

Ask HN: Opportunity to earn a cut on every transaction. How big should my cut be? - alrex021

I have been asked to put a quote together for developing and maintaining a public web based application for a promising new startup.<p>Yesterday, I presented a "no strings attached" time and cost estimation for developing the initial version of the app. I took into account that the estimated cost might not fall into their budget and presented two alternatives.
Their business model is primarily a transaction based one and is very sound. They have sole rights to distributing the virtual product/service and key retail vendors have come on board with letters of intent. 
As I suspected, the quote did fall out of their budget range and at that moment I decided to bring forward the alternative somewhat "informal" proposals.<p>Option B. 
My business owns the IP on the software. They use it and pay just for maintenance costs.<p>Option C.
They pay less for the system and I get a piece of every transaction.<p>Today I found out that they really liked the Option C. Now that the two alternative proposals where informal, they want to see something on paper and then we can come back to the table thereafter.<p>As per Option C, what do you fellow hackers think would be a good deal? What would be a realistic percentage, per transaction, to ask for? (Taking into account that their business very strongly depends on the system I will build and maintain. Also I was very highly recommend for the job by one of their current business partners. :)) Also, how much less should I charge for building the system in relation to taking a cut in the transaction costs? (Is there maybe a ratio as a rule of thumb?)<p>Any suggestions greatly appreciated.
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lrm242
A couple of thoughts:

(1) as a business owner I would be very wary of a perpetual cut, so I would
cap it.

(2) since you're capping it you can demand a larger cut to ensure that you're
repaid faster.

I would propose something that would enable you to earn ~2-3x your initial
proposal cost over a period of approximately 1-2 years. Ultimately you're
giving them a loan. This is "owner financed software development". Think about
it in terms of interest rates and the cost of money, not in terms of becoming
their partner.

Furthermore, you might find that you can secure collateral for your loan. For
example, they agree to pay you over time and secure that opportunity with you
by making you a secured creditor on their books.

~~~
stijnm
Good advice. Make sure you recoupe your costs - unless you are prepared to
carry some of the cost as a strategic decision for your company.

I am wary of the fact you say 'promising new startup'. I would err on the side
of caution and assume it isn't the giant success they(/you) hope it will be.

As a result, I would spread the risk: \- Ask for a 'normal' payment, within
their budget, trying to cover at least 50% of your cost estimate. \- Then be
as daring as you may negotiating your transaction cut on the gross.

So, I would reduce my risk as much as possible - who knows if it will take
off?

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jjs
Whatever you do, try and get a (small, depending on volume) percentage of the
gross, not net, on each transaction. Maintaining their margins is their job,
not yours.

~~~
philwelch
Most industries are not this bad, but reportedly, Hollywood is set up so that
no motion picture ever produced is ever profitable. This was originally a
corporate practice invented to screw over people contractually due a
percentage of the net, but everyone went back to negotiating based on gross.

~~~
netsp
A less weasely example might be the company simply deciding to take a loss or
very low margin at low volumes to enable faster growth.

That might make sense for them because they have an open ended upside. It
doesn't for whoever makes a cut.

~~~
jjs
Any time you take a percentage of the net, you've set up a perverse incentive
for the company to spend more money up to the exact point where they're not
paying you anything. After all, for them, it's "free" money!

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run4yourlives
Factors to consider: (or, why nobody here can give you an answer)

1\. How much do you _need_?

2\. How much of a cut do you want?

3\. What is their established sales volume? (You can lower the percentage if
sales volumes are high.)

4\. If none, what's their expected sales volume?

5\. What's their expected sales growth rate?

6\. What is your estimate of their numbers being accurate? (i.e. Cut their
expectations by 30% and see if it still works for you.)

7\. How much time (in actual $ per your hourly rate) are you expecting to put
in on this project?

8\. How much time x 30% are you expected to put in?

9\. How much is that IP worth to you?

10\. How much is it worth to them?

11\. How much is it worth to others?

Answer those questions, and then it's just a matter of relative comfort.
There's no set formula here, your cut is as big as you want, and as big as
they want it to be. IMO, set properly, Option C is the best for you, because
eventually, you'll have income for no work. That's the reward for the risk
you're taking in not being compensated up front. Make sure that reward exists.

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dxjones
If you give them ownership of the IP with Option C, then you should ask for a
bigger piece of each transaction in your contract, ... keeping in mind they
may choose not to renew with the same terms at the end of the contract term (1
year?).

If the software is so integral to the success of the project, you might
negotiate shared ownership of the IP, so you get something if they sell it.

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thebigjc
There's two ways to do it:

1) Go simple - affiliate fees in ecommerce range from 4-8%. Pick a number
you're comfortable with and use that.

2) Do the math - estimate their revenue per year/month/week, do a Net Present
Value calculation, using a discount rate based on the fact you're getting paid
over time, and the fact that you may never get paid. Divide your quote for
option A by the NPV, and that's your % to ask for.

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noodle
i would charge something that "should" recoup your "no strings attached" cost
estimate within the 1 to 3 years range. and if that doesn't include
maintenance, tack that in there too.

might require you to get them to provide you some data and growth estimations.

~~~
icey
I haven't done this myself, so I may be wrong; but wouldn't it make sense to
also figure in some cost inflation due to the fact that he is now assuming
their risk as well?

If this was an existing company with solid financials, what you are saying
makes 100% sense... But this is a startup; there is a reasonably high chance
that they won't be around after a year. Like I said; this is way outside of
the realm of things I have experience with, so I could be totally off base.

~~~
noodle
definitely true. which is why i said 1 to 3 years, and i never said anything
about stopping charging that rate after you recoup the costs.

there's quite a difference in the rate if you're aiming to recoup the cost in
1 year as opposed to 3.

on the one hand, you want to get paid. on the other, if you're going to be
getting paid by a % cut, you don't want your % to be so high that it drives a
new, possibly fragile startup into the ground. if you ask too much too fast
and they die, you'll never get the full total, instead of getting the full
total and possibly more if you were comfortable with a slower rate.

~~~
icey
That makes a ton of sense; thanks for following up. (It seems like pretty good
advice, as well.)

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alrex021
Another question that now comes to mind is dollar vs percentage? Would it be
more beneficial to put flat dollar figure or go with a percentage? Percentage
seems a bit riskier if evaluated against net profit. They could potentially
right off large portion of the income as a cost to company. Especially that
the company is a startup and needs t grow. Just to through another spanner in
the works. :)

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dxjones
With Option C, do they own the IP? If so, what prevents them from cutting you
out of transactions once they are convinced it is working, and they don't need
you anymore?

If you own the IP, then you should think of yourself as a partner. Take a big
enough piece of the action to keep you motivated to work hard on the project,
... but you also want to make sure _their_ piece of the action keeps them
happy and motivated to grow the business (and you get a piece of a growing pie
of transactions).

I don't think you've told us enough to know which rule of thumb to apply.

~~~
frossie
_With Option C, do they own the IP? If so, what prevents them from cutting you
out of transactions once they are convinced it is working, and they don't need
you anymore?_

Presumably a contract!

~~~
alrex021
To confirm. Yes, they are leaning more towards a contract option (outsource)
rather than IP. However they haven't written off the IP option fully yet. (If
strong enough case, I could perhaps still turn this.)

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spoiledtechie
Ask your self how much you want a year.

Lets say 50k a year for your self = Z. So then ask your self how many sales
are expected on the site within a given year = X.

And Y is your amount you should charge per item.

z/x = y. Shoot just a little low unless they are very happy with the idea.
Tell them that over a certain period of time, if X exceeds your personal
number, you will reduce your costs...

Seems fair and if they sell more, you get more... Each party wins.

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vaksel
It really depends on what their profit margin and volume on the product is. If
they make $0 in sales, then you get screwed even if they give 100%

~~~
thebigjc
It should be a % of their gross, not their net. Don't make the mistake of
letting their profit margin determine how much you get paid.

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jonnyw
Be careful. You should either be part of this company or get paid a set fee as
a developer. Any other solution isn't stable. A company can't really survive
with someone else owning its core IP (Option B), nor would they want to keep
paying a perpetual cut for a product that you'll presumably complete/deliver
at some point. If you want to go down Option C, take an equity stake.

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MichaelApproved
Maybe a tiered payment approach would also be good. Keep it cheap for them to
market the system initially then once they get more transactions you can
increase the cut.

