LLC · Equity

Best way to reward contractor -type work in an early LLC start-up?

Anonymous

January 22nd, 2014

I stared an LLC last year, and am now looking to incorporate at least 2 people for specific tasks (electronics, design). Both are self-employed at this pint and would work as independent contractors. 
How do (1) arrange a legal contract with them to ensure IP, scope, etc. (2) reward them if cash is not a real option in this case?
Equity? --How (LLC)? Something else? Do I need to become a corporation so I can give out shares?
Thanks for any pointers!

Anonymous

January 22nd, 2014

As someone who's done contract work in these situations before, let me pitch in.

Regarding the legal contract, most contractors will have their own contracts for you to agree with and sign (I always do when I do contract work). It's probably a good idea you go to a lawyer and get yourself a contract too. As long as the contracts don't contradict, you should be fine. The most confusing thing for me has been IP when it comes to code. It can be confusing because a lot developers build up reusable bits of code over time that they use when needed. They own that code. If your contract states that you own all the IP and the contractor used some of his/her code to build you the product as a whole, does that mean you own his code too? Make sure you talk to a lawyer to make all of this clear.

As for rewarding the contractor, it really depends on them. Some contractors accept equity on a case-by-case basis and some don't. I own equity in a couple startups because I was open to accepting that for those specific cases, but I have many friends of mine who don't accept equity as compensation. So yeah, it depends. The main thing in this case is getting developers excited about your product ... this isn't so easy because many developers have a lot of entrepreneurs telling them about "the next big thing", so they really have to see something special about what you're doing.

Lastly, concerning NDAs (as Rob Gropper mentioned), they can be a fair protection for you, but many developers won't accept them and some will charge you extra to sign them. This is the case mainly because as a contractor, you don't really always know what your next adventure will be, so the restrictions of an NDA can be a real pain to deal with. I personally don't like them and I've charged extra for them before.

Not much, but I hope that helps.

- Jonathan

Anonymous

January 22nd, 2014

Anuscheh,

Not that I want to contradict Greg, but there are ways to do equity incentives even in LLCs. The key term you want to search for is "Profits Interest". A good (though rather old) blog post about it is available at http://meetkendall.com/2009/12/06/sharing-equity-in-an-llc-profits-interest/ and you'll find some other information online, including some written by lawyers (such as http://www.strasburger.com/bios/bio_pdf/Browne-Equity_Incentive_Comp_Plans_for_an_LLC.pdf ). Note that it looks like your LLC tax election (partnership or C Corp) does matter, but I don't know enough to tell you why and how.

IMHO, the main issue you'll face is that most lawyers are not very familiar with those types of plans, so you'll probably have a hard time finding one who will be able to get the legalese absolutely right. In most cases, lawyers (and accountants) prefer to go the easy route, which is to set up a Delaware C Corp, because they know the process fairly well. I, too, have an LLC, so I've had some interest and had my wife (who's a lawyer) worked on a modified Operating Agreement that has a Profits Interest plan. But... we never completed it and I resorted to a verbal agreement with my advisor (for whom I wanted to set it up). That said, it's definitely an open issue for me as well and as I look to hiring people full-time, this will become a more pressing matter.

You might also want to take a look at the Grunt Fund model and read the Slicing Pie book (www.slicingpie.com ), which addresses how to compensate contractors for their work and grant them rights to equity once it's formalized (such as when you convert your LLC to a C Corp, which you'll probably have to do at some point, especially if you plan to raise VC funds).

Rob G

January 22nd, 2014

long discussion.  feel free to message me offline.  you can reach me directly:  robg at TuxedoTech.com  

Rob G

January 22nd, 2014

Anuscheh, there are lots of attorney's in Seattle.  It sounds like $$ is currently in short supply so do your homework first and know what you want.  i would suggest finding all the agreements/docs online first and if needed have an attorney review and modify for your particular situation.   Like any other service provider/contractor you need to manage them to get optimum efficiency and RO your I.  Peter Smith runs a small firm in Seatle, Apex Law Group:  peter@apexlg.com  Small firm, reasonable rates, reasonable to work with.  If you are planning to go after VC $$ then you can connect with a bigger firm (Wilson Sonsini, etc. later on).  You can use a site like BizFilings.com to do the corp formation to get you started (articles of incorporation, operating agreements, etc).  All of the other documents you need to get started are available online.  I have a mutual NDA and Work Made for Hire Agreement that i can share with you.  Both address IP and address issues such as mentioned by Jonathan (if a developer, for example, elects to reuse code he has used elsewhere, then you don't necessarily need to own that part of the IP, but you get a perpetual, non-exclusive license to use, modify, etc.).  Steve Blank has some experience (:-) with startups and his site http://steveblank.com/ is a fantastic site for reference material.  

Greg Upham

January 22nd, 2014

An LLC is typically not going to be the entity of choice for this strategy, it would be A C corp. Assignment agreements take care of IP. Then you can set up option agreements and vesting schedules commensurate with each of the contractors actual participation level. This is pretty standard stuff, I don't know any but there are, I'm sure, many good corporate attorneys in Seattle who can give you sound advice. Probably a good idea to consult with one. There are lots of things you want to be sure to get right.

Rob G

January 22nd, 2014

these are pretty common questions that have been batted about more than once here on FD.  i believe there is a facility on FD to review/search archives or discussion topics. i would start there. i would start with a Work Made for Hire Agreement that addresses IP assignment - if your employees/contractors don't explicitly assign IP they work on to you/the company then they own it even if you are paying them to develop it.  I would also recommend a NDA document that you can use when you want to discuss details with another individual/company - it doesn't keep your information from being disclosed, but it lets people know you are serious about your IP and lets investors know you have some legal recourse should your IP be disclosed improperly. don't disclose to people you don't trust. 

Anonymous

January 22nd, 2014

Ok, thanks. That sounds awesome so far.

So from what I am reading I would
1) get the two contractors excited about my product (It's awesome)
2) find a lawyer/ representative for my startup (anyone know a good one in Seattle area?)
3) formulate a contract between the LLC and the people working on those projects
4) take extra care that all aspects of IP/ NDAs/ are taken care of in the contract

The question that one lawyer (not a startup specialist mind you) had was if an LLC can share, and vest equity? I believe her concern had to do with taxes on the contractor side. Does anyone have experience with that (or know someone who does)?

Greg Upham

January 22nd, 2014

Agreed, equity splits can be done either way. However if you are going to seek venture cap you will most likely need to be a corp. I'd not, chances are you well have to convert. So its a qualified answer. But a good corporate attorney should know the details either way and be able to guide you to the correct choice for you.

Anonymous

January 22nd, 2014

That's awesome, I think I see clearer now.
Thanks Raphael and Greg for clearing the LLC/ corp differences and possibilities up for me. It is good to hear that it would work either way right now and yes - I am aware that if I want vc funding I will need to incorporate to make it appealing to most investors. 
Thanks also Rob for referring contacts like Peter Smith. I might email you to follow up!

 

Scott Milburn Entrepreneurial Senior Executive and Attorney

January 23rd, 2014

Anuscheh, I have worked with startups for many years, and I am also a partner in a virtual law firm in Seattle - 16 very experienced lawyers, but no actual office, which translates into rates that are about half what they would be if we were in one of the high rises. Happy to talk offline.