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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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.