One take away from last weekend's Startup Weekend Des Moines is that capital is not always the fuel that stokes the fire; it's the long days and nights put in by designers, developers and marketers working towards a common goal. Surprisingly, many entrepreneurs fail to recognize this when setting up a company.
First, they focus their equity split on the amount of capital contributed by each founder rather than the quantity and quality of the services that each founder provides.
Second, even if they do cast their eye towards services, they often fail to acknowledge that those services will be provided over an extended period of time, rather than at or prior to the date their company is formed.
These oversights can create fundamental rifts in a startup. In some cases, founders that provide material services may start to feel like they have been short-changed by those who contributed capital in exchange for a large part of the available equity, and lose motivation. In other cases, founders that contributed capital can feel short-changed when services are not timely rendered or are not rendered at all.
To deal with these issues, it is first important to thoroughly understand your business, its service and capital needs. For example, you need to examine what services will be needed to bring the product in question to market and what those services would cost in the open market. You also need to understand your capital needs and the availability of that capital in the marketplace. These and other factors should drive the relative values you place on startup capital and services. To give structure to this examination, you should develop a business model and financial projections. A wonderful tool for that has been developed by Mike Colwell and can be found at http://www.startupmodels.com/.
Once you determine the relative value of capital and services, you need to address the fact that while startup capital is generally provided upfront, startup services are generally provided over time. To ensure that those services are actually provided in a timely manner, we generally advise our clients to subject service-based equity to vesting. That vesting can be based upon time or the accomplishment of certain established milestones. It can also be tied to revenue or anything that is deemed relevant, although time-based vesting is the most common.
Vesting is technically accomplished through the use of a restricted stock, unit or a similar agreement. The exact terms of that agreement will be determined by the vesting metric that is selected, such as:
- whether the equity interest is partially or fully service based;
- how much salary the founder is being paid in cash, and;
- how the business is expected to perform (e.g. if you expect to have an exit event in two years or to give up on it if it hasn't taken off by then, a four- year vesting schedule does not really make much sense).
To make these agreements easier for startups to deploy, we have automated their production through the Start-up Launchpad. For more information on the agreements, navigate to our client area, set up an appointment at our next office hours event, or simply give us a call at (515) 288-2500. We would be happy to discuss these agreements and how they can be used to the benefit of your startup.
Jason M. Stone
The Start-Up Launchpad