Posts tagged "equity"

5 steps to follow when doing business with family or friends

It is an immutable law in business that words are words, explanations are explanations, promises are promises but only performance is reality. Harold S. Geneen

Getting into business is like all other major decisions you have to make in life. Like all complicated decisions there are factors which tend to have a more pronounced impact on the decision. Going into business with friends and family is one of those factors. In my experience these tend to be a lot trickier than standard business agreements because they come with their own baggage. Over the years I have been adviced and have learned how to deal effectively with the issues that arise when you go into such a business venture. I hope this will be of some help to you if you are planning on getting into business as well. If there are any other factors which you think should be included in this list please let me know.

  • Business Plan Development: Never fall into the trap of getting started with ‘just’ a business idea. Sure you have a greater level of trust with your business partner but that does not mean you would exclude putting down on paper what it is that you plan on achieving through this business. The process of putting down on paper what your idea is, clarifies it, identifies key areas which you need to work on and possible pitfalls you may face. This is a step which needs to be taken before you start any venture. To read more about business plan development please click here.
  • Commitment Levels: With a business plan in place you will now be able to judge with greater certainty how much money, time and effort is going to be required by the business. You need to put down clear parameters at this stage as to what each partner is supposed to do. This level of commitment needs to be clarified from the start or you will have an unbalanced partnership which leads to a multitude of problems further down the line. To read more about how to set commitment levels please click here.
  • Candor: Establish a culture where candour needs to be an integral part of the venture. The worst thing you can do for yourself and your business would be to keep all the things you want to say to yourself. This will lead to frustration, under performance and morale issues which can jeopardize the success of the business. A culture where you can be open, state your opinions and be comfortable will help you form a considerable competitive advantage and will enable your company to make difficult decisions with a lot more ease. To read more about candor please click here.
  • Noise Levels: When you set to do business with friends/family you need to keep external noise levels under strict controls. Noise levels refers to the interference in the business by members of your family or friends. When we divulge too much information outside the core group it ultimately comes back to the core group in a completely changed form. This could lead to several problems between partners, frustrate the team and affect the overall morale. To learn more about how to keep noise levels at your company please click here.
  • Equity Splits: This is an issue which is at the core of most problems which are faced by all companies but more so in businesses where friends and family are involved. We tend to be a lot more generous just because a business partner is a cousin, friend or relative. You need to correctly assess what the partners contribution will be and then use a simple model to figure out how much the partners stake is actually worth. To read more about the formula to calculate a fair equity split please click here.

Doing business is tough, especially when it involves family and friends. These couple of steps should provide a basis for a solid framework which would help you work through problems in a structured and fair manner. These steps should be taken as a frame of reference and can be adjusted for your actual scenario. If you require any advice or feedback please let me know and I will do my best to see if I could be of any assistance.

Equity Splits

“Lets all split it equally”. There are many people who agree with this and quite a few who don’t. I am with the latter group. I have been part and am still part of ventures where equity has been split equally from the word go. If there is one reason why this is done so widely it is, ‘lets not ruffle any feathers’. The other train of thought is that since the company is only an idea right , lets see how it develops. I used to think that way too, until some of the companies I was with got reasonably big or some partners became way too complacent. Thats when I realized this doesn’t work.

Since we are creating a culture of being candid I think it should start from the word go. When looking at splitting equity there are a couple of factors to consider when doing the split:

1. Money to be invested

2. Time to be invested

3. Experience of the partner

So lets take an example:

Three partners are setting up a consultancy. The business requires substantial experience and industry knowledge as well as a large amount of time commitment. Looking at all the factors, they come to the conclusion that each factor should get a certain weightage; Money (18%) Time (48%) Experience (34%). All partners decide that they should split the investment money equally. Time wise the split would be 50/30/20 and experience wise it would be 55/25/20.

Thus you would get:

Partner A ( 6% + 24% + 18.8%) = 48.6%

Partner B ( 6% +14.5% + 8.5%) = 29%

Partner C ( 6% + 9.6% + 6.8%) = 22.4%

Allocating weightage to each of the factors can be mutually decided by all partners to be set equally or using a range of values. I feel this brings more fairness into an equity split and puts pressure on those individuals with greater shares, to deliver more to the team.

There are many permutations which could be added to bring a greater level of equality among the shareholding when time is being spent equally by the partners.

This model should provide a starting point to bring more objectivity into the equity splitting process. If you have any questions please let me know.

Source #4: Incubators

The genius of investing is recognizing the direction of a trend – not catching highs and lows Anonymous

If you find yourself in a precarious situation where you haven’t been able to raise any money through the three methods outlined in the previous posts; incubators may be the route to take. Incubators are essentially centers or organizations where startup companies are provided seed funding and a office location to launch their business. An example which comes to mind immediately is Y Combinator. The website provides you with a basic idea of how incubators are run.

I was introduced to the concept of incubators very early on as the university I attended runs several of them. The way it worked was;

  1. Write a comprehensive business plan and send it in for review.
  2. If you get short listed you were called in to give a presentation about your concept or idea to a panel of seasoned entrepreneurs.
  3. Once you get through, you negotiate with the university on an equity swap for seed financing. Usually the sum would be below $15k and they would take anywhere between 5-10% of the company.
  4. You are allocated a small cubicle where you have access to shared services such as a receptionist and a business center.
  5. You are allocated a mentor to guide you along your startup route until you are ready to meet an angel investor or VC.

In theory this is a relatively easier route than the ones outlined earlier. However due to the severe shortage of incubators in most countries I left this source out earlier. I would appreciate if comments could be made regarding incubators in your country of residence to facilitate anyone who may be looking to use this source.

Source #1: Friends and Family

“The holy passion of friendship is so sweet and steady and loyal and enduring in nature that it will last through a whole lifetime, if not asked to lend money.” Mark Twain

It is natural that when we first start out on any business venture, friends and family are the first ones who are asked to support them. I used this method of sourcing for money in my first media startup. However, it wasn’t like knocking on a door and saying, could I please have $5k. I wish life was that simple. Before you embark on taking money from anyone you have to be completely sure about what was talked about yesterday. We need to be completely sure where we are going with our idea, with whom and how. So when I approached an uncle of mine for a loan I prepared a detailed document outlining how the business is going to run. It was a basic executive summary which showed him:

  1. The market need
  2. Our value proposition
  3. The market size
  4. Our services
  5. My team
  6. Payback period

A lot of individuals overlook the fact that taking money from friends and family is risky business. We have a lot invested in our relationship with them and any sort of complication leads to friendships being lost and family ties strained. You have to make it absolutely clear to them from the very beginning what it is that you need the money for. I feel this gives them much needed relief, because from their perspective they will realize that you have put serious thought into the venture and that in itself is a good starting point.

Another factor that you have to take into account is whether they will be buying in to the business in return for equity or the funding will serve as a loan which will be paid back. I have a relatively strong preference for the latter. Involving family and friends is complicated as it is, if they buy into the company this further complicates matters and they may have completely radical ways of viewing your business model. If you take a loan from a friend or family member make sure that they are financially capable of withstanding the loan. If not you could get a call out of the blue one day requesting the loan money be returned straight away due to an emergency. That is another situation which can be the end of an early stage startup.

Whichever route you take be sure to do it professionally, with openness and honesty and get everything in writing. These will help safeguard both your relationships as well as your startup’s future.

p.s Source #0: Using savings that you may have. I have made the assumption that like most younger entrepreneurs you don’t have significant savings to initially fund the startup process. However if you have a some money saved up I would strongly suggest that you use that instead of venturing out to the next source.