Forums: Discussions for entrepreneurs and small business.

Hi everyone,

I am in the process of getting my high-tech startup going and have to figure out how to apportion stock ownership for various "consultants" I plan to recruit. From everything I read, there is no formula for this, so any real-world experience / feedback will be much appreciated.

Let me describe the various roles and contributions. I am the sole founder, came up with idea, doing this full-time, and self-funded for now. I have a friend who is willing to invest probably $10-20K, I plan to invest roughly the same amount. I also meet with him regularly to discuss the details of the startup, so he also plays the role of an adviser besides being an angel investor. His wife has expressed interests in being a technical resource for about 15 hours a week. I am also recruiting a local architect candidate that I plan to compensate mostly by equity working part-time as well. I also need to recruit a part-time graphics / website designer. For development, I plan on using and paying an offshore company, so there is no equity issue there.

The startup is in the design and architecture stage now and I plan to start development in Jan and deliver the 1st version / beta by end of March 2007. So here are my questions. What is an appropriate % of equity I should grant to my angel investor friend and the other 3 consultants? Should it be based on meeting key milestones or number of hours spent?

Any help will be appreciated.
Thanks,
Bob

While I understand the reasons for using equity in place of cash to compensate employees and contracted help, be aware that it is usually very expensive -long term.

The first step in the process is to agree upon values.

1. The value of their service or product.
2. The value (valuation) of the company, which leads to the unit price per share

If you can agree on these, you have a starting point.

My answer to the second half of your question (Should it be based on meeting key milestones or number of hours spent?) is: use the same measure as above and award equity based upon that. For example, if a person is doing a specific project - then they should receive the agreed upon shares when the project is completed. People who contribute hours should get shares at intervals of hours.

NOTE: With the exception of the exchange of stock for capital (yours or the investor) all of the other transactions are likely "taxable events" and may create a tax liability for the recipient.

If want input on your specific situation- contact me directly.

Robert Johnson

 

 

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Business Growth Masters, LLC -
Capital Catalysts for Entrepreneurs
Home of the Scalable Business Plan and QuikStart Capital Programs
http://www.bizgrowthmasters.com
info@bizgrowthmasters.com

done with that subject

Would it depend on the value of the shares? For example, it your selling shares at $1 per share, the number of hours should coincide with the hours worked. If the person is charging $20 a hour, you will give him or her 20 shares. Is this right?

RobertJ, RaiseCapital, thanks for your feedback.

RobertJ, can you give me a specific example of why using equity initially would be expensive in the long term? I ask this because I was the "consultant" a number of years back for a startup. I agreed to a 50/50 split on cash/equity for the number of hours I worked. It was a good thing that I got some cash compensation because I ended up getting a bunch of useless shares when the company was acquired, I didn`t get a cent for any of my shares. Now mind you, I was the first Architect and developer from day one of the company first as a consultant and later as VP of Engineering. Essentially I had no insight into the founder financing strategy and really had no idea of how diluted my shares were.

To be honest, I am still trying to figure out the valuation process of my company as I get more funding. As an example, I agreed to give up 5% of my company to each consultant upon completion of the 3 month period for the first version, that doesn`t mean that they will get 5% of the company indefinitely through all the rounds of funding. The initial 5% could ended up being 1% when it is all said done. Any advise here would be much appreciated.

Based on what I have said so far, is 500K a reasonable valuation at this stage? Also, I guess deciding the strike price for each share, eg. $1 / share, is also completely arbitrary at this point? If I decide to do that, and I (instead of a lawyer) draw up an agreement with the consultant, is that legally binding still or do I have to get a lawyer involved?

Thanks,
Bob

Your story scares me, as well as others I`d imagine.  To have 2nd round financing come in and dilute your shares to worthlessness is concerning, but perhaps it was necessary.  Anti-dilution measures can help protect initial investors but that might prevent the 2nd round financing altogether.  Maybe some of the SuN members know what type of anti-dilution measures to look for. 

Valuation is based on future net income.  Nobody here can give you a reasonable valuation without seeing projections.  Remember, valuation is typically a "multiple" of NI.  This multiple will vary based of industry, mgmt., growth, etc.  If you project NI of $100K in 3 years and you feel the company should have a multiple of 10 then your company is valued at $1M in year 3.  Use that to work backwards into how much equity a person should receive now given required ROI`s for that investor over the next 3 yrears.  Say you value the architects contribution at $20K in todays dollars.  Let`s assume this person needs 50% ROI yr/yr to compensate for risk.  Then the equity this person should get now is ($20K*1.5^3)/$1M or 6.75%.  If only it were that easy......

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Travis Tschepen
Hibachi Bros. LLC

--My goal in life is to be as good of a person my dog already thinks I am.--

I am familiar with valuation based on future net income, however, if I were to apply that model towards youtube or myspace, I would get a paltry valuation. As I am sure you are already aware, youtube was acquired for $1.6B+ and myspace for $600M+. I understand that they are the exceptions, many other tried and failed but I don`t think I should ignore the numbers either. And this is the space I am in, hence my struggle with coming up with an appropriate valuation, maybe not so much based on future net income?

Bob

A difficult task indeed.  That youtube price is incredible.  It will be interesting to see what Google does with that.

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Travis Tschepen
Hibachi Bros. LLC

--My goal in life is to be as good of a person my dog already thinks I am.--