A startup is a business that creates or invents products, services, and technologies. The startup usually has little or no money of its own, so it must rely on the founders’ personal savings, credit cards, loans from friends and family members, investors, or other sources to fund the company’s operations.
Question: I’m launching a business that will need a significant amount of funding from private investors. I have a seed group of five investors (including myself) who have all invested an equal amount in the business so far. Each investor is responsible for raising additional funds from other sources. I started the business from scratch with my own ideas, and I’ll be doing the majority of the work both before and after it opens. Except for me, the seed investors’ total ownership is 35 percent, with each individual holding 6%. I’ve offered myself a 5% bonus for the concept and all of the effort involved in getting things up and running. Is this additional 5% acceptable in view of the effort (roughly 600-1000 man hours)?
Answer: There are no magic formulae, no rules of thumb, no recommendations that can assist you in this area.
It would be very beneficial to convert your hours into dollars rather than hours, so that you can compare apples to apples. This usually aids partners in seeing and understanding things, as well as assisting you in assigning a value to them.
Assign an hourly rate to yourself and your job and multiply that rate by the amount of hours. This provides you with a figure to compare to the remainder of the investment.
If one hour of labor is worth $25, then 800 hours of work are worth $25,000. Once you have that monetary translation, you can think about justice more simply. It leads to the following rapid nesting steps:
- What do outside investors think of your work’s current valuation? How does buying 5% of the business for $25,000 (the hypothetical example figure) compare to the bargain they’re receiving now?
- What are your thoughts on this, partners? Are they okay with you establishing your value at the hourly rate you’re thinking about? Does this correspond to the amount of equity they get in exchange for monetary contributions?
- What does this mean for the company’s total valuation? Is $25,000 a reasonable price for 5% of the business if your 800 hours are worth (hypothetically) $25,000? Is the firm valued at $500,000?
You don’t specify the investment numbers in this business, and don’t accept my hypothetical valuation as anything more than that, but I believe you can understand how converting sweat equity to pure money worth may advance a debate.
Congratulations, by the way, for taking the time to think about this problem before it fades away and becomes much more difficult to address. Too many founder groups are hesitant to scribble these milestones in black and white when they establish the business.
— Tim Berry — — — — — — —