

Equity in a new startup - brahn

I'm a iPhone/iPad developer by trade. A startup that I knew of was creating a product and service and they asked me to build an iPhone app in May '09. We discussed the requirements, and I signed an SOW that was for a defined set of requirements. I however, went above and beyond those requirements and built something that met those requirements but created a much better UI than the SOW asked for; thinking there would be some compensation for that at a later point. I just completed the app, and the hours i spent were 2X the hours stated in the SOW. I know, my fault but I believe in it. I enjoyed it. That SOW included a convertible note with a value of $7500. My max conversion rate is $4/share as stated in the note. The company's valuation per share was $0.74 in Oct 2010 based on a $150K investment; making the company worth $650K. There were 1M authorized shares, 911,250 outstanding, and 88,750 authorized but not issued.<p>Here are the options I've been given:  1) Convert my note at $2/share, create a second note with a value, conversion rate, and deliverables defined. 2) Convert my note at $2/share, and create a second "contract" that involves profit sharing from app downloads or products sold via the app. I feel that $2/share is very high. Is it too high? Whats reasonable? What can I do from here? Any advice is much appreciated.
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fleitz
You need to sort your stuff out and figure out what you want.

Do you want to build this app because it's fun, do you want to invest in
startups, or do you want to contract for cash?

What it sounds like you have is equity in the school of hard knocks.

The question you need to be asking yourself is: If you had $7500 in cash would
the number 1 thing on your mind be investing in this company? If the answer is
no, then don't convert your note. You can also neglect to convert your note
and take cash. It sounds like you want cash up front.

The company now has $150K in the till, if they can't figure out how to get a
guy who did 2X what they asked for $7500 then it's not a company you want to
be an investor in. Go for a free consult with a lawyer and he'll explain the
options your client is not providing you with.

Lessons learned:

Don't accept payment in convertible notes, accept cash up front.

Don't do 2X the work you're being paid for, talk to the client and get paid
2X.

~~~
brahn
Thanks for your response.

Cash up front wasn't important to me. I was looking more for the longer term
investment: work, take the note and convert it to equity at a low
dollar/share, and hope they get bought out. I guess I feel fairness would be
double the equity that was originally to be given, whether thats with a change
to the firs note, or the creation of a second note. Problem is they don't seem
to be willing to compromise and allowing me to convert my note at a lower rate
than $2/share, since 3.5 months ago shares were $0.74. I just find it hard to
believe the company is worth $2M. I've asked to meet in the middle at
$1.37/share, but not sure that'll fly either. And if it doesn't, it seems my
efforts are futile. Even if they 2X my note to $15K, thats MINIMAL in
comparison to the big picture of things for them; or at least it should be.

I can only get cash if there's another round of investment, which there
may/may not be, correct?

Trust me, lessons have been learned here. I'm trying to figure out my options
now.

~~~
fleitz
Ok, so you only get cash if there is another round of investment, BUT, you can
only convert your equities to cash in the event of another investment.

Doesn't your note specify a payment schedule or is it just lumpsum upon expiry
of the note?

~~~
brahn
Posted below is what the note states exactly, so there's no loss through
translation:

The note will automatically mature and be due and payable five (5) Years (60
months) from the date of this note, with accrued interest at 6%.

Some or all of the entire principal amount of and accrued interest on this
Note shall be, at the option of holder, converted into shares of the Company's
equity securities (the "Units") issued and sold at the close of the Company's
next equity financing yielding gross proceeds to the Company of at least $1
(the "Qualified Financing") equal to the value paid in the offering at said
round of financing. The number of shares of Equity Securities to be issued
upon such conversion shall be equal to the quotient obtained by dividing (i)
the entire principal amount of this Note plus (if applicable) accrued interest
by (ii) 100% of the price per share of the Equity

Securities, rounded to the nearest whole share, and the issuance of such
shares upon such conversion shall be upon the terms and subject to the
conditions applicable to the Qualified Financing.

If Holder has not converted prior to Maturity Date, the Notes shall be
convertible, at the option of the holder and only upon maturity, into common
units at a conversion price of $4 per share.

Holder may also convert, at any time, some or the entire principal amount of
and accrued interest on this Note into shares of the Company's equity
securities (the "Units") at a price agreed upon by Holder and Company. In no
event shall the parties agree to a price that is less than the most recent
closed equity financing price paid. If the parties fail to agree to a
conversion price, Holder shall only convert at the next Qualified Financing or
upon maturity as stated above.

