Equity OwnershipENTR599, Winter A

Perry SamsonAaron Crumm

Basic Course Agenda

Time and Place• PlaceDuderstadt Room 3350 • Time 8:30 am to 11:30 am (Michigan Time, 8:40 am to 11:30 am)

Typical Agenda• Review Homework Assignment

– One or more random students will be selected by faculty to concisely and persuasively present their individual results in a compelling fashion.

• Content Lectures per Syllabus• Homework Assignment Preparation• Guest Speaker or Other Content

Educational Objectives

• This course is designed to present the Entrepreneur’s perspective of equity ownership.

• The student shall develop the critical thinking skills and analytical frameworks necessary to appreciate the trade-offs of equity ownership while making decisions around hiring, day to day operations, fund raising, long term operation, or exit from their business.

• The ideal graduate from this course will be able to make informed decisions to efficiently and effectively deploy their precious equity.

Specific Equity Tools

• Corporate Formation• Capitalization Table • Investor Term Sheet• Understanding of Business Types and Funding Paths• Founder’s Stake Allocation and Future Option Budgets• Shareholder Agreement Terms• *Corporate by Laws (*limited discussion)

*The topics and information presented in this course should in NO WAY be considered as legal or tax advice!!!!!!!!! *Every Entrepreneur should seek professional legal and tax advice for decisions surrounding Equity Ownership.

Resources

• The World Wide Web.• Popular Press

– Slicing Pie, Mike Moyer– Venture Deals, Brad Feld– SAIC Solution, J. Robert Beyster– The Founder’s Dilemmas, Noam Wasserman– Disciplined Entrepreneurship, Bill Aulet

• Films (DVDs available upon request)– Something Ventured – The history of Venture Capital– Triumph of the Nerds– Silicon Valley, PBS Special– We the Owners (available for streaming from UofM library)

• http://digital.films.com/PortalPlaylists.aspx?aid=20441&xtid=52820• USER: Accountuser20441, PASSWORD: digital

Professor Perry Samson

Weather Underground

Lecture Tools

Dr. Aaron Crumm

Adaptive Materials Inc.

Ultra Electronics - AMI

Syllabus

• Week 1. Equity 101 and Founder’s Stakes• Week 2. Basic Capitalization Table• Week 3. FFF and Angels• Week 4. Venture Investments• Week 5. Valuations and Strategic Investors• Week 6. EO, Boot Strapping, Non-Dilutive• Week 7. Non-Profits, Hybrids, JOBS Act• Week 8. Final Exam and Oral Presentations

Evaluation and Grading• 40% Homework

– Quality, accuracy, and support of weekly homework assignments.

• 20% Participation– Throughout the semester every student will be called upon at least

once to present in front of their peers as part of the weekly homework assignments.

• Grading will be based on demonstrated grasp of the topic and the ability to deliver concise, persuasive content with compelling delivery.

• 40% Final Exam– Take home exam to translate a case study into a capitalization table

and entrepreneur’s exit valuation. Individual students will give a short presentation on their results and respond to questions from the teaching staff.

Why do you want to be an Entrepreneur?

Whiteboard Exercise

Real Life Stories of Entrepreneurship

• Zip Car Acquisition, http://www.cnbc.com/id/100349819

– Founded by Antje Danielson and Robin Chase– IPO April 2011, Acquired by AVIS for $500M in March 2013.– Robin Chase owned 2.96% at acquisition.

• Facebook IPO, http://whoownsfacebook.com

– Mark Zuckerberg retains 28.2%– Next Largest Holder is investor Accel Partners retained 10%

What is the difference? (ENTR 599 Equity Ownership)

Capitalization Table

• The Capitalization Table tracks changes in equity ownership as a function of corporate expenditures of equity to gain funding, partnerships, or human capital.

Capitalization Table

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http://fundersandfounders.com/how-funding-works-splitting-equity/

http://fundersandfounders.com/how-funding-works-splitting-equity/

http://fundersandfounders.com/how-funding-works-splitting-equity/

What is Equity?Whiteboard exercise

Shares by any other name…

• Authorized– Total number of shares available per the Articles of

Incorporation. It represents the maximum number of shares a company can issue.

• Issued– Shares are issued when the company sells them to an investor

and receives cash or some other benefit in return.

• Outstanding– Once issued, shares are outstanding as long as investors hold

them and the company has not repurchased them.

• If the corporation purchases its own stock through a share buyback, an account called treasury stock is created to hold the stock. These shares are no longer considered shares outstanding, and they neither vote nor receive dividends. Treasury stock appears as a negative amount, reducing shareholders’ equity, because this amount has been returned to previous shareholders.

What is an Entrepreneurial Business?

Entrepreneurship“Entrepreneurship is the pursuit of opportunity without regard to resources currently controlled”

HBS professor Howard Stevenson, 1975

“They see an opportunity and don’t feel constrained from pursuing it because they lack resources,” says Stevenson. “They’re used to making do without resources.”http://www.inc.com/eric-schurenberg/the-best-definition-of-entepreneurship.html

The Entrepreneur’s Task….

• Key Resources– Technology– Money– People

People

MoneyTechnology

The Next Several Slides were extracted from an iCorps Session

Ecology of Innovation

People

MoneyTech

Key Skill of Professional Entrepreneur

Engaging the Ecosystem to Support the Venture

EntrepreneurshipOpportunity

Engaging the Ecosystem Builds and Ecology of Innovation

The Entrepreneurial Venture FOUR PERIODS of DEVELOPMENT

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The Entrepreneurial Venture FOUR PERIODS of DEVELOPMENT

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“Pure entrepreneurship”

The Entrepreneurial Venture FOUR PERIODS of DEVELOPMENT

“Strategic focus”

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The Entrepreneurial Venture FOUR PERIODS of DEVELOPMENT

Time

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“Systems Building”

The Entrepreneurial Venture FOUR PERIODS of DEVELOPMENT

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“Corporate Management

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THE ENTREPRENEUR’S TASK

Freeman, J. & Engel, J. (2007)

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Pull a Vision of the Future into the Present

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THE ENTREPRENEUR’S TASK

Freeman, J. & Engel, J. (2007)

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“Nail It” “Scale It”

What start-up business categories exist?

Startup

Lifestyle Startups Work to Live their Passion

• Serve known customer with known product.• Work for their passion not for scale or exit.

Large Non-Profit

Social Startup

Social Entrepreneurship Startups

• Solve pressing social problems• Social Enterprise: Profitable• Social Innovation: New Strategies

Small Business

Startup

Small Business StartupsWork to Feed the Family

• Serve known customer with known product

Exit Criteria- Business model found- Profitable business- Build a management team

5.7 million small businesses in the U.S. <500 employees99.7% of all companies

~ 50% of total U.S. workershttp://www.sba.gov/advo/stats/sbfaq.pdf

ScalableStartup

Large Company

Scalable Startup

• A scalable startup is designed to grow BIG• Typically needs large amounts of high risk capital• What Silicon Valley means when they say “Startup”

“Nail It” “Scale It”

ScalableStartup

Large Company

Scalable Startup

“Nail It” “Scale It”

Goal is to solve for: unknown customer &

unknown features Exit Criteria- Business model found- Total Available Market > $500M- Can grow to $100M/year

ScalableStartup

$5M to $5B Acquisition

Buyable StartupBorn to Sell

Typically: Internet, Mobile, Gaming Apps,

Big Data, Hardware

“Nail It” “Scale It”

Sell to larger company

How do the Different Categories Differ?

• Draw the relative curves for;– Lifestyle Business– Social Innovation– Small Business– Scalable Startup– Buyable Startup

What Type of Startup Entity are You Contemplating?

Why? The type of corporate entity establishes the legal rules governing equity ownership and control.

Establishing a Corporate Entity

Once you understand your entrepreneurial objectives, consult your legal and tax experts to determine the best possible corporate entity for your business.

http://www.diffen.com/difference/LLC_vs_S_Corporationhttp://www.bizfilings.com/learn/s-corporation-vs-c-corporation.aspxhttps://www.incorporate.com/business_structure_comparison_chart.html

Corporate Documents – By Lawshttp://www.onestreet.org/starting-an-organization/110-bylaws

• Work with your fellow leaders to ensure that your bylaws will cause the sort of leadership behaviors necessary for your organization to thrive.

• Your bylaws must include:– Purpose of the organization (aka mission statement)– Whether or not the organization has members and what

privileges they have,– Responsibilities of different leadership roles,– How leaders are chosen and removed,– How amendments are made to the bylaws,– Any other specifics required in your country.

*The topics and information presented in this course should in NO WAY be considered as legal or tax advice!!!!!!!!!

*Every Entrepreneur should seek professional legal and tax advice for decisions surrounding Equity Ownership.

Corp Docs – Articles of Incorporationhttp://www.legalflip.com/Article.aspx?id=23&pageid=112

The Articles of Incorporation serve essentially four (4) purposes:1. It brings the corporation "to life";2. It represents a contract between the corporation and the shareholders of the

corporation;3. It represents a contract between the corporation and the state; and4. It puts everyone on notice about the corporation’s existence.

Articles of Incorporation generally contain the following information:• Name & Address:• Purpose: engage in any purpose for which individuals may lawfully pursue• Duration: usually "continue in perpetuity”• Capital Structure: Authorized stock; Number of shares per class of stock (and

any preferences) and par value (minimum value that each share must sell for)*The topics and information presented in this course should in NO WAY be considered as legal or tax advice!!!!!!!!!

*Every Entrepreneur should seek professional legal and tax advice for decisions surrounding Equity Ownership.

What is the Right Founder Allocation?

Establish the Business• Business Type

– Lifestyle, Non-profit, Small Business, Scalable, Buyable, etc.

• Business Entity Determination– Sole Proprietorship, LLC, LLP, C-Corp, S-Corp, 501c, etc.

• Establish Governing Documents– Corporate By-Laws and Articles of Incorporation

Establishing Founder’s Stakes

Founder Stakes

• Founder Stakes represent the first round of equity granted for any NewCo.

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Establishing Founder’s Stakes

Also Known As

The ticking time bomb buried within every start-up…

Who is a Founder?• Founders are people who take a very particular kind of risk.• Founders as a function of Corporate Stage of Life

1. Founding (Nail it).

2. Startup (Nail it).

3. Real company (Scale it).

4. Real company (Scaled).

http://www.geekwire.com/2011/wrong-answer-5050-calculating-cofounder-equity-split/

Who is a Founder?• Founders are people who take a very particular kind of risk.• Founders as a function of Corporate Stage of Life

1. Founding (Nail it). The only money the company has is what you put in. You are getting no money out of the company. The company will probably fail, and you will lose all the money you put in, plus the lost salary, plus you have to find a new job.

2. Startup (Nail it). The company has money, either from investors or from revenue. Your salary is less than what you’d get at a big company. 50/50 odds the company fails. The difference between your startup salary and the BigCo salary is at risk.

3. Real company (Scale it). You get “market” salary. It’s unlikely the company fails, and if it does, your downside is limited to unemployment.

4. Real company (Scaled). You are part of BigCo.

http://www.geekwire.com/2011/wrong-answer-5050-calculating-cofounder-equity-split/

Who is a Founder?

• Rule of Thumb: if you’re working for a company that’s so young it can’t pay you, you’re a founder. If you are drawing a market salary on your first day at work, you are not.

• http://www.geekwire.com/2011/wrong-answer-5050-calculating-cofounder-equity-split/

What is a Founder Worth?

Rule #1. Fair but not Equitable.

Consider the past, present, and future contributions and opportunity costs of every founder.

What is a Founder Worth?

• A founder’s primary job is to get their company money – either by raising investment or by generating revenue.

• A founder is valued by two things:1. Their contribution2. Their market value

Founder Stake ConceptsEveryone starts out equal, but the following rules apply…• Ideas are precious, but dwarfed by execution (+5%)• The first step is the hardest (+5%-25%)• CEO gets more (+5%)• Fulltime commitment is expensive (+200%)• Reputation is the most precious asset of all (+50% – 500%)• Treat cash like an investment (Valuation Math)http://www.geekwire.com/2011/wrong-answer-5050-calculating-cofounder-equity-split/

At the end, if you have equal shares, you did it wrong!

Why Can’t We All Just Be Equal?Mark Suster, video clip “the co-founder mythology.”

50/50 isn’t a business decision, it’s a compromise• You need to get used to hard questions. • You need to get used to trusting each other. • You need to get used to the idea that you’re not all equal. • You need to have the difficult discussions about responsibilities, contributions,

roles, and compensation. • You need to do it before you make commitments to investors and employees.• If you find that the only way you can get a decision made is by compromising –

then you need to stop now, before the price of failure climbs higher.• There’s no way around it. You’re going to have to split the baby, but it doesn’t

require the wisdom of Solomon to get it right.

Take your time, keep a level head, and remember: this is just the first of the decisions you’ll be making together for the rest of your company’s life!

Founder Stakes Gone Bad

• Early Departure– A fully vested founder leaves the company very early in its life cycle.

• Human Nature– Humans are hard wired to compare themselves to others. What once may have been an ideal

allocation of equity may not be in the long run. This can/will create discord, resentment, envy, and/or jealousy between members of a team.

• Corporate Evolution– In the beginning, company X showered equity upon people with a certain skill set. A short

time later due to a pivot, change in market, or maturity of the company’s business the key skill sets change.

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• 1,001 Other reasons founders have a falling out…

What is the Right Founder Allocation?

Establish the Business• Business Type

– Lifestyle, Non-profit, Small Business, Scalable, Buyable, etc.

• Business Entity Determination– Sole Proprietorship, LLC, LLP, C-Corp, S-Corp, 501c, etc.

• Establish Governing Documents– Corporate By-Laws and Articles of Incorporation

Founder Stakes – There are NO Rules• Fair but not Equitable.• Not Equal.• Founders are valued by a combination of their contribution

and market value.

Establishing Founder Stakes

1. Static Allocation of Founder Stakes

2. Dynamic Allocation of Founder Stakes

Perry Samson

• Exploring what is most important to your business concept. Active learning exercise.

Slicing Pie, Mike Moyer

• Dynamic Allocation of Founder Stakes during the first phase of corporate formation (Nail It).

• Founder Stakes grow from time zero based on contributions made by members of the founding team.– Vesting happens as part of the first round investment.

Grunt Fund Spreadsheetwww.slicingpie.com/the-grunt-fund-calculator/

• Market Salary and Lost Salary• Cash Invested• Equipment and Supplies• Facilities• Intellectual Property• Commissions

Demonstration of theGrunt Fund Calculator

What is the Right Founder Allocation?Establish the Business• Business Type

– Lifestyle, Non-profit, Small Business, Scalable, Buyable, etc.

• Business Entity Determination– Sole Proprietorship, LLC, LLP, C-Corp, S-Corp, 501c, etc.

• Establish Governing Documents– Corporate By-Laws and Articles of Incorporation

Founder Stakes – There are NO Rules• Fair but not Equitable.• Not Equal.• Founders are valued by a combination of their contribution and market value.

Founder Stakes – What is Best for the Business?• Dynamic vs. Static Allocations• Fundamentally founder stakes must be compatible with business needs.

Homework Week 1.Slicing Pie Grunt Fund www.slicingpie.com/the-grunt-fund-calculator/

• Setting the Stage– You are a brilliant entrepreneurial founder. The excellent UofM

entrepreneurial education has given you the perspective to know that you must bring two more people into the firm to create the team you need to get the company moving into the ‘founder stage’.

• Person 1 is Cindy, a very experienced and capable person with direct experience in your business space. Cindy make $200,000/yr in her previous position and she is willing to put $50,000 cash into your business and contribute $100,000 worth of high tech equipment you desperately need and she just happens to have in her basement. Cindy is in high demand, she is also working part time at another startup.

• Person 2 is Rodrigo. He is a young, but bright, engineer seeking his first position at a small company. He is fortunate to come from a wealthy family with significant real estate holdings. They are willing to bank roll his first year out of college (salary not required) and provide lease space (market rate is $2,500/month). Rodrigo is highly motivated to be part of a ‘start-up company’.

• You are Person 3. Your Great Aunt recently passed away leaving you with $50,000 in cash. This is your first start up company.

Homework Week 1. (cont’d)• Written Assignment

– Create a 12 month Grunt Fund spreadsheet for your startup. Assume the business concept is identical to your planned start up concept and hence all assumptions should reflect what your business will need for success.

• You must use the three persons listed above,• You must change the scalar multiples in the spreadsheet to reflect your business and generate

justifications(no default values!).– Example: your business might be very dependent on cash and therefore offer a higher 5X

multiple for cash contributions.• Every other term in the spreadsheet should be based on your assumptions and reflect your business

concept.

– Summarize the pertinent points of your business concept in half a page. – Calculate the % Equity stakes earned by each of the three founders at the end of 12 months.– Summarize the scalar multiples you applied and provide a short description why.– Write two concise and compelling cases why Cindy and Rodrigo should join you and start this

business. What is in it for them?– What is your opinion of the Grunt Fund calculator? How did you fare after 12 months?– Should your team add or subtract sections from the Grunt Fund Calculator?

• Class Room Presentation (5 minutes)– Be prepared to provide an executive summary of your business concept– Be prepared to present a concise summary of your Grunt Fund spreadsheet and results. – Be prepared to present a compelling case for why either Cindy or Rodrigo should join you.