Equity distribution · Royalty

What royalty should I pay my engineer? He's graciously offering to work without a cash advance.

Gabe Greenwood Littlecat Labs

March 1st, 2016

A gracious engineer has offered to accept compensation by way of royalties instead of cash upfront, and I'm trying to figure out how much to offer him.Here's some info that seems relevant:
  • He has offered to design a PCB for me, in exchange for an as-yet unspecified percentage of future profits resulting from sales of products that use his PCB.
  • He is new to the project, whereas I have been working on it for a long time. I hold a patent on the product's industrial design (which is a key selling point), and have put in substantial work promoting it and soliciting feedback.
  • He is a relatively experienced EE in his early thirtieswith a good track record in the broader field (audio), but his prior work is not super specialized to my application. I am an inexperienced entrepreneur in my mid-twenties with a background in mechanical and software engineering.
  • He is a prolific freelancer with various other sources of income, so he will not be in financial jeopardy if the project doesn't succeed.
  • I am going to pay for R&D materials directly, so he will not have to put up any cash for the project.
  • We live near each other and can easily meet in person, so we will be collaborating very closely.
  • Currently we are the only two people working on the project.
I feel he is being very generous, offering to put up so much time without any guarantee of compensation, so I want to be generous in return. But I don't want to be outlandishly over-generous to the point where I will feel foolish later on. What percentage of future profits would you offer him if you were me?

Thank you all for your suggestions!
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David Levy Innovation and Product Development Executive

March 2nd, 2016

It may be semantics, but if he's not contributing protectable intellectual property, I don't think you should consider paying him "royalties." As I understand it, he's just providing a fairly readily accessible service. His appeal to you is that he's willing to be paid later. to be clear, it sounds like there's an infinite number of ways to accomplish the task is being given. meaning that at any point you had money, you could just pay someone to redo the PCB from scratch and eliminate his contribution completely.

A question to ask yourself is how is this proposal different than your IP provider offering to delay payment in exchange for a percentage of on-going revenue. You probably wouldn't do it.

A guideline to start with: determine the value of the work if he (or an equivalent him) were to be paid today divided by your estimate of the likelihood of successfull payment. if the work is worth $1000 and there is a 50% chance of him being paid, then the cost of late payment is $2,000.

again, that's just a guideline, but it is a rational starting place. of course, he may not agree with your assessment. That's where negotiation starts.

if you want to pay as percentage of income, you can cap his ultimate payment to3X baseline. Or 10% of revenue, untill he receives 1X, 5% of revenue until he receives 2X and 2% of revenue until 3X. Etc...

But I would avoid ongoing payment for what is essentially contribution widely available on the market.

Michael Meinberg Teacher (iOS Development) at The Mobile Makers Academy (A Hack Reactor School)

March 2nd, 2016

With all due respect, David, what you are missing is" "widely available on the market".

Quality engineers are NOT "widely available on the market" today, especially if you want them to work for nothing up front, which too often means "nothing ever".  So guess what I am saying is the "50% chance" is way off.    Better offer way more than that.

Adam Pressman

March 2nd, 2016

Our revenue royalty model isn't for everyone.  There has to be enough margin to ensure sustaining the business and offering 6 to 12 cents on dollar revenue.  That said, such a deal provides more control to investors and entrepreneurs, is structured with a buyout option that clarifies everyone's exit from the event,and is fixed in term and cap.  The only downside is the lack of revenue to pay out royalties.  Our assurance model fixes that by returning the investment of royalty holders if the venture should fail.   We are pretty sure that, if you can do it, revenue royalty financing (for investors or contributors) is a great way for most startups to get funded, keep control and not interfere with later funding rounds. 

Julius Sky

March 1st, 2016

but options mightn't cut it for him. the other option to not jeopardise cash-flow is raising capital and paying him cash

Thomas Sutrina Inventor at Retired Pursue Personal interrests and family

March 2nd, 2016

Is he working on the project as a favor or does he think it has a good chance of success?  Shares would be my choice for thinking it would be a success.  Royalties does hurt cash flow but you can write the agreement to pay them after X items are sold.  Then pay back those early royalties over the sale of more units.   Quantity is everything ask the music or film industry.  The inventor of the M1 gun only got a dollar a gun.  He is very rich.  The royalty will be based on expected sales and the margin.

Doreen SPHR Recruitment, Recruitment Process Outsourcing, Startup & Technology Recruitment, HR & Recruitment Expert

March 3rd, 2016

There is excellent suggestions here to consider.  If you decide to give this engineer options for his contribution, make sure you have agreed upon deliverables along the way, giving each deliverable a value.  That way, if there is a performance issue, or non performance, then you are not obligated.

I'm very curious as to why he is asking for a Royalty, of all available choices.  you might ask him what he accomplishes for himself by receiving a royalty.  Perhaps, what ever his need is could be satisified in ways that would work equally well for both of you. 

I favor you raising capital.  Crowd funding will be available in May of this year.  You may be able to take advantage of that.  If you are interested to learn more about this, let me know.  I know an expert or two on this.  Good luck to you.

Jim Reich Entrepreneur, engineer and inventor

March 1st, 2016

Royalties would be an unusual approach, because they interfere with cash flow that you're likely to need to survive when you're shipping the early, probably unprofitable initial versions of your product.

It would be a lot more common to offer options or shares in your company, and that would avoid cash flow as an issue.

ingrid bond founder, steward; bioponic world org & llc, art dealer; bond fine art, consultant; bond business consulting

March 3rd, 2016

just incase you haven't checked something like this out yet... our story; we, a group of collaborating businesses, are developing an alternative energy heating tech. through the state of NM department of economic (and small business) development we were connected with sandia labs, ABQ, NM through which we received to date (2 years) $120,000 worth of ME technical assistance. often large labs or such related have programs offering technical assistance for viable projects for which they then receive credit against their tax liability.

if there is a small business economic development program for your state they would know of such an opportunity.

all the best to you in your endeavor.