Advice on giving equity to contractors/manufacturers

October 14th, 2013

Hi everyone,

I started a hardware company, and we have engaged a contract manufacturer to refine, make final prototypes and manufacture our product. Currently, we are in the process of making final prototypes, which we can then take to kickstarter and raise money from there.

However, I do not have all the funds to make the final prototypes before Kickstarter, so the manufacturer has offered to take some equity in return.

Has anyone been in this position? What do you think of this option? If it is a fair option, how much equity should I offer?

Nancy Vartanian Founder/CEO at shenYon, Inc.

October 15th, 2013

Hi Arnav,

I personally have some experience in the same situation. It's a case by case though. Is your manufacturer in the US? Feel free to ping me, I can discuss it more in depth for you,

Alfred Tom Co-Founder and CEO of Wivity

October 15th, 2013

Arnav, It should be pretty simple. You have two choices: 1. value the company now, and the equity stake is just simple math given the cost of the services. 2. take convertible notes that convert to equity on a funding round, and give them a large premium on their services in exchange for their risk. Alfred Tom +1.415.299.9195 High Stakes Productions, LLC atom@highstakesproductions.com

Mike Moyer

October 15th, 2013

Hi Arnav,

Hooray! Another fantastic equity problem that can be easily solved using a dynamic equity split! This is a very common and perplexing problem for people in your position who have early-stage companies and no concrete way to value equity. The answer is to implement a dynamic program with will allow you to determine exactly how much each person deserves (no more and no less). Dynamic models allocate equity based on the relative value of each person's contributions. Here is a link to a list of calculations for each contribution.

I've written a book about splitting equity that describes, step-by-step how to implement a dynamic equity split. If you would like a free sample please email me at mike@slicingpie.com

Thomas Knoll Executive Advisor & Business Coach. I help entrepreneurs survive and thrive at building their teams and businesses.

October 15th, 2013

Any time I'm pondering equity questions:

100% of $0 = $0
Equity should be reserved, whenever possible, for people committed to the long haul.

If those sound like competing statements, they kind of are. But, I like to lay those down as the "ground rules" and keep them in mind as I explore a solution.

Arnav Dalmia

October 15th, 2013

Nancy- Yes, the manufacturer is in the US. I'll message you! Thank you so much!

Alfred: Thank you! What rate of interest should I offer on the convertible note? And how high should the premium be in terms of percentage of the contract price?

Mike: Thank you so much about the advice. I've actually heard about you at the Polsky Center at Booth. Thanks for the comment! I'll email you for the book!

Thomas: That is absolutely right. Any suggestions to navigate the problem and decide based on those two points?

Alfred Tom Co-Founder and CEO of Wivity

October 16th, 2013

Arnav- you will need a corporate attorney to prepare the loan docs for you, and they will have a good idea about going rates for premiums. Manufacturing is different from, say, consulting because there are real costs so the premiums might be more. You could also choose to pay just cash instead of stock when you raise money. The premium could cover that option as well. Alfred

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