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gaming_mouse 11-29-2007 11:53 AM

How does equity work in a new company?
Say 3 people are beginning a new company. At inception it is simply an idea. Two partners, Resource1 and Resource2, are considered more valuable because of the skills they are bringing to the company and the work they will do in the future. A third partner, Money, will be putting up most of the money.

They decide that the following equity distribution in the shares of the new company will be as follows:

Money -- 20%
Resource1 -- 40%
Resource2 -- 40%

In addition, each partner also puts up money for the company's operating costs, as follows:

Money -- 100
Resource1 -- 50
Resource2 -- 50

My question is (and there may be more than 1 "standard" answer -- please let me know if that is the case), how much money each person would get in the following scenarios.

Scenario 1 After 6 months of operation, half the company funds have been used up, and all partners make a decision to dissolve the company and receive their fair shares of what is left. So what are those fair shares?

Scenario 2 After 6 months of operation, company profits = company losses, so the company has its initial 200 still intact. They decide to dissolve. What is each partner's fair share?

Scenario 3 After 6 months of operation, the company has profited 200, so the company has 400 in assets. They decide to dissolve. What is each partner's fair share?

midas 11-29-2007 12:02 PM

Re: How does equity work in a new company?
There is no such thing "fair share" they all get their legally agreed upon equity distribution. That's why corporations are formed by lawyers to avoid this issue.

mindflayer 11-29-2007 12:45 PM

Re: How does equity work in a new company?
$x gets you y%. X and Y are whatever deal he/she can strike.
You seem to be missing a whole lot of information.
What do resource 1,2 and money get paid for salary. What type of work is being done?!? How viable is the venture long term, does it repeat, is it (linearly) upgradable?
if $200 gets you $400 after 6 months, can you double that to $800 after 12 months?
How probable is each outcome?
Is there a 4th outcome? The business continues?

Without knowing much, I would guess it is probably Not a new business but a one off deal (since you consider closing after increasing to 400.

APXG 11-29-2007 03:33 PM

Re: How does equity work in a new company?
i'm not sure if this is commonly done, but i would issue warrant-style shares to the resource partners that would only vest at strike prices above an equity threshold, and also introduce a time component. for example:
rp1 = $50
rp2= $50
mp= $100

rp1 = 80 --> 20 fully vested at time 0, 10 at time 1, 15 at time 2, 20 at time 3, etc. of the 10 at time 1, 2 would vest at strike / equity = $2.5 per share, 2 at $3 per share, etc.
rp2 = 80 --> same as rp1
mp = 40 --> all fully vested

you can obviously change all the numbers to drive how much the mp wants to pay the rp's for their work outside of equity creation, hence vesting 2 shares at $2.5 despite that being breakeven equity. if you want to pay them extra despite equity destruction, make some of the shares vest at $1.5 or $2 and scale this in for as time gets longer.

perhaps some of this is wrong / doesn't make sense, but i think its a start in the right direction in terms of framework.

bobman0330 11-29-2007 04:24 PM

Re: How does equity work in a new company?
For tax reasons and for fairness, you would usually set up the company so that, e.g., the money guy gets preferred stock worth $75 and pays $25 for 20 shares of common. The other two pay $50 each for 40 shares. If that was the structure, Scenario 1 gives all the money to MP, Scenario 2 returns what they put in, and Scenario 3 gives 140 to MP and 130 to the others. (Unless the shares have vesting requirements, which would also be common.)

Quercus 11-29-2007 08:02 PM

Re: How does equity work in a new company?
It gets sort of complicated, because typically these deals typically involve different classes of stock for the pre-money and post-money cases.

In the case you describe, if there is less money after 6 months than everyone put in, then typically the initial shares pre-money would get nothing and the post-money round 1 investors would get back proportionally what they put in.

Preem 12-01-2007 05:23 AM

Re: How does equity work in a new company?
Here in Silicon Valley, the Money guy would get the most shares (>50%) and have the most voting power.

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