How to fairly decide upon share structure between 1 programmer and 2 "business" guys

Question

I am entering into a venture between myself and 2 other people:
A) Programmer - Me
B) Business guy 1 - long time former client and somewhat of a friend, lots of industry contacts....it was his idea initially.
C) Business guy 2 - wealthy, industry insider, MBA. I have only met once at lunch.

The application can be most simply described as a very spacialized auction site in a narrow vertical industry, involving large dollar amounts. To stay on topic, let's assume this venture is a good idea.

The company will consist of a website with very minimal supervision required. Marketing by the 2 business guys will drive customers. Outside of some marketing presentations and lunches, and some analysis sessions with myself, their time input will be minimal. I would estimate on a pure hourly basis, I will put in 80%, if not more.

When asked what share I was interested in, I asked for 30%, as that was what I estimated was the fair amount for me. I fully appreciate that even though I will be doing most of the "work", it is their connections that will ultimately determine the monetary success. I also realize that I can theoretically be swapped out for any other developer (although at much greater cost than they realize, and high risk of not finding the right person). But the same can be said of Business Guy 2...there are many people other than him who have similar money and industry contacts....so, the idea that I, as a developer, am dispensable, applies to him as well.

Long story short....my 30% equity request was countered with 25%. I still only have a small portion of the specs, and know little about Business Man 2, yet I feel like I am being pushed to agree or disagree on the proposed equity share before we go any further. On an hours worked basis, at the end of the day I think I would likely be extremely happy with my payout of 25%, based purely on $/hour, but I am quite confident that at the end of the day it will then be quite clear that success was much less a result of inside connections and moreso of a good product at the right time.

So....what should a person do in this scenario? My current thought is to just keep working on the software to bring it to beta andhold off on signing anything, as I will have more leverage the further I can drag things out. Thoughts?

UPDATE #1
No one is injecting any noteworthy amount of capital. I am donating the entire design and programming of the site (as well as administration I would imagine). We may spend $5-$10 k on a CSS person later. Other than that, it is just picking up the phone, going for lunch, maybe a few presentations. Extremely minimal capital investment is required.

As for the code....I am doing all development offsite as of now and not releasing any source code. But I definitely have a lot of thinking to do about the legal aspects of protecting myself in this regard.

Answer 1

Bad negotiating in the first place. You have to start from a high point and assume they're going to counter with something lower. Never start with what you actually want. 90% of the time you'll split it down the middle. Next you should say you need to think about it for awhile and then settle on 27.5%. Your real win here is the gamble on this being profitable. In the end, 25% isn't terrible. If it hits you'll probably be rich, if it misses 25% of zero is the same as 30% of zero. It doesn't sound like there is much of a middle ground here.

Answer 2

You're a techie, so you can approach it from a techie point of view before touching the suit-clad boardroom table shenanigans. It might sound a bit simplistic, but one way you could look at it is:

• Assume you hit 20% of the target overall sales - will you still be happy with 25%?
• What would they have to pay to get another guy of similar talent to yours to run this thing, again assuming a wide range of possible incomes?
• What would you have to pay to get a high-level consultant with product/brand/industry awareness and golf-course networking talent to drive the business, marketing and sales?
• What's the deal-breaker, and what happens if you stalemate, if they refuse to give you more than 25%? Can you take the product with you, and get a new business partner?

There are other questions, but these will get the ball rolling in your head.

Sadly, it's easy to be oversold on potential earnings by guys who oversell all the time. Bear in mind that you may only gross 10-15% what they project, so use those figures as a basis.

Also, keep your options open: there are non-obvious alternatives, e.g. you could demand an hourly rate in lieu of the 5% they're dropping you, and pro rata based on their expectations for the gross profit. That way they'll have to exceed targets if they agree to cut your share, in order for the deal to be in their benefit.

Answer 3

I think 25% sounds very reasonable. At the end of the day, this company could always go a different direction for the development and leave you with nothing or pay you a strict hourly fee. I think in this situations the developer needs the business contacts and $$'s more than vice versa.

I would also say that if you believe in the product, do not worry about the 5%. If the product is a long term success, the 5% will not be an issue.

Answer 4

Long story short....my 30% equity request was countered with 25%.

Which makes my Spider-sense tingle.

So....what should a person do in this scenario? My current thought is to just keep working on the software to bring it to beta andhold off on signing anything, as I will have more leverage the further I can drag things out. Thoughts?

My two cents: don't write a single additional line of code without signing anything. For 30%.

Without you, these guys won't have anything to market. Either they consider you to have sufficient skill and unique qualifications to be a great fit for their team and equal partner, or they see you as a somewhat expendable pack mule.

In development forums it is easy to discount the contribution of sales folks towards the success of a product. While I don't want to fall into that trap, from what you've written it sounds like these guys will be benefiting from your hard work.

Without signing something, what prevents them from going "oh well, it looks like this isn't going to work out" and then handing your code over to another developer in 3 months, thus leaving you without a dime?

Maybe these guys are on the up-and-up, and there are other factors at play here. If that's the case, then they should be able to clearly explain why you warrant only 25% of the share. If they're trying to cheat you, then they'll balk at 30% and nix the deal.

And if that's the case, you're probably better off for it.

Edit: Another thought that occurred to me is this: even if you continue to work on the software and retain all rights to it, you're still providing something for nothing if it falls through since you're likely having to figure out workflows and UI issues. Without an agreement, they can still take your design (ala Apple from PARC).

Answer 5

These guys are business types, so they're negotiating the way they do professionally. You can't match them at that game, so don't try.

What you can do is be stubborn about 30%. Repeat that you think it's fair. You're going to be doing most of the work, and contributing greatly to the success of the project. They're unlikely to let 5% be a deal-breaker.

Remember that you're the lone techie here. The others don't understand what is and is not possible, and they're used to flexible limits. I'd suggest that showing some stubbornness up front can keep you from unpleasantness later. If they get the idea that you'll just give under pressure, you won't get rid of the pressure. Ever.

And never go into a deal like this if you feel resentful. This is the sort of thing that requires commitment, to the job and to one's partners.

Answer 6

Let's see... Three guys. One startup company. All three guys needed to ensure success. What the hell is wrong with one third each? Fair, equitable, easy.

Why are people so greedy?

Your comments on "just keep working" are interesting. I assume that the new venture does not exist as a legal entity just yet? If not, any code you write belongs to you? If so, nice!

Perhaps you can think a little differently about the deal - equity isn't everything. For example, offer to write the software, but retain ownership of it. Take a more modest equity position in the new venture - say, 10%. Negotiate an appropriate royalty on the software that matches their pricing model, like 10% of subscription revenues or 20% of advertising revenue. If you do this you get an early revenue stream, a small slice of the pie if it is sold off and you retain the source code as an asset.

I hope it works out for you, but be prepared to walk away if the deal just doesn't feel right.

Answer 7

You're missing a key piece of information - where does the 25% counteroffer figure come from? How can you possibly make progress without knowing the answer to this question?

You have the option (and obligation) to say 'no' if you don't like the answer you're given. As they say, there are plenty of fish in the sea.

Answer 8

My question is: "Who retains control of the codebase in the event of the contract being cancelled?"

For example, if the codebase is Open Source or worse, is a company asset rather than your personal property, you should stop work till the contract's agreed. Otherwise, you are working for free, and once it hits beta, they can trade you out instead of signing the contract, keep all your work AND potentially sue you if you try to compete against them using your copy of the codebase.

As long as you retain legal control of the code you're writing, I think that it's arguable that you're right to keep working, so that the project doesn't stall. But if they have any access to the code, then you really don't want to get into a situation where they copy your codebase and refuse to give you credit. Lawsuits are expensive for everyone except lawyers.

I would remain firm at one third. Make it clear that this is not "hard bargaining", this is what your contribution is worth, and you're not willing to negotiate unless they come up with a reason why you're worth less than either of them. Frankly, I would have gone for exact equality, to prevent any loss of control. Also make it clear that you don't want to negotiate based on "what you will accept". That's what you do with your holiday souvenirs, not your life's work.

Answer 9

How much capital are your two partners injecting for their share of the equity?

If Business Guy #2 is coughing up more than $2m I would expect him to get 70%-85% share. Even if it's around several hundred thousand, I sill would expect him to ask for more than 50%.

Time invested and industry contacts have tiny valuations compared to capital. I would take the 25%.

Answer 10

You need to go talk to a lawyer.

My thought is that, the way your company is now structured, you're going to do most of the work to get the code up to the point where it can be demonstrated. As you said, there will be minimal outlay of money.

Once it's time to market and sell the software, maybe even to hire staff, and office space, and things like that, that's when money will be spent. At that point, if you haven't been careful, I expect there may be a restructuring of the business, leaving you with a lot less than 25%. In fact, you could easily be left with a percentage based on your financial contribution. Even if they account for the time and effort you spent in a very generous manner, how much is that going to come to? US$ 100k?

Answer 11

Be aware of the fact that even though you may be putting in most of the work, you are the most replaceable person. They could always find a new programmer if push came to shove, but industry contacts are priceless.

If you believe the project will do well it may be better to accept the 25%, keep the scope of your work tight and if they're after extra development in the future push for a greater share of that.

Sorry if this sounds a bit harsh, but observing friends who come up with business ideas (with varying degrees of success), they always see programmers, designers, etc as a means to an end and in a way they're right. Of course, when someone technically able has a good idea, that's when things really fly...

Answer 12

Keep in mind that any kind of negotiation has the possibility of failing, if both parties are not able to reach mutually agreeable terms. That means that unless both parties are better off working together, then they do not work together.

On top of that, any agreement must be reasonably fair, such that benefits and risks are distributed equally to all parties. That doesn't necessarily mean each party gets the same benefits, but that for every party the risks are in balance with benefits.

Start by considering how each party could potentially make do without an agreement. You have a modest amount of source code, ready to go, but possibly very little business contacts to make that a viable product. Even so, You have said that you feel that success is largely going to be derived from the right product at the right time, rather than from marketing.

Your partners do not have a product in hand. Although they could reasonably hire another programmer to create or recreate a product, it puts them pretty far behind where they would be if they were in partnership with you.

Analyzing the risks are a bit harder. There has been little capital investment, aside from the time you have all spent working on it, so there is minimal up front risk. Down the road, though, you are likely to have a customer that believes (whether you have or not) you have harmed them, and you need to look at how the contract protects you and your partners from a lawsuit. That's going to be the most significant issue on that side of the issue.

You can also help your case by putting the burden on your partners to demonstrate the value they will bring to the partnership.

Having some contacts isn't really a very good indicator of success, but past successes can be. List all of your own past projects, what you contributed to them, and how they turned out. Even if they all failed, you can show that what you did then is applicable here, and in what ways you learned from those failures.

Unless your partners are able to show a comparable track record of entrepreneurship, their claims of value are going to be weak. On the other hand, if they have a long and storied history of business success, you would do well to partner with them.

Answer 13

A lot of answers so far have focused on the perceived disadvantage that techies have when negotiating with the business types. For anyone who is interested in improving their negotiation skills I would recommend the book:

"Getting to Yes: Negotiating Agreement Without Giving In".

I found it very helpful in my last job negotiation helping me craft what I refer to as the $10K email.

Answer 14

First of all, I cannot recommend the book The Entrepreneur's Guide to Business Law highly enough. Chapter 5 deals with exactly this issue, and the book is written by lawyers. Almost every mistake and issue I've seen in the real world is in this book, in one form or another. For $50, it's a no-brainer.

Regardless of what %ages you end up with...

You want a vesting schedule and you want IP assignment agreements from everyone to the corporation so that you avoid these two scenarios:

• No one should flat out own 33% and then have the ability to walk away, do nothing, and benefit from the works of the other two.
• No one should be in the position to claim the company "stole my IP" and sue you for damages once you are successful.

What a "vesting schedule" means is that each month (or some other period of time) you accrue another 1/Nth of your ownership. Usually N = 36 or 48 months. There are various parachute clauses you can negotiate for, but everyone should usually start off with the same package--whatever you negotiate for yourself, you are negotiating for the rest of the team as well.

As for IP ownership--What if one of you leaves and believes, fairly or not, that he had major contributions? If you have an unclean "chain of title" on the IP, you have a liability--and he can extort or sue you on that liability. No matter how good of friends you might be, any possible outside investment will be stopped cold in due diligence if you are missing these agreements with anyone.

Find a lawyer who does this kind of thing and get set-up properly. Even if an expensive attorney charges you cash, it won't cost more than $7500 to get the ball rolling. You can often negotiate deferred or lesser payment from the attorney, but with this being the first time out and having a lot of questions, that might be a little more difficult.

Cleaning up these kinds of things is extremely expensive, stressful, time consuming, and can even kill the company and everything you've worked for. I have had to deal with this firsthand before and I lost a lot of money.

In every venture I have started, at least one founder has left or been asked to leave. You need to have the legal entity created and papers signed before you do anything significant.

Everyone is saying you should all be equals. That is probably true most of the time, but in some cases people are not equal. I worked at a start-up with a $2 billion exit and the three founders were 50/25/25. But for the first time out, 33/33/33 sounds a lot better.

Remember, your goal is to make the pie as big as possible, not to quibble over how big your slice of the pie is.

Good luck!

Answer 15

In lieu of an equity stake you could always incorporate yourself and then license the technology to them for a flat rate. You could have them sign a contract that will make you the exclusive provider of the technology they use for X amount of months/years for a specified rate. This will cut you out of the "HOLY CRAP GOOGLE BOUGHT US FOR 30 MIL" cashout, but if you structure the contract correctly, you could continue receiving X dollars from the new owners even in the event the original company is purchased. I'm not saying you should do this instead, but it is an alternative.