Startup · Entrepreneurship

Deferred compensation structures for pre-funded startup?

Sarabjeet Kaur Senior Software Consultant at HCL Technologies

December 6th, 2016

I am in the pre-funded prototype development stage of my product and have been making some very useful connections with people who are interested in contributing to the effort (UX, design, code, biz dev) for deferred compensation.

The part I want to think through carefully is how to protect both myself and the collaborators in this equation -- without writing formal legal contracts etc. It seems that getting into legal costs would put the cart before the horse at this stage. We're building the proof of concept.

My thoughts have been to write a brief statement of understanding that simply gets iterated/emailed/signed back and forth describing the timings, expectations and compensations. Not a formal legal doc, but at least concretizes and marks the basic understandings.

But I am trying to think through the compensation part. How does one structure something before one has an established biz structure?

* Equity.
* Placing a monetary value on hours spent to be compensated at time of investment and or revenue.
* The possibility of key role/involvement in the funded phase of the product.

It's more straightforward when there's simply a local-fulltime-team being built -- all agree on a division of equity and off you go. But I am talking about working with people in smaller time-chunks, and in scenarios where being a part of the ongoing team may not even be desired, or an option; for example a collaborator is half way around the globe and creates a set of visual themes.

It's great to be able to collaborate like this ...but how can we set this up so that when things do take off there are no messy situations, just coolness and excitement all around.

Appreciate any experiences, resources, ideas.
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Kevin Carney Content Marketing works, but needs better tools.

December 6th, 2016

I recommend an equity distrubution model based on individual contributions. The book Slicing Pie by Mike Moyers contains an excellent model, which we're using. Kevin

Mike Moyer

December 6th, 2016

Slicing Pie, as mentioned above (thanks Kevin) will solve 100% of your problem and answer all your questions. Pick up a copy of The Slicing Pie Handbook, or email me for a copy.

You can find legal templates on SlicingPie.com 

Let me know if you need any help!

-Mike

Mike Robinson

December 7th, 2016

"Deferred Compensation" sounds a lot like you may intend to pay these people cash out of a future investment that you might raise. That's probably not going to work. Investors hate the idea that their money is being used to retire debt and hand cash to others who got involved in the company previously.  If you set the expectation that these people will get back-pay from investment proceeds, you and they will likely be disappointed when incoming investors nix that idea.

Kelly Lefkowitz CEO at Strat/Assist, Conditioning Companies for Capital & Growth

December 6th, 2016

Don't be foolish.  You are hoping your emails constitute a binding contract.  Why not have one that protects you, rather than an understanding.  

Martin Omansky Independent Venture Capital & Private Equity Professional

December 6th, 2016

(1) Legal costs: Have your lawyer draw up a template with blank spaces for the numbers, and use this template for all contributors. There is no substitute for a legal and binding agreement, but you can economize by standardizing; (2) Compensation: can't help you there, brother; you are on your own. Sent from my iPhone

Dane Madsen Organizational and Operational Strategy Consultant

December 6th, 2016

Any agreement you generate is a legal agreement regardless how formal and who drafts it. Make sure you cover the issues you know to be important such as ownership of IP and use by the collaborators in other projects. If you have a fairly standard contractors agreement it should help. If not, there are many available on the internet. For compensation, you should know in advance what the person wants. Some will want equity, some will want cash, and of course some will want both. When you pay in equity, there are many issues you need to get addressed in advance such as voting rights, dilution, distributions (if any) and simply keeping track of the people over time. Equity not well controlled can cost you as much tracking the people down as you saved. Placing a value on the labor but then compensating in shares presents a tax exposure for the people. This is a W2 issue and a cost basis issue. Further, in some states, the person may have a wage claim against the company in the future. What I have done is to default to a common share with a low "par" value that then needs to be articulated in an IRS 83 (b) filing to lock in a low cost basis for the recipient. You want to have a voting rights language that puts all these in the same pool with you as the trustee to vote as you deem fit. You can avoid that by having them be a separate security with no voting rights but that too adds complexity. If it were me as the collaborator I would prefer a voting security ( controlled by a trustee) with a monthly amount (keep your cap table in mind when you do this) to be issued when projects are accepted. This would allow me to work on the project in my available time but not prevent me from losing value if another project takes me away from yours. I would avoid enticing people by promising them permanent roles because this can be construed as an actual employment agreement that, while not, can also embroil you in other employee related issues. You can encourage people you like to keep them involved in other ways, but this issue you are struggling with can be the most murky so it is very worth the time to get good advice from a lawyer. Dane Madsen Dane@DaneMadsen.com 206.900.5852 Mobile Sent from my mobile device. Forgive typographical and grammatical errors.

Martin Omansky Independent Venture Capital & Private Equity Professional

December 7th, 2016

I second Mike Robinson's motion. We want our funds to go to the building of a future. Sent from my iPhone

Ken Kostyo

December 8th, 2016

"deferred compensation" is problematic for all the reasons stated above. I would further argue it is no a legally enforceable at ALL. Parties in a contract need to surrender something real and get something real. In our world, that is equity or cash. If you are not formally incorporated then draft up a quick "memo of understanding" ... "we intend to incorporate soon and when we do Mrs. X gets 2% of the stock ... " I've done docs like that in the past. I can take a look, but models and forms are on the net.

Tom DiClemente Management Consulting | Interim CEO/COO | Coach

December 9th, 2016

If you have no business structure and no revenue, the last thing you want to do is to try to pin down a deferred compensation plan.