Owning equity in a for-profit venture is a powerful motivator – particularly in the early stages. It’s also one of the most contentious, negotiated parts of building a high-growth venture. This comes from our organizational conventions of control and scarcity – we need to control and amass resources to control and weild power and get things done.
In taking a peer-produced approach to building Shldlss, the for-profit offshoot of the Social Venture Commons, I found we needed a new model to fairly attribute the economic value to those who actually created it. After many conversations, including on this post, here’s where I’m at with what has now become our “Kudos Model” for economic value distribution.
- Phase: Set the phase of value creation ending with a valuation event or economic value distribution
For shdlss this is the founding phase extending through to Series A investment. At this point we should have a reasonable grip on the value of what’s been created and what others think it’s worth. - Proportion: Set the estimated proportion of enterprise value that will be newly created during this phase.
For founding phase this would be 100%. Over time, the new value created will likely be proportionately less each time – though not always. A basic benchmark for where to set the proportion might be what a comparable venture might issue in option pool. - Appointment: Appoint key people to allocate Kudos.
For shdlss we will go probably go to 4-6 people who have been and are committed to being involved for the whole phase. This appointment is happening essentially half-way through the phase and will be done shortly.These are people who are closely involved in the project for the entire phase and will have a reasonable sense of the relative value of contributions made during the phase. - Allocation: Have a KudoFest at the end of the phase.
All appointed people will gather to review the stream of all contributions made during the phase. We will use the twitter and VenTwit streams as the core history. Each appointed person will then be able to allocate 100 Kudos to those who made meaningful contributions. They must allocate all Kudos and cannot allocate any to themselves. The 100 limit means the smallest contribution they can recognize (1 Kudo) represents 1% of the value they have to distribute. After each person does their allocations, we will aggregate the allocations and have an initial allocation. The group will then review and discuss and can make any changes provided their is unanimous consent. - Distribution: Distribute financial value rights according to Kudos allocation.
During the founding phase, this could be in common or preferred shares, in subsequent phases this could be through options or other forms of financial value sharing.
This will no doubt evolve as we work our way through the process. As the lead founder, I’ve been asked why I would do it and even told that I’m crazy for trying it. With where I’m at now, I can only see us all as having a much more to gain. Without the spirit of this in play we wouldn’t be where we are at – and that’s what it’s all about – getting it done – together.
Creating a model for allocating ownership to peer-produced intellectual property in a world of unknowns will always be difficult; as I've said before, any rote formulaic approach will be at worst misguided and at best gamed. So with that disclaimer, couple thoughts:
1. Why does the phase have to be set to artificial events like valuation events? Phases of value creation need not line up with phases of valuation events. Are you worried about significant value contributions mid-phase? Does it matter if the round is non-priced or priced?
2. Love the idea; will the contributors ever be able to set the estimated proportion of enterprise value accurately? Will contributors at different phases be incented to create different effective valuations in different routes?
3 & 4. Totally in: only those closest to the enterprise will be able to judge the value creation distribution effectively. How will this model scale as the # of contributors increases?
Any though of vesting schedules, or do you want everything to vest immediately? (a couple thoughts on vesting schedules: http://www.angelblog.net/Share_Vesting.html )
Taylor – excellent comments and thinking as always. Maybe you can lead our
actual process with ^shldlss?
My reflections:
1. Because this model is about allocating financial value I think it will be
less disruptive if valuation/distribution events frame the phases. I also
think that pending valuation/distribution events will 'focus' the importance
of the distribution excercise and while there is potential for that to be
disruptive, I think that will largely be determined by the spirit of the
process and people involved. As far as a non-priced round – like the
love/seed round we're doing now which is a convertible debenture tied to the
series A – I'm not thinking non-priced rounds need to close off a phase.
2. I think the proportion will be more set like options are — what
percentage do we need to make available to be able to attract the talent and
contributions we expect are needed to create the value-proceed through next
phase.
3. This a tough question that I'm not sure on. In a way starting with this
for founding shares is an easy test – though percieved by some as risky.
The harder part is figuring out how this scales – which I think it can – but
I also think we need the experience of this first phase to help inform that.
And we need some smarter minds to help this… so again… maybe you'll take
this piece up as part of your 'contribution' đ
At FairSoftware we have been brainstorming on similar principles for a while now. You may want to get in touch with us (alain at …) and we can take this discussion off-line.
Always glad to see those principles being put to good use!
Hey Alain – thanks – would love to know more about it and chat it through –
though I would much rather the conversation be in the open for everyone’s
benefit. Think I heard about your work from Marc at Enterpreneur Commons.
Sounds like great stuff!
1. Solid justification: framing the discussion around valuation/distribution events is a solid way to keep contributors focused on creating value rather than constantly managing to justify value creation. Especially since the value created around knowledge work is so variable, adopting longer timeframes will help capture a good measure of time.
My only thought is that the model might not scale as the number of contributors gets larger and as more contributors create value “in the middle”; but then perhaps that's not a concern, that it's only necessary to compensate with equity long-standing contributors.
2. I'm curious how the option allocation could / should work: does it mean creating a large option pool? How can the ideal be executed using available corporate structure tools?
3. Scaling might be the most important test of the model; perhaps the nature of the way the value is created and the tools used will enable the value distribution process to scale in the same way the value creation process will scale. In any case, it will be fun finding out…
And as you know, I'm interested in helping with the Kudos process in whatever way the team feels is valuable…
you tell us đ
1. Solid justification: framing the discussion around valuation/distribution events is a solid way to keep contributors focused on creating value rather than constantly managing to justify value creation. Especially since the value created around knowledge work is so variable, adopting longer timeframes will help capture a good measure of time.
My only thought is that the model might not scale as the number of contributors gets larger and as more contributors create value “in the middle”; but then perhaps that's not a concern, that it's only necessary to compensate with equity long-standing contributors.
2. I'm curious how the option allocation could / should work: does it mean creating a large option pool? How can the ideal be executed using available corporate structure tools?
3. Scaling might be the most important test of the model; perhaps the nature of the way the value is created and the tools used will enable the value distribution process to scale in the same way the value creation process will scale. In any case, it will be fun finding out…
And as you know, I'm interested in helping with the Kudos process in whatever way the team feels is valuable…
you tell us đ