Asking this on behalf of someone I know. The guy is non-technical basically an MBA and doing a business consultancy job.
He has a startup idea (concept of mobile application) on which e has worked for a quite some time, He also have a prototype (just slides on my phone that change in particular order, depending where you click - so it provides experience close to the working app) and already tested it on potential targeted auditory (20 people from which 18 said that they would use it). So far, the feedback is better than he thought.
The problem is that he, not tech guy, He don't know how to write code to develop the product. He has been told he might be fine with two coders to create and sustain it initially... But he doesn't have these guys, either fund to hire them.
I have advised him to find a coder or two and make them co-founders of your startup. But he has a concern that "How to make somebody a co-founder and give a person some equity if you know yet nothing about him?"
If later in some stage he finds out that he/she can't do the job, but this person already has some equity then what he can he do about it?
Although I have told him that you don't make someone co-founder straight away, you both need to pass each other's scrutiny before making the deal but I think he needs to know more about the process. Kindly advice.
Your friend is conflating several issues, and also setting himself up for mistakes by following assumptions that are fundamentally flawed. First, he has an idea, not a plan. He needs a plan. An anecdotal check of interesting in terms of suggesting there may be something of value in the idea, but it is not a reason to start a business. Starting a business requires an amount of research he hasn't even imagined yet.
Focusing on a co-founder is a mistake at this stage. The first step is in figuring out how an idea becomes a business. No one in their right mind will join a company as a partner/co-founder until the creator has done their homework to reduce the risk, establish and test a strategy, and defined the plan to reach specific goals.
The next fundamental mistake is treating equity the same as salary. It's not anywhere close to the same thing. Equity is worth ZERO until the business has customers, so asking someone to work for equity simply because you can't afford to pay them a salary is asking them to work for free. And if you haven't reduced the risks for your stakeholders, there's not even a promise of money in the future. What your friend needs to focus on now is how he would run the business if he had no outside money ever. What would be the first, smallest step he could take in a plan to generate money, on the path to paying for the next step?
A cofounder is not the first employee. A cofounder is someone who shares the same vision of the way your product/service will change the world, they're doing the work for the same reason, and they are amplifying the work you're doing yourself.
You don't pay developers with equity, you pay them with cash. If you don't have cash, you figure out what you can do to make cash so you can pay developers. Maybe it's a second job. And you delay starting your business until you have collected enough personal resources to get you through to the next step where you can make some money from some component of what you're doing.
Businesses frequently fail because they start too soon, chasing an idea without a plan, and without adequate resources lined up. An entrepreneur should always have a plan that includes no outside money, because most will never get any. They can have another plan that includes outside money, but be able to fall back on the self-funded plan. Very few do this because it can significantly limit the speed they can manifest their idea. The planning stage is all about determining whether the business is a fantasy or can be a reality. Since the entrepreneur has an unlimited amount of time to figure this out, committing too early is always a mistake. It's their job to figure out how to make it work with the resources available, or how to acquire the resources necessary.
Last point is that equity should never be given, it needs to be earned. With this approach, you won't find yourself trapped in a situation where someone can't perform but holds equity.
Paul Garcia is correct in most of his comments. I would add two things, though.
First, all equity should be vested with a cliff. A cliff requires someone to be with the company for a period of time, usually one year out of a four year vesting period, before any of the stock vests. This gives the CEO the opportunity to get rid of underperformers or nonperformers before it becomes irreversible.
Second, to turn the "idea" into a "project" that can become a "business" one must research the business elements. Look up Lean Startups for a good guideline. Fundamentally, answer questions about the competition and perform surveys of potential customers to validate the "idea". Then, map out the steps and milestones. From that, you may determine the people you need and resources. You should create a Pro Forma, which doesn't have to be a really complex thing but will demonstrate your thinking process on costs and revenues. This can then be shared with Friends and Family to try to raise some cash that can be used to pay contract software developers, probably overseas, to develop the prototype.
All of this is modified based on the complexity of the idea, project, business, and the competition. Innovation can come in many forms, not just new technology. Take Uber for example. The technology behind it is fairly straight forward, but it is the business model that makes it strategically innovative.
Your friend is correct - it would be a big mistake to give them stock. We have seen this cause so many issues.
You are trying to combine an investor with a coder. Hard enough to find either one alone - impossible to find both in the same person.
Even if he had the funds, do not hire any coders. Its extremely unlikely he needs even one full time person at this stage. In all likelihood he needs a few weeks of programing and then nothing for several months as he further validates the market.Who knows if he will still need a coder after that.
There are companies specifically setup to make MVPs for startups - much cheaper than trying to do it yourself.
I recommend your friend read our white paper on the stages of a startup.
He should consider rolling up his sleeves and learn to program it himself. Web apps are not that hard to develop anymore given a crazy amount of free help is just a Google away.
If I was to invest $x in his idea and he was to pay a developer to create the app, he would have no clue if the job was done right or used the right technologies. Worse, he could be saddled with a solution that uses proprietary libraries from that developer making it hard to bring a different developer on board at a later date.
Yes learning to code is a pain, but if you want to start up an app based business and don't have a tech co-founder that shares the vision or you don't have the ability to raise cash on just an idea, you don't have an option but to learn to code.
@steve owens I've found that a lot of these dev shops claim to be agile in their approach but sometimes it's little too late to pull the plugs after they've been commissioned(paid) to start the work. That being said there are a few development shops that are reputable and true to their words and that would take some solid research.
I believe it's very possible to find diverse co-founders and that's why investors, legal counsels often advice one goes into a business relationship with someone that complimentts their skills e.g if you're a business guy, find a technical co-founder or someone with coding skills or relevant skills to the problem you're solving. In fact these days investors will most likely not invest if your team doesn't look like what i've described, so you're very correct he shouldn't pay anyone for instant gratification and for trust issues. He needs to do the ground work to find that suitable co-founder.
When he finds a good co-founder, this person would be in for the long-haul, ofcourse they have to build the MVP and even if there's no coding work to be done for several months, there are alot of things that a technical co-founder and a non-tech co-founder could be collabirating on. Afterall the rewards and everything that comes with a startup will be experiienced together. Ultimately, they want to win together.
- It's a simbiotic relationship
Most people think this is an issue, but it's actually a non-issue. Seriously, this is not a problem in the least. I promise there are two fool-proof ways to do this:
Option one: simply pay fair market compensation and don't allocate any equity. This is how most people are employed. Your developer will be perfectly happy. If he is too expensive look for a lower cost option. I've found great talent in the Philippines.
Option two: if you can't pay him a full fair market rate pay him less or nothing. Treat the unpaid portion of his fair market rate as a "bet" on the future outcome of the company in terms of profits or capital gains. Every time his comp is unpaid or his expenses are not reimbursed he is placing additional bets. The same applies to your friend and anyone else who contributes time, materials, equipment, and other resources for which they are not paid. Keep track of the bets (this is easy, basic accounting is a normal activity for literally all legitimate companies).
When the business generates enough cash (revenue or investments) to start paying everyone the betting slows down and eventually stops. At that point you can easily calculate each person's bet and apply this basic logic:
A person's share of the equity is based on that person's share of the bets.
This is an obvious, logical, unambiguous reality. It always produces a fair split, no other approach can.
If the person quits or gets fired for cause he is walking away from his bet and will lose it.
If the managers terminate for no cause or otherwise push him out his bet stays on the table along with the other bets.
This is known as the Slicing Pie model and it always works. You can learn all about it at SlicingPie.com
Slicing Pie by Mike Moyer is mandatory reading before you get into the "sweat equity" play with anyone.
Text could be misunderstood sometimes but based on everything you've said, I'll assume your friend has done alot of market research and believes this problems need to be solved hence the proof of concept. If that's that case, he's on the right path because if he intends to raise money this will be a key metric alongside other variables ( is the idea scaleable? ) and is this the best solution yet to the problem he's trying to solve?
Now unto co-founder, this is often a tricky part and i had thesame question when i kicked off my first start up. There are a few resources out there but through my experience, here's my suggestion :
- He needs to know what he's looking for in this potential co-founder and screen people based on that. Once he's able to have a checklist of what he's looking out for, filtering becomes Easy.
- The contract: people tend to forget that contracts and agreement help to form a relationship. The shareholder or cofounder's agreement should contain things like: vesting and clif period which serves as a precautionary measure should 'things fall apart'. This actually helps ensure that equity is earned and not just taken. Most likely Your friend would be the hiighest shareholder and there should be a buy-out clause at fair market value spelled out should in case things go sour. Ultimately Vesting and Clif would solve trust issues at the initial stage and buy-out clause will address a falling out down the road. I'll suggest a lawyer is involved to examine the situation and give the best advice on what would work.
PS: I am not an expert, it's merely a suggestion from experiences. Also better to hope for the best and prepare for the worst.
I hope that helps.
Good Luck to your friend.