Recently, Marcus shared afterthoughts on his participation in the September 2007 Houston StartupWeekend, which launched TipDish, a product placement/blogger matchmaking service.
StartupWeekend brings together anywhere from a few dozen to as many as 70 contributors who work like maniacs over a three-day weekend to incubate a company from concept to corporation. In exchange for the effort, participants are given equity in the nascent company based on the number of days they’ve participated. For example, showing up for all three days of the Houston weekend would have earned you a 2.2% equity stake in TipDish. Half of the shares of the company are doled out in this fashion, plus another 5% to the event organizer. The remaining 45% of the company is retained for future allotment to employees and investors.
StartupWeekend, for all its quirks, is at the very least an iterative attempt to address the myth of free labor.
Marcus raises a question many others have posed: should people whose total contribution involved simply showing up for the first three days of a new company really collect 2.2% of the value of that company should it ultimately succeed?
He goes on to ask:
However, in the longer run the current distribution creates real challenges for the go-forward team. Even if we assume there is no further dilution and there are only 10 people on that team, dividing the rest of the equity evenly would give each of them another 4.5%… or roughly double what you could have gotten in a single weekend. Not only would that be absurd, but dividing the equity evenly would likely be as well… shouldn’t the CEO (whoever that is) get more?
Let’s put a value on the post-StartupWeekend tipdish.com. We have 30 people putting in roughly 1000 cumulative hours of free contracting work. Assigning this a nominal $50/hour rate for labor, we end up with what could be considered the value of paid-in capital for the new enterprise of $50,000. With half the equity distributed, this suggests that the enterprise valuation of TipDish after the weekend would be in the ballpark of $100,000. The “extra” $50,000 could be considered goodwill, or free advertising generated by bloggers and StartupWeekend participants doing free marketing.
The real value of the company is no doubt much less than this. Guy Kawasaki’s Truemors.com achieved a similar level of development (on a not wholly dissimilar idea) for about $12,000, and even Guy took heat for not being wise with his spending. Is a weekend of work worth 2.2% of $12,000, or a little over $250? Probably not. So let’s assume that a least a few of the equity-holding participants would believe in the likelihood of the venture achieving a short term valuation of $100,000.
Two Classes of Shares
To address the concerns of the differing level of contribution between hangers-on and core contributers, I would suggest that the solution is to create two related but distinct classes of shares: Weekend Shares and Go-Forward Shares.
Weekend Class Shares hold a par value reflecting the nominal consulting rate, and vest only if there’s a funding event. They are treated as a liability for the go-forward company, but a liability that is capped at a fixed enterprise valuation of the $50,000 in paid-in capital. Show up all weekend and erase whiteboards for your 2.2% share of the company, and you can expect a fat $1,100 should the company ultimately get funded. Or receive nothing if it goes nowhere. Put more traditionally, Weekend Class shares are simply options that only vest for a fixed amount when the company meets certain funding or revenue milestones.
At the conclusion of the weekend, a board is created from a subset of the top equity holders. Let’s say this consists of the CEO/coordinator (StartupWeekend sponsor Andrew, holding 5% of the company) and the three-day contributors (who individually hold around 2.1% of the company each). Contributors who choose not to participate going forward opt out, but retain their Weekend Class Shares. (Cut to the punchline–if TipDish moves forward, it will do so without Marcus, who bowed out from the follow up team shortly after posing his question, presumably opting for the Weekend Class status.)
This board meets two weeks to a month after the Startup Weekend to assess progress, select a CEO, and vote on assignment of Go-Forward Class Shares. The timing is important since the shareholders should have enough time to have assessed who is really part of the go-forward team, and who’s hanging on, and vote accordingly. Coups involving a plurality of passive board members taking out active members is mitigated somewhat by the fact that the enterprise itself is hurt if key contributors are run off, although should there be funding imminent, such power plays may inevitably occur, clearing the decks to reduce dilution.
This is really the make or break meeting—the wrong CEO could be picked (or the true CEO deposed, left only with a potential realization of 2.2% of $50,000, or $1,100.) The team could become completely fractured and flounder in the aftermath. In some regards, it’s the prisoner’s dilemma for all involved. Or perhaps more optimistically, mutual assured destruction working to keep all players cooperating.
Assuming that this initial meeting is successful, Go-Forward Class Shares would default to the equivalent of Weekend Class Shares (and would replace them). Subsequent board meetings would allocate any remaining shares in an equitable manner, with reserves for VC ownership.
Let’s say that 6 months later, an angel funds the company with $250,000 in exchange for 10% of the shares. The Weekend Class Shares would vest, netting participants anywhere from $100 to $1,100 depending on their participation. The investment indicates that the Go-Forward team would then be looking at a valuation of $2.5 million. Assuming there were four of the 2.5% team members and a 7.5% CEO, all of whom doubling their positions over the course of the Go-Forward period under the board’s charter, the CEO would hold $375,000 in value, the other board members $125,000 each. Not exactly a fat IPO-style payday, but healthy enough to maintain the incentive to further increase the value of the company and to continue to stick around to receive incentive options from the pool reserved for founders.
Coming out of this funding event, the initial Weekend Class shareholders would be vested and their “debt” retired—in fact, only a fraction of the $50,000 may actually need to be paid out since the Go-Forward owners’ shares converted to real equity and no longer show up as the same type of liability. The company would be left with $200,000 in seed capital. As many as 55% of the shares remain for future funding or incentive compensation or hiring.
Dying on the Vine
What if the business collapses, dying unfunded?
One option is the route Kiko took: sell the assets (code and domain) on eBay. Kiko took in a little over $250,000 when it sold its code in 2006 on eBay. Assuming the same happens for a failed StartupWeekend payday, and no debt exists, Weekend Founders get their small payouts. Go-Forward founders split $200K in a ratio related to their ownership.
Too complex? Possibly, but an approach like this could make it fair for all involved. The weekend warriors still have a shot at some fair compensation for their efforts; the Go-Forward team and future investors still reap rewards commensurate with their ongoing contributions.
The real value of a Startup Weekend appears to be, for casual participants, a networking and learning opportunity. For potential lead founders/CEOs and VCs/angels, it presents an opportunity to identify startup talent in what amounts to an extended job interview in a near real world setting. If the equity issues can be resolved in a repeatable fashion, a model of impromptu startup collaborations could flourish, further eliminating friction, and reducing cost and time-to-market for new ventures.
