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Life science entrepreneurs Know your roles and your profit sharing

on July 31, 2012

You've probably spent a lot of time thinking of the day when your life science startup reaches profitability. But try a new vision quest: think about how you'll split those future proceeds between your other founders.

There's a natural tendency when making new healthcare business plans to postpone discussion of “sensitive” topics, such as deciding on founder compensation, but procrastination can only make resolving money issues more challenging, says Kauffman Foundation Vice President Lesa Mitchell

“When you start talking about these issues from the very beginning of a new venture, it's going to make it a lot less difficult,” Mitchell says.  “Unfortunately, it doesn't usually happen that way.”

The issue of sharing proceeds from your life science business is a crucial – and complex – decision for life science entrepreneurs that can lead to conflict and may jeopardize partnerships. For example, giving founders equal shares of the company might not be the most equitable solution, said Jason Greenburg, a New York University professor who has studied startup entrepreneurship.

“It might seem fair at first to split the pie equally, but that might be the furthest thing from the truth because you don't know about the unknowns that are going to happen,” says Greenburg, assistant professor of management in NYU's Leonard N. Stern School of Business. “You don't know how much commitment to the venture someone is going to have in the future. So an equal split might ultimately be the most inequitable because of future performance and contributions to the company.”

While it's advisable to get an early start on compensation discussions, profit-sharing structure is a moving target that evolves as a startup company develops and grows, says Stephen Cary, co-founder and CEO of San Francisco-based Omniox.  At the beginning of a new venture, “you never know who's going to participate in building your company,” Cary says.

Here's how Omniox, a biotherapeutics company, handled the issue when it started:

“We started with four inventors,” Cary said. “Our strategy was that everybody would get an equal share of a tiny 'pie' with the idea of (eventually) incorporating lots of extra shares. So, when it became really clear who was providing value six months later, we reorganized the board, with two people instead of four. Then it became obvious what the equity split should be.”

Cary and his fellow founders believed that people who helped build the company deserved to own part of the business. But if you're no longer helping the company, your share will continue to get diluted, even if you played an important role on day one.

“The value you provide to the company later on is worth less and less as you're getting further 'down the road,' ” he said.

The relative ease or difficulty of early compensation discussions can be a predictor of whether a company will eventually succeed, or implode, according to Elliot Cohen, co-director, MIT H@cking Medicine/Corengi, Inc.

“I don't think there is a right answer as to how you have the conversation. The companies I've seen where it's been a difficult conversation basically never succeed.  In the companies I've seen where it's been an easy conversation, people seem to be much more committed to solving the problem the company is trying to solve in the world than they are to making sure they get the biggest share of the pie,” Cohen said.

When you start discussing this topic, ask yourself and your team: What is important in all this? How much value do you give to the original idea?

For example, an idea based on 20 years of scientific research should obviously receive more value than a founder's chance observation that led to a new enterprise, which is “definitely going to change the second he talks to his first customer,” Cohen said.

“It's not really 'having an idea' in the same way as spending 20 years developing new technology.”

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