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.
- Software As A Service: Is India ready for it yet? - September 25, 2008
- Sweat equity in new ventures - October 28, 2007
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)