Equity math for co-founders based on Hartator Cash Method

After reading a lot about equity, profit-sharing and other various related subjects, I was profoundly dissatisfied and I decide to come up with my own method, humbly called Hartator Cash Method, in order to split out equity in a fair way between co-fonders. First and above all, I don’t believe that equity should be divide evenly, like 50/50 or 33/33/33. It’s morally profoundly wrong and economically inefficient. Indeed, it sates in an agressive and coward way, that either you believe that everyone in the early company are equal, and that’s never the case, or, and that’s maybe worse, that too poltron to do something about it. There is other methods, that guide you to list and rank elements like level of responsibilities, commitments, experience, industry knowledge or the importance of the idea or the business plan. You try to give a rate, seriously a rate how retarded is that?, to each founder for each elements in the scale of 10, 0 meaning your are a sh*t in this area/skill and 10 you are an expert. Unfortunately, this process is profoundly subjective  in every single steps and lead to more incomprehension and confusion than an evenly distributed equity.

I believe in cash. I believe business is about money. Everyone that told you that business is not about money is damn hypocrite who lie to himself or lie to you. Everything, and I emphasize everything, that makes a company, a product and service can be quantified in cash. Equity shares is consequently just the amount of cash brought on the table by each co-founders. The hard part is to work on the valuation of each component that makes a company. And your arguments, you must have at least one!, must be focused on theses valuations.

You have to work on evaluate each co-founder contributions against the components list here:

  • Capital and Investissements
    We are starting with the easiest, startup capital and investissement contributions are strictly egual to the amount of cash a co-founder invest. This investissement is at risk, so I advise you to not take account of interest rate or currency depreciation. If a co-founder invest $100,000 just had $100,000 as his contribution.
  • Potential Salary
    We move forward directly to the hardest part, but I’ll make it easier for you! Estimate each co-founder potential salaries based on the best they can expect if they were working for a competitor that will pay them the most they can expect to be paid if your competitor recognizes fully their expertise/skills. Don’t be shy and write down more than decent salaries! Indeed, if you are starting a company, it is because you believe that your work can be valued much more than the price you can have by selling it in the regular job market, so make your best shot! For example, you can value your CEO at $250,000 by year, your CTO, $150,000 and your CMO, $120,000. Don’t add up right now each potential salaries as contribution, keep it down somewhere and we will use it latter.
  • Work already done
    Even if you are starting a brand new company, the odds that one of you or some of you have already done some work are not negligible. Make your best estimation of the time spend by each co-founder, be precise specially if you are dealing with some people working part-time and some full-time. Then, calculate the contribution of each founders based on worked time and the potential salary, the one we calculate before, they can have claim for this time. For example, if the CMO who can claim a potential salary of $120,000 yearly had worked 2 months full-time for free, it should have $20,000 more as contributions. If a co-founder has been paid by another co-founder, he can’t claim any contribution as he wasn’t working for free. The money paid by the other co-founder must be accounted as a regular fee for this co-founder.
  • Future Work
    Any work that is going to be done without being paid must be counted as a contribution of the co-founder. As soon as the revenue of the startup is enough to give a co-founder a decent salary, his work shouldn’t be counted anymore toward cash contribution. Estimate this date and add as a contribution to each co-founder the time they will work for free evaluated again the potential salary they can have claim. If you expect the company to not be able to make enough money until 6 months, give at each co-founder half of the potential salary you have calculated previously. Obviously, if the company will make tremendous amount of money since day one, nobody deserve any contribution based on the work that are going to be directly paid.
  • Social Connections
    A startup team is rarely balanced, they is often one who is more socially active than the other, who get more connections, more business-related friends and can use his network for the benefits of the company. The question is: How we value that? The simplest answer will be whatever you will be ready to pay in the regular marketplace. The commission rates for a sale are in every industry are pretty transparent, from 5% for real estate to 50% for tech services. For example, if one co-founder bring to the company a client that is worth $100,000 and the commission rate in your industry is usually 20%, give to his co-founder $20,000 as a contribution. Exactly the same thing work with contacts with potential hires and capital venture: How much an external agent will be willing to take to give you his contact?
  • Miscellaneous Fees
    Fees include anything that have been paid by a co-founder and must be counted as a contribution. It can be domain registration fees, legal fees, contractor payments, subscriptions, rents… I strongly recommend to include all fees even small ones to add the more fairness possible to your math.
  • Idea Conceptualisation
    The idea and the idea conceptualisation, alias business plan, has also a price. Idea worth almost nothing, all the value of a company is based on the aptitude to execute the idea, to make it real. Idea conceptualisation takes time, energy and experience and have a higher price. A tip will be to evaluate the contribution of the co-founder who have done this work as if he was working for an external marketing agency.
  • Others
    If you think of other things that can have a value and are not listed above, take time to evaluate it based on its market price. Then, give the co-founder concerned the value of his contribution. For example, if a co-founder has a working prototype, try to evaluate the value of the prototype if you have to pay an external company to make it.

When you are done, sum up all the contributions of each founder and you will have the value in cash bring on the table by each co-founder. Sum up all the total values of each co-founder and you get the virtual valuation of your company, basically all the money, real and virtual, needed to start the company. Then you just have to make a ratio, co-founder’s contributions/total company valuation, to estimate each co-founder fair shares.

Here is an example, assuming the CEO’s potential salary is $300,000, the CTO’s $150,000 and the CMO’s $120,000, and the company will take 1 year and half to make enough money to pay the founders:

  • CEO
    Capital = $150,000
    Work already done = $100,000 (4 months full-time)
    Future Work = $450,000
    Social Connection = $50,000 (1 customer worth $500,000 with 10% commission)
    Legal Fees Paid = $20,000
    Total Contributions = $770,000
  • CTO
    Work already done = $50,000 (4 months full-time)
    Future Work = $275,000
    Prototype Build = $70,000
    Total Contributions = $395,000
  • CMO
    Capital = $100,000
    Work already done = $20,000 (10 months part-time at 20%)
    Future Work = $180,000
    Social Connection = $200,000 (5 customers worth $2,000,000 with 10% commission)
    Marketing Fees Paid = $30,000
    Total Contributions = $530,000

In this company, the total valuation will be $1,695,000. The CEO will receive 45%, the CTO 24% and the CMO 31%.

Congratulation, you are all set. Feel free to use this method and adapte it to your own business, company or startup. Remember, the main discussions with your business partner must be focused on the valuation of each components and not the resulting shares of each person. Thank you for reading, I am hoping it will help you to make better and fairer co-founder deals and, above all, good luck with your business!

Advertisements