Development compensation for prototype pre-funding

Chris Hartman Experienced Product Development Consultant

April 22nd, 2013

Hey All,

So we are working on a new product and I'd like to generate some interest prior to beta launch. As most do, we are thinking of a basic 'coming soon' landing page with high level detail and a form to submit contact info to get potential customers to let us know they are interested.

Anyone have experience doing this and can speak to best practices? I'm interested in tips on driving traffic / sign-ups to the page, tools to get the page up, etc.

The product is aimed at brick & mortar SMBs.

All the best,

Jason

Daniel Eberhard CEO, Koho

April 22nd, 2013

Hi Chris,

I have been giving this some thought myself. Personally, I am leaning towards an equity option with an aggressive buy back policy. So equity would issued as the development moved forward but because jumping in with a founder I don't know is a significant risk, I would mantain the right to repurchase their equity at 100+x% within the first two years. This should leave me an option if things are progressing and the CTO isn't working out and mitigate their risk with a quick return. Just an idea I am toying with.

Vadim Oss Co-founder at Rentini

April 22nd, 2013

Hey Daniel,

I like all comments here and I think by digesting them all you may develop a pretty good strategy for yourself. However, I've been through that brainstorming sessions about equity split for co-founders and employees. Here's what I learned combined with many advices from my lawyers.
You always do a "cliff" for any equity offer. It could be a month, it could be one year. My lawyer recommended a year and it seems to be common in the industry.
You always want to have your equity grants on a vesting schedule. It's normally 4 years, could be 2-3 years though. Some people you talk to may be concerned that it's too long but you can offer a new equity grant every 6 months with a new vesting schedule date. This will keep your and your partners happy as long as there is a perfect fit.
A cliff of one year means even though their vesting schedule started on day one they can't quit on you 6 months later and grab a half of what you promised for the first year. You need a full product and not 50% of it, that's why you need a cliff. Vesting schedule (or/and cliff) could also be contingent on the product delivery. If milestones defined for the first year are met 3 months earlier then certain portion of equity is vested (or cliff is over). This will motivate your partners to deliver their product sooner.
A couple things that didn't work in my experience, not saying it will not work for you.
- A developer with another well-paid full-time job is focusing on his/her full-time job. You will be a priority #2
- A market salary will not affect much their motivation
- A happy mix of equity/reduced salary works better than either one of these options on its own
I would be happy to chat with you more on what I learned from my own experience. It's always better not to repeat mistakes that others already did before. I made a lot of them:)
Cheers!

Ken Woodruff Software Architect

April 22nd, 2013

Speaking as both a contract developer and as an entrepreneur I don't think contracts and equity mix well. Having a meaningful chunk of ownership held by someone who's no longer involved in moving the company forward is almost always a bad situation, and businesses regularly "fix" this problem by dilution. Savvy contractors know this--you would for example find it almost impossible to hire a lawyer for equity, but many of them will work on a contingency basis, getting paid on any liquidity event. You may find devs who will accept the same deal--but you'll probably have to offer them *above* market in total comp, just with some or (if you're really lucky) all of the pay deferred until the company gets an influx of cash. If and when the contractor morphs into a CTO or permanent member of the dev team it would be appropriate to negotiate swapping some or all of that deferred pay for equity, but I really think those negotiations should wait until then.

Blake West Software Engineer at Hint Health

April 22nd, 2013

Sorry... the message got truncated for some reason when I sent from e-mail... here's what I actually wrote (with better formatting)

Hey Chris,

I have a full-time guy on my team now, but prior to that was hustling around trying to find developers for months. And even now, I continue to look and talk to guys because we'd like to add a second person. I also don't have money to pay market wages (or any wages at all for that matter), so here's what my experience has taught me.

--> If you don't want to bring them on long-term, then you're talking about contract work. Getting contract work strictly for equity of any kind is not likely to feel appealing to any serious developer unless you have some combo of the following: A.) An awesome track record, B.) The actual thing that is being contracted is ready for serious profits (probably not the case for a V1) and C.) Even if (B) is true, you also have a whole team and set of connections ready to market the product and make iterations after the contract is over.

--> There are good dev shops who are happy to take small-ish equity plus some "reasonable" amount of cash. That might be $10-30k, but that's much less than a years dev salary, and you can get your V1 way quicker than with one guy. You will also often get design help, which is invaluable if you don't have those chops yourself. Even here though, they often like to see at least some developer who's actually on the team so that iterations could be made after their contribution is done.

--> You may not want to get a "full-time CTO" founder. But why not a part-time lead dev? The point is it's extremely valuable to have someone "on the team" and committed to the project for more than a few features. There's just too many small details that will constantly be getting changed and updated, and that doesn't fly for someone who's working on a "contractor" mindset.

--> Mitigate your risk by using cliffs and vesting in your contract. For instance, the contract I worked out with my developer was that his cliff ends after a year or after we start taking in our first dollar from products he's built. After that, his equity vests over 15 additional months. Gives him incentive to get it done. But regardless, I've had months to see him in action while he works, and if I want to, I can pull the plug before his cliff and he ends up with no equity. Cliffs and vesting are 100% standard in any contract, and it's foolish not to include them.

Hope that helps. Happy to chat more - Blake

Felipe Lara

April 22nd, 2013

I found an interesting method in this book:
http://www.slicingpie.com/
It is working well for me so far and it seems fair for all, but you need to trust the people working with you and they need to trust you.
Take a look. After a bit of research and looking at different options including the method that Jonathan mentioned from the book, Founder's Dilemmas, this is what worked best for me and my team.

Michael Brill Technology startup exec focused on AI-driven products

April 22nd, 2013

I know this isn't the question you asked, but if you delay finding a co-founder until after you've developed a product, then you're really looking to just hire an employee, not a co-founder. A bit pedantic, but extremely important because these days everyone wants to (a) work on their own ideas, (b) work for a super-hot well-financed startup, or (c) work for Google/FB/etc. And speaking from recent experience, I took the approach you're talking about and sort of ended up in purgatory with a reasonably-developed product but hard to get anyone to emotionally buy into it.

In any case, to your question, I was able to work with a few developers at reduced rates in exchange for equity. We simply established market rates for their service, determined how much cash I could pay them and then paid the rest in options. That was determined by using a reasonable expectation for Series A pricing and used that (you can poke holes in that as ignores the value of prefs and equity pricing doesn't really have a direct bearing on option pricing, but it's close enough and people understand it).

Jonathan's recommendation is as good as any... Fred Wilson uses one for early employees: http://www.avc.com/a_vc/2010/11/employee-equity-how-much.html.

But, again, I think you need to first answer the question of whether you want a co-founder or not.

Matt Mireles

April 23rd, 2013

Do what I do: Sign them up as consultants and "pay" them above-market rate in the form of a debt note due in 1 year, with 5% interest. If you decide to have the person join you full-time, the counterpart can "trade in" (aka cancel) the note in exchange for more equity in that negotiation. The upside is: if things don't work out between you two, the person still gets a decent cash payout if the company goes on to raise money or be profitable. If the company tanks and you can't pay, then it's the same outcome if they had been granted equity--they get nothing. Best of all it, this method keeps "strays" off the cap table, a problem we had in my last startup. Because i'm sure it's not obvious to you now, having to ask some guy who consulted for your startup for 3 months two years ago for a signature to sell your company or issue more stock is a fucking PAIN IN THE ASS. I've done it (the guy was backpacking through Paris); not fun. --

Jon OShaughnessy

April 22nd, 2013

Hm,

Good question Chris. I've never been in that situation myself so please take this answer with a grain of salt.

I'd imagine that you would use the same framework as you would use if you were further along (think classic CTO/CEO team and you were making your first hires). How would you determine how much equity to offer employee #1 or employee #5?

In the book Founder's Dilemas, there is a framework they discuss which I like a lot. It's a grid framework. On one axis of the grid, you divide each distinct stage of a startup into multiple parts - weighting each stage by a % of the whole. For example: pre-development was 10% of the total expected effort, early iteration was 40% and growth was 50% of the effort. On the other axis, you weigh each member's contributions. I.e. In stage X, founder 1 put in 90% of the effort, founder 2 put in 10% (or other employees/contractors/whoever). You then multiply across the whole spectrum to determine total contribution (and therefore, equity). Also note though, things are not always even. For example, what happens if one member is getting paid and the other isnt? There's no set formula here, but I think in this framework, you can start to hone in on specific trade offs (how much is this first stage worth versus a later stage) versus getting mired in the ambiguity of it all.

Another way to say it is how much total effort of the entire startup did they contribute? Depending on the time requirements involved I would imagine this would be sub 5% for your specific case. That said, it might be a tough negotiation with someone depending on the time commitment.

Hope this helps.

Jon Cooper Chief Technology Officer at Colchis Capital Management

April 22nd, 2013

A solo non-technical founder needs to do one thing extraordinarily well: own the vision.

You need to sell the living sh*t out of the vision.

If you can do this, you should be able to hire for equity plus a nominal monthly rate. (~$3 - 5k/mo in the SF area.)

If you can't, your vision is not compelling or you aren't delivering it well enough. Rinse, lather, repeat until you succeed at hiring. If not I'd advise you to wrap it up and try a different idea. If you're non-technical and can't hire, you are not going to be able to raise money from clueful (i.e. non friends-and-family) sources, so save yourself the sorrow and take a pass.

(Note: I have been hired on this basis and know a double digit number of other folks that have.)

Andrew Sparrow Web Developer

April 23rd, 2013

I would recommend against cash payments as a % of future revenue - it basically saddles your company with debt before you launch, which investors won't like, plus you have to pay above market because there's a high risk involved of getting paid, without a jackpot equity reward potential if things take off. Ideally, you want start paying straight cash for the first 40-100 hours of work to determine a solid working relationship, and then bring them on as a co-founder if there is a good relationship (this is what I've done in the past). If you don't have the cash for it, then I suggest giving out non-voting pre-funding equity based on benchmark achievements with the potential to convert to a full co-founding partnership upon completion of the prototype and a positive working relationship. I also think you're goal should be to have a CTO co-founder when it comes time to seek funding - it looks better if you've convinced someone else your idea is valid as well.

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