Question: I am starting a company that will require a substantial amount of financing through private investors. I have an initial seed group of five investors (including myself) who have all put an equal amount of money into the project thus far. Each investor is responsible to raise more capital through outside investors. I created the company with my own ideas and will be doing the lion’s share of work both before and after opening. The total equity for the seed investors is 35% with each person owning 6% except myself. I have given myself an extra 5% for the idea and all of the work to get things up an running. Is this extra 5% reasonable in light of the efforts (approximately 600-1000) man hours of work)?

Answer: There are no magic formulas in this area, no rules of thumb or guidelines that help that much.

What would help a lot would be to put your hours into terms of money, not
hours, so you can compare apples to apples. That generally helps partners
see and understand, and it also helps you put a value to things.

Assign a value to yourself and your work as an hourly rate and multiply that
rate times the number of hours. That gives you a number you can compare to
the rest of the investment.

For example, if your hour’s work is worth $25, then 800 hours of work is worth $25,000. Once you have that monetary conversion, then you can more easily consider fairness. It leads to some quick nest steps:

  • What do the outside investors think of this valuation of your work so far? How does 5% of the company for $25,000 (the hypothetical example amount) compare to the deal they are getting?
  • What do you partners think about this? Are they comfortable with your setting your value at the hourly rate that you consider?  Does this match the amount of equity they get for monetary contributions?
  • What does this say about the overall valuation of the company? If your 800 hours is worth (hypothetically) $25,000, then is $25,000 a fair value for 5% of the company? Is the company worth $500,000?

You don’t mention the investment amounts involved in this company, and don’t take my hypothetical value as anything but that, but I think you can see how putting sweat equity into straight money value can move a discussion forward.

Congratulations, by the way, in considering this issue before it gets forgotten and is then much harder to correct.  Too many founder groups are shy about setting these mileposts down in black and white as they set up the company.

— Tim Berry —

Tim BerryTim Berry

Tim Berry is the founder and chairman of Palo Alto Software and Follow him on Twitter @Timberry.