Pay Back the Founders

One of the commonly misunderstood components of an investment in a growing business by people who have not been there before is the concept of paying back the founders. That is, the company has a value, and people sacrificed in some way to help the company get to where it is today. That might have been money, connections, time, or pretty much anything that can be valued.

When the potential investor comes around, the question arises as to how to place a value on that form of equity.

First, though, what has to be realized is that technically, the founders are not entitled to anything. Strictly speaking, the investment is a purchase of shares from the company, usually done by issuance of new shares, for a stated price. The founders are not the sellers, they are merely authorizing the corporation to create and distribute new shares according to the terms of whatever deal it is they made.

However, the founders may have to be convinced of the value of gaining the investment, and the company may owe some debt to the original founders (depending on how they structured the startup investment). As well, the investors may want to show some goodwill toward the founders by alleviating some of their contribution in the form of a payback.

As a buyer, though, the amount to be paid to the owners will be somewhat a function of the amount of real value that the initial brought into the company. If it’s merely time, that can be priced at a known rate (discounted by the amount of ownership the founders are retaining). Often, though, there’s also some form of IP (intellectual property) which, not relating to whether or not it is protected by the company, was provided by the founders.

At the end of the day, though, the amount to be paid to the founders is more a function of goodwill than of concrete value. The numbers may fluctuate wildly, and may have limited relationship to the value of the company as it stands in the accounting records. It is more of a bribe to the founders to convince them to part with a piece of their company than a part of the purchase.