How do you determine new partner equity in a pre-existing business? I've read the book Slicing Pie and it explains a lot of it detail. My confusion is how to actually determine what a potential partner's contribution is valued at to figure out what that brings to table.
Hi, great question.
You determine the value of the business before the partner joins, then you determine the value of what they bring.
You then issue new shares to them.
I made this video which may clear things up a bit for you.
And this one about share dilution:
If you want to discuss your specific circumstances, please feel free to request a call.
Not exact science and so so so many variables based on many things.
Here is one approach that might help you get to a framework to adjust from. Remember since you are a pre-existing company, it is really about share of value creation in the GROWTH of the company not the whole company.. that is CURRENT VALUE is the starting basis and so the question is how will the new partner help deliver the value above that current basis and how should that be shared?
- start w a value for the current pre-existing business. this value can certainly include value for where its is heading as is
- next, how would the two of you split things up based on expertise, experience, etc if you started a NEW company today... would it be 50/50? or do one of you bring more to the table than the other
- use that as one variable as a starting point of equity split of future added value.
- then look at other variables to add in or subtract out.. the company is not risky so the other partner is joining w less risk in the future, how is the new person being compensated vs you, is someone adding in capital or someone taking future capital risks, will you both be in full time, how stable is the company, etc..
- then you can also prescribe part as 'to be earned' (vested) based on certain targets for the partner or for the company...some of this is obvious '20% of your equity will vest based on you delivering Y.." but some is less so "I know the company, without you or someone else, would be worth X more in the next years, so I'll share a small part of that, but share a larger part of any value above that"
The idea is:
- current company value
- how do you see value split for new partner in creating new value to Company
- how risky is it / and who is bearing risks now and into the future
- criteria to vest "earn' part of it
hope that helps you some..
..... schwartz out
I've found that if you are going in with 1 or more partner and you are all doing it full time, then split it out equally. You'll prevent a whole lot of resentment in the long run. Of course, the devil is in the details. For example - if Founder A put $$ in as well as time, then they are probably going to ask for and would be justified in getting more equity than Founder B who is just putting in time. Happy to chat about this in more detail having been through a handful of co-founder situations where we had both success and failure.
If you are about to start a business with someone go 50/50 if you don't feel confortable doing it then don't start the business anyway. Just like mariage it's a trust situation.
If you are about to bring someone into your existing business, the equity amount does not really matter because what you want to do is vesting, give the shares bits by bits after certain milestone that you predefine. You don't want to give 10% right away to someone who has done nothing and just slack on his/her shares.
It would also be a good idea to start from the willingness to contribute ie. the partner would be an active partner or simply investing and being an inactive partner - all in comparison to what skills, funds and workable solutions they are bringing to the table.
Partnership equity is the percentage interest that a partner has in partnership assets. In other words, partnership equity represents the partner's ownership interest in the business. The total contributions of all partners plus retained earnings are reflected on a partnership's balance sheet as equity. It is not uncommon for an equity partner to have unequal equity in the partnership. The two agree that the fair market value of services that Tim brings to the partnership is $75,000 . Tessa funds the partnership with $100,000. Tim will have about a 42 percent equity stake in the partnership and Tessa will have about a 58 percent stake. Profits and losses are distributed between the partners according to the partnership agreement. While allocation of profits and losses do not have to be equal to the percentage of the equity each partner has in the partnership, it is a common method of allocation. Michael has a 75 percent equity interest in the partnership, and Janice has a 25 percent interest. Michael and Janice agree to distribute profits and losses in accordance with their respective partnership interest.
You can read more here: https://smallbusiness.chron.com/partnership-equity-64265.html
Besides if you do have any questions give me a call: https://clarity.fm/joy-brotonath