Founder Equity, Vesting Schedule, what is fair?

Patrick Holman Enterprise Technology Sales

October 11th, 2013

I am building a SAAS product to support the industry I currently work in (day job); I have legal sign off from my employer to build and test this product while I continue my employment. I intend to self-fund the MVP; I assembled a product plan and shopped it to SW development companies who could build out my product.

One of the development company owners I took the plan too is also an experienced entrepreneur; he has been running his development shop for a several years, in the past he launched companies, and most recently bought a small SAAS company (different market) and has most of his development staff assigned to that product.

After a couple of working sessions I am confident that his influence will be very helpful, he knows: product, product creation, UIX, and his team of engineers are well suited to build this application.

He likes the idea so much that wants to be an equity partner with me, but I would pay his guys hourly (at his cost) for the development work. Doing some rough calculations I can fund his guys for the first 4-6 months, then we would most likely seek outside capital.

I bring allot to the equation because in my day job I am the target user and I will immediately test the product in the real world (approved by my employer); on top of that I am funding the first 4-6 months of development.

He brings allot the equation too because he knows how to build products and has a team of engineers he can execute with.

I think bringing on this person as an equity partner sounds like an acceptable arrangement, as long as the founder equity split, vesting of that equity, and my cash investment into the company are fairly accounted for. I do worry that he might be distracted because he does own another company and he would not be focused 100% on my product.

If we decide to partner, what is a fair arrangement?

Bill Kelley

October 11th, 2013

Well, as I understand it, he's charging you like any other client. So his equity participation would be on the level of a board advisor. Maybe 1-2% after 3 years.

Marc Dewalle

October 11th, 2013

You need to date before you get married. So find a way to have him do some work (not just advice) before you do equity. That will tell you if you're getting his focus, plus you'll find out if you like the work and process. For now there is no need to discuss equity, since you're paying him. In any equity agreement, you should vest over a period of time and have a written agreement that spells out what you get for the equity (i.e. how many hours of his time per week).

- marc

Mike Moyer

October 11th, 2013

Patrick, Jeffrey Cary's answer is a dynamic equity split (thanks Jeffrey!). The Grunt Fund is the model I outline in Slicing Pie (http://amzn.com/0615700624). Like I said in my previous answer, I'll send you a copy if you don't want to buy it.

Andy Agrawal Director of Engineering at Zenefits

October 11th, 2013

If he is charging you for the development work, equity does not make a lot of sense. He's a contractor at that point and it doesn't matter if the work is being subcontracted out or not.

I would also be very careful of an outsourced team like this. You shouldn't need a team of devs to build your first MVP. Often times with outsourced teams, the cost is deceptively low. You pay a lower hourly rate, but it ends up requiring a TON of hand holding, you typically get low quality code that is difficult to maintain and the extra layers of communication are harmful.

Mike Moyer

October 11th, 2013

I LOVE problems like this. Hooray! I have the perfect solution for you. It's called a dynamic equity split and it will allow you to determine exactly how much each person in the company deserves. The split is dynamic so it adjusts based on the participants actual contributions to the firm. It also has protection in case a member of the team flakes out. I wrote a book that provides step-by-step instructions called Slicing Pie ( www.slicingpie.com ). The book is available on Amazon, but if you email me at mike@slicingpie.com I'll send you a free sample. The book was written for EXACTLY this situation.

Jeffrey Cary Senior Project Manager at netPolarity, Inc.

October 11th, 2013

Hi Patrick. I was in the exact situation, and brought on a team with offshore development resources, with the principals as equity partners. 4 months into the relationship they developed internal issues and could not fulfill the terms of our contract. Learning from that situation, I am awarding equity (founders, etc.) from a new concept called a “Grunt Fund”. There is a pool of equity that is shared, a defined value is placed on each individuals contribution, and they are compensated according their “actual” contributions. This keeps everyone honest, and everyone would be compensated according to their efforts. Long story short, they get out of it what they put into it. Hope this helps. J. Alan Cary Chief Executive Officer LifeSpan Behavioral Technologies, Inc. 760 Old Roswell Road, Suite 122 Roswell, GA 30076 (770) 580.2470 - Work (678) 767-0808 - Mobile (770) 334-2603 - Fax www.lifespanbt.com

Jason Oliver Founder and Technology & Product Executive

October 11th, 2013

Since they are forgoing profits, assuming its a fair cost model, then they are investing that money into your start up and probably the leader is throwing in his time also. That all has a value, regardless. What I've done in the past is to add up that value based on actual time and roll it into a convertible note.

When you have a round of funding, you can roll the note into the round at the market value of the amount of value they have "invested" along side the cash investor. Also - you can have a clause in the note where you agree to be able to buy them out prior to the conversion at some agree upon value - 2x the actual cost - something like that.

Andy makes a good point to not over develop the project - keep it simple to prove out the model.

Abigail Watson Clinical Applications Architect, Bioinformaticist

October 11th, 2013

One of the things that surprised me, years ago when I was waitressing! was how restaurants had different accounting systems. Most would have the house set prices for for food, customers would buy food from the house, and the waiters and waitresses would be tipped a percentage (15% to 20%) based on the quality of their service. However, the best place I ever worked at inverted that relationship (it was our college pizzaria). Instead, they chose to have the wait staff work as independent contractors, who purchased food from from the house, and independently resold the food to customers. Same experience for customers, but much better tips, everybody was enthusiastic, everybody was responsible for working their own ledger, and a much better system overall. Because the house trusted us to keep our own books.

I bring up this example because to answer your question, I suspect you need to ask (and answer) some questions about how the accounting is going to happen. Will there be a new business entity created for this SaaS? Or will it be a subsidiary of the parent company? Who will be running the accounting system? Is the development team providing a service to you by developing a product to spec? Or are you providing a service to them by generating sales? (The distinction isn't always as obvious as it may seem, because our egos have a tendency to bias our perceptions.).

Beware of the 50/50 split. It seems the most fair from a simple arithmetic perspective, but calculus tell us that it's the volume under a curve that often matters the most. Add in some real-world statistics concerning normal distributions and Gaussian distributions, and you quickly find yourself with Pareto's Law (the 80/20 rule) which describes the relationship of inputs to outputs, and is a 50/50 split, once one accounts for statics and volume under the curve. Ever wonder why waiters and waitresses get timed 15% to 20%? Look to Pareto's Law and the 80/20 rule.

If I were in your shoes, negotiating equity in a SaaS project (and I am, in fact), I'd be looking for an 20% split +/- 5%.

Rick Nguyen Cofounder @ Spot Trender

October 11th, 2013

Hey Patrick, I was in the exact situation as you.

Background: I have a science and business background, no coding skills. So I locked myself in my apartment for months learning how to code and raised $50K for Spot Trender. With this money I got a development firm to help build the product. Since Spot Trender is an enterprise solution for A/B testing video ads, the quality needs to be high so the development cost was quite high. Fortunately the owner of the dev firm believes in our product as well, so he wants in as an equity partner.We both are very happy with the terms and the arrangement has been working out very well for Spot Trender.

Below is the term I have with him:

-Spot Trender gets 50% discount for all development work.
-Dev firm owner acts as interim CTO, and goes with us to investor meetings. He's quite a tech veteran with proven records so this is a big plus.
-Dev firm owner gets 5% equity vested over 2 years.

Note: We worked with him as pure contractor for 3 months before agreeing to the terms above. Like Marc DeWalle said, date first before you marry.

Hope this helps. Feel free to contact me rick@spottrender.com if you want to talk.

Cheers!
-Rick

Todd Oliver Proven Sales Leader, Process Implementator

May 9th, 2017

Super frustrating at times. I come from a place where I scale sales for start-ups, but I'll give this one a shot.

My recommendation is to keep it simple. Sample math: Say you grant 1% equity per every 20k profit (vet that number) he forgoes after the first 20k profit on the project, up to a percentage. Say 10%. This way you get the first x amount to make sure the work is what you want. After the 10%, if you still need the work to be done and it takes more to sink into the thing than you both thought, he'll still be in as he has a 10% stake.

Good luck!