(4 votes, average: 3.75 out of 5)
Loading ...I recently read one article about compensation in early stage ventures. One of my friends is planning to invest in a startup where he is one the four partners of which two of them will be running the show while the other two will be just investors. The proposed equity structure is 25 percent each for the pure-investors in return for 35 percent investment (each) while the two guys who would run the show are putting in 15 percent of the money for a 25% stake (each). This means they are getting 10% extra as sweat equity. Interestingly, both of these folks would work for full salary in the new company (no salary cut).
Is this a good arrangement? In my view the managing promoters don’t deserve any sweat equity upfront as they are working for full salary. I would say that all four should have equity proportional to their percentage investment.
My friend wants to know what would be the best equity structure for this company with 2 working and 2 non-working promoters assuming that the working promoters take market compensation.
I find that none of the responses has addressed the question raised, namely, whether the ratio proposed is reasonable/justifiable and ifnot, what would be afair ratio.
Reduced to simple facts, one set brings MONEY and the other set brings WORK EXPERTISE - both are critical.
But, Work expertise when put to test - operation - is fraught with risk.
Hence, the Money provider takes a calculated risk in venturing to put his money . Therefore, he is entitled to a reward for the risk taken.
In my view, such reward may be determined with reference to SAFE return and the DEGREE of risk. For example, if the money is invested in a safe avenue like Bank Deposit, Govt. Security or the like ,areturn of 8% -10 % is to be expected. In the Venture , he is likely to get X% ( based onprojected profits ) BUT THEREIS AN ELEMENT OF RISK. BASED ON THE LINE OF ACTIVITY AND MARKET CONDITIONS, THE VIRGIN NATURE / PROVEN NATURE OF THE TECHNOLOGY OR PRODUCT OR PROCESS , ETC THE EXTENT OF COMPETITION, ETC A VIEW has to be taken on the degree of risk of earning the X%. And, thus discounted the resultant rate is to be compared with the SAFE return% and determine the ratio of investnet value (premium/ Discount)
No doubt there is an element of subjectivity which unavoiudable due to perceptions on business , execution capability, etc. ( For example , a proven experienced technocrat with track record when compared with a academically qualified but not having any hands-on experience, would carry less risk )
Given the business model and the perceptions on critical issues, I believe a fair ratio can be determined for consensus.
For assistance, contact at the email addrees given
( Asenior banker with nearly two decades of experience)
I have been a part of several business partnerships. In the early days I was the sweat equity guy. Now I’m the money guy. In this world cash is king. I know that you feel proud of your idea and your talents - and you should! But new businesses don’t get started without enough cash. There are more ideas out there than there is money to fuel them. If you find someone willing to invest cash in your idea they are taking the biggest risk and deserve the lion’s share of the company. If it fails you lost your time, but the investor lost cash. You could make the argument that by giving up your time to work on this you lost out on the ability to make money doing something else. Ok, fine - then go work for a year doing something else, save your money and then start the business on your own. Having cash on hand is a much more rare occurrence than having time on hand.
I also have to decide. My venture has my idea, my experience, my full time commitment and my friend(s) only invest. I am responsible for planning, execution, launch and profitability.
My dilemma is how much sweat equity should be mine along with the salary ?
My friend(s) bring 100 % investment. The venture can not take off without me as no one as qualified and as experienced is available as I.
Please help with your examples and experience.
Thanks and regards,
Mahesh Khera
I have a similar dilemma, I have come across a deal which requires investment of Rs. 60 Lakhs, since, I am unable to invest the entire amount, one of the investors has proposed that I invest 15 Lakhs (25%) and the remaining 45 Lakhs (75%) by himself and the equity ratio be in the same proportion. He has proposed a couple of incentives over the increase in the business.
I feel that sweat equity is essential whether it is a business resale or its a fresh startup. I would request your opinion on the same.
I have gone through many such occasion where I be as a mediator since I also had undergone two such startups early on my carreer. Following is my comments and for every one doing so.
Equity Investment
Sleeping 50%(25+25) 80% (40+40)
Working 50%(25+25) 20%(10+10)
But no salaries for the working two partners. In case the salary required to be put on then:
Equity Investment
Sleeping 70%(35+35) 80%(35+35)
Working 30%(15+15) 20%(15+15)
Best luck to the team.
Hi all,
I have a similar arrangement in my startup.
Its my idea and I’m responsible for execution.
My friend is the investor. The arrangement is as follows:
1. I put in 20% of what he funds. So my effective financial contribution is 20/120=16.67%.
2. The money is to be brought in 5 stages, 1/5 at each stage. Investor has to compulsorily fund first 2 stages. He has the option for the later 3 stages. ( Arrangement to minimise investor’s risk)
3. I have qualifications, professional work-ex and have lot at stake in terms of reputation risk and getting back to a salaried job in case the venture fails. My friend has a traditional wholesale business which he can easily go back to.
4. I work full time and friend works part time.
5. The share is me:75%. My friend 25%. This is the proportion b/w me and my friend. this proportion will b maintained even after future dilutions thru’ esops or other investors.
The only drawback of the above structure I’m grappling with is the share premium issue. Since my friend brings more share of money than shares issued to him, it results in a huge amount of share premium.
regards
BB