How to Calculate Equity for a Partner
How to calculate equity for a business equity partner stumps many Entrepreneurs, and it’s a question that no one can seem to answer. Well, I’ve included a simple formula for calculating equity for your partner; so you’re in luck! It’s a very simple, step by step formula.
Calculate Your 1-5 Year Revenues
Again, this is why it’s so important to have these financial projections! It’s not just for investors or a boring 50 page business plan no one looks at, it has alot of other importances such as this scenario!
When I say 1-5 year revenues, you’re probably thinking “Well, which is it Amanda?”, “Make up your mind”. The good news (for me anyway) is that I can’t say a specific amount of time here, because that depends on your exit strategy. An exit strategy isn’t just for you; it’s when and how you propose to provide an exit for your business equity partner. In other words: when the heck are they going to get paid.
Will your equity partner exit when you pay them back? Will they exit when you sell? If you’re unsure, I usually use 3 or 5 years to be safe.
Calculate Milestones & Objectives on the Equity Partner
From the time they enter into the business, until the time they exit (when their contract expires); calculate key milestones and objectives you want the equity partner to take. These are big milestones, not pidly ones. Be specific, these goals can be in terms of numbers as well. How many customers they bring in, how many big clients or winning partners they secure, or how much revenue they produce. Usually, the rule of thumb is to set major milestones over the time period.
Calculate the Retail Price of your Partner’s Services
Relax. This is going to be so much easier than it sounds. Start by figuring out how much the RETAIL PRICE of the milestone is. If it’s a sketchflow or requirement docs from an equity development partner, research the retail price on this. You can also calculate retail price on salary if you’re trying to figure out equity for an executive: take how long it takes to complete that objective, and compare it to the average salary. Example: If it takes an executive 6 months to secure 10 winning contracts, times the average monthly salary for an executive times six. But..this isn’t all, so don’t stop here!
Calculate the $ Amount of Equity on Your Partner
Now that you’ve determined the RETAIL price of the service…times it by 3 (general rule of thumb for a good equity partner). This is to compensate your equity partner for not seeking upfront payment for their services.
At Last, Calculate that $ Amount into Equity
Hopefully, you didn’t avoid step one, and you completed your revenue projections. Now you can take final number on your revenue projections and divide your equity partner’s $ amount to determine the percentage of their equity stake.
Now..Calculate Equity at Each Milestone
Take the overall equity in the last step, and divide it among your equity partner milestone objectives. Example: I calculate the total equity over the 3 year period to come out to 15%. My equity partner has 3 milestones, one for each year through exit. At each milestone, my equity partner gets 5%.