We're planning on offering some key early employees equity in our startup, an LLC, in the form of ownership shares. The benefits include:
- proportional sharing in distribution of profits
- proportional share of money in the case of an acquisition
We aren't looking for an exit however, so in the meantime, we'd like to offer something if/when:
- they decide to leave
- they would like to "cash out" some of their equity even while still employed
However, given we are a smallish private company that isn't trading on any market, what is a fair way to value the company in order to pay out before an acquisition? We could hire a professional to perform a valuation each year, but that seems like too much money for a young startup. We could go with a formula like book value, but that is pretty paltry especially for a software startup with relatively few "tangible" assets. Are there other formulas out there? Perhaps some function of revenue, number of employees, profits...?
As you say, it is very hard to value a company that isn't actually being traded, but there are a few commonly accepted methods. One fairly simple option is to value the company at some multiple of EBITA or profits.
The tricky part is figuring out an appropriate multiple for your business. For example a company selling consulting services will generally have a lower multiple than a SaaS platform company would have. I'd recommend doing some research on said multiples and using that as a guideline for at least starting the valuation process.
We run with a basic premise when you can't get
Sweat Equity multiplier Basically their time * an agreed amount per day/week = their direct contribution that is comparable to you earning else where.
Apply a multipler to it say 3X or 4X due to the risk and hardship involved in earning less (any maybe not seeing a return)
Then Moving forward their continuing investment would look like
As the company starts to make a profit (assuming it does which is their risk), everyone starts to draw earning from the company, they get paid out at a higher rate of pay to the new people until the payment is met.
The other way to look at this that the $54,000 owed to them by the company buys them a greater amount of shares in the company.
It isn't so much a valuation you need... really what you need to establish is what proportion of the company each member is entitled to, rather than the valuation. As you alluded to, the value of the company will be in constant flux and as you are not trading you are entirely illiquid.
But you're an LLC... In a private limited company this would be relatively simple - there is a pool of stock in the company and it is split across it's founders and key employees and other employees may be offered share options. Over time people accumulate a certain amount of equity and if the company is traded in the future either on the stock exchange or by acquisition, the shareholders will receive their proportion of value either in cash or other equity. Until the company exits there is little opportunity to 'cash out' although you may be able to sell your shares privately.
In both cases the money has to come from somewhere... if an employee that has some 'share' in your LLC leaves and they want to 'cash out' where is the money going to come from? If they leaving and someone is coming in with an investment then this could be the source of funds. Valuation is going to be incredibly hard and to be honest, it will be a major distraction for all the employees of a young startup that is trying to get off the ground.