Quick case study: To give up equity or not
A colleague of mine contacted me to ask if he should give up a 30% equity stake in his company in exchange for about $10,000 services in kind (e.g. office meeting space, other support). (Numbers disguised to protect the innocent).
How do you think about an offer like this?
1. NEVER give up equity unless you have the opportunity to SIGNIFICANTLY increase the value of your company to your new partner. This means: major management or board talent, new technology, significant funding for ongoing operations. It rarely means a normal operating expense like meeting space.
2. If you do consider giving up equity, know the math:
a. What will be the value of the company in 3-5 years?
b. What is that value in today’s dollars at some appropriate rate of return. In this case, say that at a 15% discount rate over 3-5 years, the company is worth $100,000 in today’s dollars. The discount rate and expected value of your company are all determined via negotiation, so you should have a good sense of valuation (which I can get into later if anyone wants, or you can discover by getting a basic finance/valuation book).
c. Divide the value of the investment or contribution into that number. So $10,000 into $100,000 is 10%. That’s the maximum equity you should give up.
So in this case, here is my advice:
1. Don’t give up equity for meeting space. Instead, barter your services for meeting space. Equity is too valuable.
2. If you were to give up equity, in this hypothetical case 10% is about right.
Finally, you have to create a company that is worth something down the road. If a company is only “you” as an independent professional offering services, it won’t be worth anything. You need to develop a system that lasts beyond you, so someone sees value independent of the owner.