Looking for the right answer - Ownership Rights (creditors, loan, debt)

[artillery77]

For new companies. How do founders tend to to split up ownership fairly? What are different methods that work?

Lots of contributions on this. Founder has process never done before. Engineering is making new machine not made before. Software is making a new app. Operations is getting industry rivals to work together without them realizing. Supply chain has secured best in industry pricing. Sales has landed a critical opportunity....with a 40 year moat that make the entire thing profitable, assuming execution.

Oh, and then there's the start-up money. There's the at the start money to get things to proof of concept. There's the promised loan after that for the remainder of the project, given a personal guarantee....

I know it's not a valuation shop, but it's a good shop for popular opinion, and I'm the only finance guy anyway. Ideas on breaking up ownership? Break up pieces in different companies?

At the end of the day, I can set it to hit %'s....but what is fair? All are friends. I want everyone to win. I want nobody to be envious. Not possible...so....how do we do it?

[luv4horses]

Sell the whole sheebang and split the profits.

[cpg35223]

There is no set formula. But having been through a couple of partnerships, here are some principles I would offer:

1) Someone has to be in charge. Before you set ownership levels or anything else, decide who is going to act as the CEO. That's a person who should be technically adept and understands the broad strategic needs of the marketplace. Who among you is multilingual enough to understand how all the parts of your organization need to work to achieve a harmonious functioning? Who has a vision for where this thing could go?

2) Ownership is really dependent on contribution level, both in terms of intellectual property and capital. You can have the best idea ever, but if you don't have capital then it will never get off the ground. So I think you really have to negotiate that between all of you. If nobody has controlling interests, there has to at least be an acknowledged leader in the organization.

3) The separate company idea is an idea that might sound attractive in theory, but will quickly go off the rails in practice. It means that everybody will act in the interest of their individual companies rather than in the interest on the one company. Companies will be billing one another and paying one another, leading to a real mess on the financial end of the equation. So one for all and all for one in that sense.

4) The Friendship Thing. It's great that you're friends. But this is a business. When real money gets involved, that handshake agreement you had at the beginning will not last long. That means you need to start with a very good attorney to draft by-laws, corporate papers, buy-sell agreements, and everything else under the sun.

Make sure you have very clear wording about the shareholders' responsibilities to the company in terms of maintaining good credit (I had to deal with a former business partner who started a side business without informing me and got into serious problems with his creditors. Because we were an S corporation, his credit problems became the company's credit problems), chain of command, succession plans, and a host of other things.

Better to have all this thought out now than being forced to confront it five, ten years from now. Have agreements on, when the thing starts to cash flow, how you're going to dividend and how you're going to compensate. Finally, how thoroughly can you trust your partners? Do they have stable personal lives? Good marriages? Because your financial fate will be tied to those guys for a long time. And if one of them has big problems in his personal life, it will quickly become your problem to deal with.

[artillery77]

Originally Posted by cpg35223

There is no set formula. But having been through a couple of partnerships, here are some principles I would offer:

1) Someone has to be in charge. Before you set ownership levels or anything else, decide who is going to act as the CEO. That's a person who should be technically adept and understands the broad strategic needs of the marketplace. Who among you is multilingual enough to understand how all the parts of your organization need to work to achieve a harmonious functioning? Who has a vision for where this thing could go?

2) Ownership is really dependent on contribution level, both in terms of intellectual property and capital. You can have the best idea ever, but if you don't have capital then it will never get off the ground. So I think you really have to negotiate that between all of you. If nobody has controlling interests, there has to at least be an acknowledged leader in the organization.

3) The separate company idea is an idea that might sound attractive in theory, but will quickly go off the rails in practice. It means that everybody will act in the interest of their individual companies rather than in the interest on the one company. Companies will be billing one another and paying one another, leading to a real mess on the financial end of the equation. So one for all and all for one in that sense.

4) The Friendship Thing. It's great that you're friends. But this is a business. When real money gets involved, that handshake agreement you had at the beginning will not last long. That means you need to start with a very good attorney to draft by-laws, corporate papers, buy-sell agreements, and everything else under the sun.

Make sure you have very clear wording about the shareholders' responsibilities to the company in terms of maintaining good credit (I had to deal with a former business partner who started a side business without informing me and got into serious problems with his creditors. Because we were an S corporation, his credit problems became the company's credit problems), chain of command, succession plans, and a host of other things.

Better to have all this thought out now than being forced to confront it five, ten years from now. Have agreements on, when the thing starts to cash flow, how you're going to dividend and how you're going to compensate. Finally, how thoroughly can you trust your partners? Do they have stable personal lives? Good marriages? Because your financial fate will be tied to those guys for a long time. And if one of them has big problems in his personal life, it will quickly become your problem to deal with.

Thank you for the excellent post and certainly what I want to do is give clarity to the participants. I will be CEO. I should clarify that they are all MY friends, not necessarily friends with each other. What I'm doing in a nutshell is taking an old school fragmented service industry that has basically no R&D and putting a new tech overlay on it.

I know the tech engineers through past workings, social groups and school. Three were wedding groomsman/bridesmaids, but they don't know each other outside of me. This is the portion I will have the toughest time managing, but have someone who's built from concept to product previously.

The old school operations are through my wife and her extended family operations. The know-how operations will be augmented by the tech, but the operations are easily overlooked by many as it is low tech.

I have the idea, the process and have pulled together the team. They have the relationship with the major customer, and am confident in being able to generate new sales fairly easily once we've made proof of concept. I'm supplying the majority of the capital/credit, but will give each the opportunity to exercise financial ownership as well.

I'm envisioning paying employees (albeit relatively lower wages at first or possibly in arrears) with a healthy profit sharing portion. The true founders will get options to buy equity. The starting value of the company is x. As the pieces are completed, the value of the company will obviously go up. So those contributing right at the start will get more shares for their money than those doing so later. People buying only when it is safe to do so (i.e. major pieces are complete) will have to pay more for their relative shares.

Valuing the components is difficult. I've got a giant project GAANT and relative wage rates for time, and expected spend amounts for materials/expenses and if it is to be contributed or paid by the company. On the engineering front, I'm having them fine tune expectations, but I need to keep all parties motivated because getting 7/8 of the requirements done still leaves us burning cash. I've already got agreement for 100% debt financing for the entire first deployment ($2.5M) once we can demonstrate proof of concept and show the final contract with the large customer (which requires proof of concept before finalizing).

Yet I don't want to show the costed GAANT as basis, as it may lead to manipulation or picky fights. I need them to focus on just getting it done, and if we hit the opportunity, it shouldn't matter for any of us. Beyond which, I told the lead engineer, if you hit this, and I don't pay you, someone in Silicon Valley will snap up you and your team in a heartbeat.

The other way is to have a preferential IRR for the initial $ capital, but capped once a high rate of achievement has been achieved to make sweat equity worth more. There's also room for a tax investor as the capital equipment will generate large depreciation amounts in the early years, and will be a good source for monetizing tax losses early on.

All of the partners are accomplished professionals. All but one are married with kids. All have low six figure annual economic costs associated with participating. Nobody is living paycheck to paycheck, but everyone needs a paycheck still and I really don't want to **** off everyone's wives.

So it's that mix...how to carry it through the first 12 months, and keep people motivated, and keep it funded...and we come out the other side.

[cpg35223]

Originally Posted by artillery77

Thank you for the excellent post and certainly what I want to do is give clarity to the participants. I will be CEO. I should clarify that they are all MY friends, not necessarily friends with each other. What I'm doing in a nutshell is taking an old school fragmented service industry that has basically no R&D and putting a new tech overlay on it.

I know the tech engineers through past workings, social groups and school. Three were wedding groomsman/bridesmaids, but they don't know each other outside of me. This is the portion I will have the toughest time managing, but have someone who's built from concept to product previously.

The old school operations are through my wife and her extended family operations. The know-how operations will be augmented by the tech, but the operations are easily overlooked by many as it is low tech.

I have the idea, the process and have pulled together the team. They have the relationship with the major customer, and am confident in being able to generate new sales fairly easily once we've made proof of concept. I'm supplying the majority of the capital/credit, but will give each the opportunity to exercise financial ownership as well.

I'm envisioning paying employees (albeit relatively lower wages at first or possibly in arrears) with a healthy profit sharing portion. The true founders will get options to buy equity. The starting value of the company is x. As the pieces are completed, the value of the company will obviously go up. So those contributing right at the start will get more shares for their money than those doing so later. People buying only when it is safe to do so (i.e. major pieces are complete) will have to pay more for their relative shares.

Valuing the components is difficult. I've got a giant project GAANT and relative wage rates for time, and expected spend amounts for materials/expenses and if it is to be contributed or paid by the company. On the engineering front, I'm having them fine tune expectations, but I need to keep all parties motivated because getting 7/8 of the requirements done still leaves us burning cash. I've already got agreement for 100% debt financing for the entire first deployment ($2.5M) once we can demonstrate proof of concept and show the final contract with the large customer (which requires proof of concept before finalizing).

Yet I don't want to show the costed GAANT as basis, as it may lead to manipulation or picky fights. I need them to focus on just getting it done, and if we hit the opportunity, it shouldn't matter for any of us. Beyond which, I told the lead engineer, if you hit this, and I don't pay you, someone in Silicon Valley will snap up you and your team in a heartbeat.

The other way is to have a preferential IRR for the initial $ capital, but capped once a high rate of achievement has been achieved to make sweat equity worth more. There's also room for a tax investor as the capital equipment will generate large depreciation amounts in the early years, and will be a good source for monetizing tax losses early on.

All of the partners are accomplished professionals. All but one are married with kids. All have low six figure annual economic costs associated with participating. Nobody is living paycheck to paycheck, but everyone needs a paycheck still and I really don't want to **** off everyone's wives.

So it's that mix...how to carry it through the first 12 months, and keep people motivated, and keep it funded...and we come out the other side.

Excellent. Sounds as if you're on your way.

Here's my only other bit of advice. No matter how well you draft your pro forma, no matter if you calculate expenses down to the paper clip, plan on your assumptions going completely up in smoke within 90 days. Pro formas are typically points of departures, not long-term strategic plans.

So, regarding the compensation of your key people, you need to make sure that everybody understands the risk involved and also make sure that you've seriously underestimated expenses while overestimating income.

One other thing. The spouses need to know exactly what is going on at every point, even when it means telling them the ugly truth about things. The worst situation you can have is if you collectively blow sunshine up their youknowwhats and they plan accordingly. They are partners in the enterprise by proxy, if not in the shareholder agreement.