea between the founders as multiple founders could very well input to the implemented idea.
  • Asking the value of the idea in monetary terms from each founder and then using the average value of the idea for equity calculations. This will allow negate the over valuation by the original idea founder and possibly result in a fair agreement with constructive discussion about the value of the idea.

Our equity-split algorithm then uses the input from above two questions to decide the idea valuation and internally uses to compute equity distribution between the founders. What do you think about the idea valuation and the idea contribution in terms of equity split?

Note: You could register to get early-access to our PieChopper tool by registering at www.FounderSolutions.com

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The importance of vesting

Image courtesy of FreeDigitalPhotos.netYou most likely heard about vesting. VCs often talk about it in their blog posts. Somehow startup founders still find it tricky to understand what vesting is about.

We’ll try to explain it here in the easiest way possible. It’s hard to overestimate the importance of vesting. If you are a founder you need to get used to this concept as early as possible in your entrepreneurial career.

Otherwise, you may find yourself in a situation Mark Zuckerberg talks about: He didn’t know what vesting was at the point when he started the company, and it cost him billions of dollars because of his co-founder Eduardo Severin.

The notion of vesting comes from a legal universe. Vesting is a common provision in equity schemes. Vesting means receiving the right (to the shares of equity).

To put it simply, if founders agreed to divide equity with a vesting condition, what they get at the beginning is unvested equity, which is just a promise. A promise that they will get their shares of equity as agreed only if they certain vesting conditions are met. The most common vesting condition is to stay with the company long enough for the equity to vest. Vesting conditions may include various milestones important for the company. An example would be getting 1 mln. of registered users – if this happens, founders may agree to have accelerated vesting of 25% of their shares of equity.

Vested shares are the shares the founders already earned. Founders can walk away with those shares if they decide to leave the company. That will be fair, as they received those shares for all their hard work.

Vesting is important even for teams with unequal equity splits. In fact, vesting has little to do with equal or unequal splitting. Imagine there are three of you, you split your startup equity 45%-35%-20% and get to work. In a month a founder with 35% looses interest in the project and leaves… taking 35% with him! The other two work hard, get VC money, become famous and in 6 long years launch an IPO. Of course, over those years 35% get diluted to, say, 7%, but that’s 7% of a billion dollar company – not bad for a month of work, heh?

That’s a made-up example, of course, but if there were a vesting provision in place the founder who left in a month would get no equity. And this would be fair to those who stayed and made their company a huge success.

Image courtesy of FreeDigitalPhotos.net

What it takes to build Facebook

To continue our series of weekend videos, here is a nice one from Y Combinator in which Mark Zuckerberg talks about early days in Facebook. Highly recommended to watch. For those who don’t have time for a 36-min. piece, here are our favorite lessons-to-learn from the video:

– On motivation: Stay inspired by what you are doing. There will always be skeptics saying that your thing can’t be a business. Just care about what you are doing, and that’ll drive you forward.

– On hiring great people: The only way to determine whether a person you are hiring is really good is to realize if you would want to work for that person.

– On making decisions: Out of a hundred things that you can potentially go do, pick up the one that actually matters.

– More on motivation: In the early days Facebook had a serious competitor called “College Facebook”. Every time the competitor would launch at a new school, the whole Facebook team would literally not leave the house and work until they address the problem. They still have this concept of “lock-down” at the company and many teams do it themselves.

– On founder equity (we couldn’t miss this one!): All founders must be on vesting schedule. Mark heard nothing about vesting at the time when they started the company. They just divided equity, and then his co-founder Eduardo left. “That mistake probably costed me billions of dollars” – says Mark. But even when things like this happen, it’s important to move forward.

Feeling right about an unequal split

FounderSolutions Here founders of Zenlike are sharing their story of how they came to a decision to split unequally and why it felt as a right thing to do.

For a short resume: they agreed on a 55/45 split. Founder 1 got 55% for two reasons: first, he had been working already for 2 months on the project and secondly he had made a significant investment into the project. No premium was given for the idea. As for other factors, the two founders seemed to have a comparable level of experience, expertise and network value.

Recommended reading for those who are in the process of negotiating equity division with their co-founders. It clearly shows that in truly successful ventures even equity talks are more about fairness and cooperation than about “splitting” or getting into a more advantageous position in comparison to your co-founders.

We were also happy to see that the logic of Zenlike founders can be absolutely replicated in our FES model. While our model by default assigns some equity premium for an idea, this can be easily overridden by indicating that all founders are the “idea persons”. And FES helps founders consider even a wider range of their strengths and competencies which can be vital for the startup and which should therefore influence their equity splits.

FounderSolutions

Two real-world stories: a good and a bad decision on equity split

This video is definitely worth watching. It’s a case study of two startups and their decisions about equity splits between founders. Two real-world stories with lots of wisdom to learn from them.

In short, the first story is about a 50/50 handshake (the equal split!) the Zipcar founder Robin made with her co-founder – and how much angst and regret it caused her shortly afterwards. “It was the stupidest handshake to make” recalls Robin.

The second story is about Ockam co-founders and their decision to split unequally. The decision was very logical because, for instance, one co-founder had worked for the other one for seven years as a junior before they decided to start a company. It was clear that their contributions to the startup wouldn’t be the same. And they did a great job of evaluating different scenarios of how much they would be involved with the startup (what if one of the founders wouldn’t quit his full-time job to work for the startup and so on) and identified different equity splits for every scenario.

Here are the key lessons to be learnt from this video:

  • if you don’t want equity split issues to ruin your startup deal with them early
  • when you deal with them, keep in mind that a 50/50 split is almost never a good solution
  • it’s better to find out early whether you are compatible with your co-founder. Equity talks are the best time to do that.
  • go through several scenarios of how your startup is likely to evolve. Decide how your equity split will be changing depending on the scenario.

9 types of founder conflicts that can sink your startup

Are you working on a new business idea with a small group of friends or colleagues? Is this the first time that you start a startup? Then you absolutely need to check out this entertaining infographics below from an infinitely creative FundersandFounders team.

Do any of these issues sound familiar to you? Beware of these founder conflicts, as they can easily sink any promising venture.

And yes, we would recommend any of those solutions – except just one. When answering the question “Who gets what” you should never jump to a 50/50 equity split. This is the only wrong answer, as Dan Shapiro put it in his widely cited and much discussed blog post.

Use Founder Solutions model instead and find out immediately what’s a fair equity share for each and every member of your startup team.

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The Facebook effect

Do you know how Mark Zuckerberg split equity with his co-founders in the early days of Facebook? Bear with me and read this post to the end, as this story teaches the importance of dividing equity fairly – which almost never means equally.

Zuckerberg was from the very beginning a true leader of the project destined to become Facebook. He was the “idea guy”. He gathered the team around himself and inspired them. He wasn’t focused on money, but “content to make something cool”. His idea and execution attracted great mentors and investors.

Zuckerberg’s early team included Eduardo Severin, who knew business stuff and who gave Mark Zuckerberg $15,000 to pay for the servers needed to run Facebook site, and Dustin Moskovitz, Facebook’s first CTO.

At the beginning Facebook shares were split between them, with Zuckerberg owning 65%, Severin owning 30% and Moskovitz owning 5%.

If you watched the “The Social Network” movie, you should be familiar with the rest of the story. Severin made some false steps failing to perform his duties at the company and even trying to promote his side-startup at the expense of Facebook. Luckily, his share was smaller and Mark Zuckerberg had enough control to do things his way and fix the problem.

What would happen if their team had divided shares equally at the start, with each of them owning 33,3%? Zuckerberg then wouldn’t own the majority of shares and wouldn’t be able to force Severin out of the company. And Facebook would probably never become the successful giant we know today.

Now, think again in the light of this story – will equal split be good for your startup?

This story is based on a much longer, but insightful article from BusinessInsider.com