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.

Related posts:

1. Founders Agreements
2. Balance of Founders
3. IPO – Initial Public Offering

One such question was regarding an idea for a new website. The person asking the question had, at the time of this writing, asked a dozen questions related to his idea and turning into a business, the last of which was focused on the difficulties he was facing in finding a co-founder.

I went back and looked at the previous questions, and realized that there was a more fundamantal problem – he couldn’t explain clearly what his idea was, and how it would make money. He had long treatises on various aspects of his business, but he lacked a 30-second elevator pitch.

To counter that, there’s a site that makes a joke of this: So What Does Your Startup Do? where it randomly generates ideas for new businesses. While some of the ideas are funny, some odd, and others intriguing, the basics of the site is that in one sentence, you should be able to describe what your business is.

Forget the long explanations – only people hooked on your idea will bother reading them. Forget about trying to explain market demographics and complicated affiliate programs, it’s not exciting.

Try it like this:

It’s a gaming site where you can bet against your friends using Vegas-odds, with no house to lose all your money to. (Cash Poker Pools)

I didn’t explain the margins, I didn’t get into details about what happens on the site, or who would use it. I just explained in broad terms what the business is. For someone who really wants to know, I can get into the exact details about the nature of the bets, how the odds work, and where the site gets its revenues from. Most people, though, don’t care about that kind of thing.

If you really want to convince someone you’ve landed on the next big deal, make sure you can say it quickly. When they ply you for more information, make sure you can answer the questions actually asked, which are likely not the same as the ones you hoped they would ask.

Related posts:

1. Pay Back the Founders
2. Slow Economy and Developing a New Business
3. A Novel Idea

Rules differ between countries, but there are a few basics which seem to be fairly common which govern the acquisition of investment capital.

First, there is often a limit on the number of investors you can approach before you will be required to file a formal prospectus with the appropriate regulatory body. As such, it is important that you limit your discussions regarding investments to the smallest number of prospects as possible, and only those you realistically believe will actually personally invest in your business.

Second, before your investment can be completed, you will need to have a formal entity for your business – that is, some form of corporation which can issue shares – along with associated banking and financial accounting in place for accountability.

Because of these restrictions, finding a potential investor, at the early stages of development of a company, can be difficult. If a corporate structure does not yet exist, there is nothing to invest in. If you cannot broadcast your interest in acquiring capital, potential investors won’t know about you.

This is where your network can come into play. You may have a family member or friend who does know investors, and can make an introduction. The value of such introductions can be quite high, but that should not be taken to mean that the price is also expensive. Be wary when making use of such a referral in regard to payment – in some places, payment can only be made to a registered broker, while in other places, no such restriction exists, at least from a regulatory perspective.

However, investors will not be pleased to see their investment dollars going to a third party who has done little to no work in growing the company. An introduction, while invaluable in terms of opening doors that might otherwise not exist, is only a drop in the bucket in terms of the effort that will be needed to close the deal.

The investor will question the founders and their team intensively to determine the potential value of the deal – the broker will have little to do here. Lawyers will be hired to document the terms and finalize the arrangements. Accountants will be needed to perform due diligence on the finances of the company to determine, as closely as possible, the actual value of the company.

That’s not to say that the broker should not be rewarded. However, the reward should either be handled privately, in the case of a private introduction with no risk, or perhaps outside the terms of the deal. For example, if the broker runs a company which performs a service that your company is in need of, consider giving the broker rights to exclusive bids on projects, which will survive an audit of your company’s actions.

If the broker is asking for equity, beware. Even if it is allowed by the regulatory bodies for such a transaction to take place, there is going to be a conflict of interest, and the broker is likely being overpaid for their work. There are plenty of ways to reward the broker without giving up a piece of the company.

Related posts:

1. Tell A Story
2. Get Some Skin in the Game
3. Pouring the Foundation

I early on pushed for getting an operating contract agreed to by all three because I intuitively believed “make things explicit” would prevent heart-ache in the long run. My one big mistake was not doing due diligence, that I’ve now done, on how things should be done for a startup. The agreement that we are currently under is each founder gets a third, but we log our hours and get paid an hourly wage (significantly less than my contract rate but significantly more than A’s salary rate) which will be paid when when the company starts making money. The wage was a concession to me because I knew I’d have a lot of up front labor (but its now not seeming worth the risk its supposed to offset).

The meeting of partners

The issue with this arrangement is simple – there’s no vesting, and the contributions being made by each of the three founders is not going to be equal in terms of time (although the value of the contributions may be equal in other ways).

First, what’s vesting?

Vesting in terms of a startup is the granting of partial ownership in the company (that is, shares in the company) that the employee gets over time. What this does is ensure that the employee will do their work (or they will be forced to sell the unearned component of their shares), while guaranteeing to the employee that they will, in fact, get their shares if they do the work required.

This is important in a startup in which the various people involved will have different levels of contribution, at least in the early stages. However, an assumption is made that the idea, IP, or company is initially owned by a single person (or company) which is recruiting others. In order for the initial founder to guarantee his investment in other people, he can vest their portion of the company.

In the case of the question above, however, the company was founded with three people, each with an equal share. Vesting was not actually an option, since no one owned the company beforehand (that is, who is the current owner of the company if not all three founders). Therefor, what this person needs is not a vesting schedule, but a solid founders agreement.

A founders agreement can be as simple as a single sheet of paper called a Statement of Understanding. The first lines of the paper would be something along the lines of:

This document is informal, and is intended to be the basis for a formal Memorandum of Understanding between the parties named below. It is meant to be interpreted as plain English as understood by a reasonable person. It is not a contract, but is intended to define the parameters under which a company may be formed.

The rest of the document outlines who the various people or companies are subject to this statement, what each one will be contributing to the partnership, and what each will get in return. Over time, this document can be expanded to include things like payout options, buyout options, dividends, reinvesting profits, and so on.

Regardless, it is critically important that any partnership have such a statement at a minimum, in order to prevent misunderstanding later. It should be easy to understand – it’s not about creating a complicated legal document that covers all contingencies. It’s to make sure that each of the partners understands what is expected of them and what they will stand to gain from the arrangement.

If you are looking to get into a partnership with someone, whether you are initiating the arrangement, or the other person is, make sure that you have such an agreement, and that any concerns you might have are outlined in it.

Related posts:

1. Pay Back the Founders
2. A Preferencial NDA Clause
3. Balance of Founders

How novel does a startup idea need to be?

There were several answers provided, and I obviously like my own the best:

Even if your idea is novel, within days of your site going live, there will be several imitators out there hawking a similar product. You have to do the best job you can to make your product provide as much value as possible. Thus, the issue of being novel is [almost] irrelevant, since even if it is novel today, it won’t be tomorrow, so why worry about that? Instead focus on being better than whatever competition is out there!

Thinking of a novel idea?

However, in looking at the question, there really is more that can be said about this. An idea for a startup needs a few components in order to be eligible for success, and novel is not one of them:

1. Is there an unfilled demand for this idea?
2. Who will pay for developing this idea?
3. Can I do this, or can I recruit someone who can?

Is the idea original? It doesn’t really matter if the demand is not being filled currently (question 1). If I can fill the demand (question 3), and someone will pay for it (question 2), then my idea has the potential to be a success. If any of these questions cannot be answered satisfactorily, then it may be a good idea for someone else, or it may not be a good idea at all.

As a hopeful startup founder, what you need to do is be aware of how unique your idea is, because it will help you pay attention to the appropriate competitors. If there aren’t any at the moment (which in general demonstrates that you haven’t done your research properly, but occasionally might be true), then as soon as you launch, find out who started right after you. There is not a single niche market for which there is no competition – and I challenge you, my readers, to show me an exception. No, the competition may not be exactly the same as you, and they may not be at the same level as you. But they exist.

If you can understand who your competition is, and how you and they differ from one another, then you’ll understand the being novel is not that important. What is important is to be as good as possible at whatever it is you do.

Related posts:

1. Clever idea… but are you the first?
2. Balance of Founders
3. Conception to Creation of a Business Idea