Need opinions: equity, salaries and risk in a startup

[Awasaba]

Hi all,

let me give you a brief run down of my case: a couple of other people and I are thinking about creating a technology startup for a niche marketing product. It would involve an initial ~8 month period of research and development which would cost ~$70k, after which we could begin to actually start selling and (hopefully) see income. These other 2 potential partners have the tech know-how required for this project, and I know them to be skilled and capable people in their fields, while I have the running-a-business know-how (I'm a business major).


However I don't like the initial investment proposition they made to me: They want to split shares ~52% for me and 24% for each of them, but since they have no cash to invest they propose I put up the entirety of the R&D investment required in the form of an investor's loan to the company, which would be accruing an yet-to-be-determined-but-fair interest rate until there was income that the company could use to pay me back the loan. Additionally they would both dedicate themselves as technical directors during the R&D phase as a part time job (~4 hours per day each), and would pay themselves wages for this during the ~8 month period. After the R&D period is over, the wages would end, although they'd continue working in the company.

So obviously I don't feel comfortable assuming all the risk (because if the company goes ****-up, there would be little assets left to liquidate) yet getting only half the shares , although I am not opposed to having them paid fair market wages for their work during the duration of the R&D period, given that admittedly I will be doing little during that phase. I'm having my own ideas about a counter offer, and I do want them to have participation in shares in some form because they're needed for the long haul and shares provide a great incentive to give 110%, but I want to hear opinions on what others here would think is fair or workable. Suggestions please?

[Freelancier]

Well, first of all, congratulations on having partners who get that a 50-50 split is bad for the business, since it means you can deadlock and freeze the company at a critical moment.

Your numbers are probably low, both on money and time. Just because something is done with development doesn't mean you're going to get sales any time soon. Sometimes it takes a year (or more) beyond that before you can convince anyone to take a chance on your product. Sometimes you have to keep tweaking things to get what the customer really wants from it. So, assume your money and time are going to prove to be overly optimistic (and then be happily surprised if your numbers are really good ones).

If you're doing your investment as a loan, then the equity is for... what? Security on the loan that will get paid back? Are you doing something for the equity other than providing cash? Have you contemplated what a buy-out would look like or what would happen if they quit on you before you get to the end? I'm unclear on why you're giving them equity for ... what exactly? The idea that may not pan out? I'd be more inclined to start by owning 100% equity and then pay them for hours and grant them equity based on hitting delivery targets. You see how that provides the incentive you want?

[tallen]

I am just wondering about the cash flow -- the other two partners are supposed to be paid wages for their work during development -- where is that money coming from -- your investment? Or is it accumulating as an unpaid debt owed to those partners? Similar to your loan of cash to the company, they make a loan in the form of "sweat equity?" What about your work for the company during this development phase, are you going to be paid too? The management and administration, setting everything up, marketing or pre-marketing, etc...? Shouldn't you get paid for that just as they get paid for their technical work?

[Paul]

I’d say you dictate the terms. It’s your money. Get new tech guys if you have to. Giving them almost half the equity AND paying them doesn’t make sense. One or the other. Let them work part time for the equity OR just get paid, not both. Maybe use a bit of equity as an incentive.
Also, from personal experience, if you pay them don’t pay hourly. Pay a total project price incrementally with payments due at milestones.
After the development/research period what happens? What do they do?

[Awasaba]

If you're doing your investment as a loan, then the equity is for... what? Security on the loan that will get paid back? The loan itself is the actual investment equity, it's just that if I put it into the company when incorporating it as initial capital the other two partners have nothing to match it with and can't get any equity of their own. That's why they proposed incorporating it with very little starting capital, and then injecting the needed capital as a loan.


Are you doing something for the equity other than providing cash? At first, not much. Just cash. My business expertise comes in when we actually start operating.
Have you contemplated what a buy-out would look like or what would happen if they quit on you before you get to the end? No, I should think about that, thanks for bringing it up.
I'm unclear on why you're giving them equity for ... what exactly? The idea that may not pan out? That's why I don't like their proposal - they're getting paid + equity, so in effect they're double dipping.
I'd be more inclined to start by owning 100% equity and then pay them for hours and grant them equity based on hitting delivery targets. You see how that provides the incentive you want?Yup!


I am just wondering about the cash flow -- the other two partners are supposed to be paid wages for their work during development -- where is that money coming from -- your investment? Or is it accumulating as an unpaid debt owed to those partners? Similar to your loan of cash to the company, they make a loan in the form of "sweat equity?" Yes, the wages come from my investment.
What about your work for the company during this development phase, are you going to be paid too? The management and administration, setting everything up, marketing or pre-marketing, etc...? Shouldn't you get paid for that just as they get paid for their technical work? No, I'm not getting paid. My contributions time-wise will be small during this phase, and I don't want to increase cash flow requirements more, although technically speaking, yes, I should be getting paid.


I’d say you dictate the terms. It’s your money. Get new tech guys if you have to. Giving them almost half the equity AND paying them doesn’t make sense. One or the other. Let them work part time for the equity OR just get paid, not both. Maybe use a bit of equity as an incentive. Yes, that's why I don't like their offer. They want to have their cake and eat it too.

Also, from personal experience, if you pay them don’t pay hourly. Pay a total project price incrementally with payments due at milestones. Yes!

After the development/research period what happens? What do they do? Oh, there'll be plenty of work for them given that each client project requires extensive 3D modelling and that's their strong suit. Plus future upgrades to the software developed during the R&D phase.

[Endico Ennoble]

Your scenario needs tweaking. As an ex-venture capitalist I can share these thoughts: first, I would spend time not money on the research of your niche marketing product. There goes the $70, no need to have someone else do what you need to do in the first place -- and save the bucks. While you are researching let the techs do their thing and get a model up and running. Secondly in terms of the way the business is split up is cockeyed. Everyone at this stage should simply provide whatever expertise they can, whether it is technical, research or pre-sales just get things going. In terms of percentages when determining ownership, I would recommend tht if you follow what I am saying then figure an amount of money necessary for the business to sustain itself i.e. supplies, pc's,subscriptions etc. Then split that amount of money between the three of you. Make certain that amount of money will carry you through for at least 18 months or more. Finally, one way to work the percentages is to give each person a percentage -- say 10% of company shares while doing initial work, then setup milestones you guys want to reach and distribute those to one person in the group, as a person hits a milestone they would be awarded more shares or percentage of stock. Make thing interesting! Good luck.