

Ask HN: Equity terms don't align; other compensation options? - disposable_me

I&#x27;m a consultant. I&#x27;ve built software for 8 years. Approached ~2 months ago by a friend with a business idea for which he &amp; partners need very complicated software. My quote landed at $200-250K.<p>Met with friend &amp; majority partner (MP) today. MP asked for 50% rate in exchange for 5% equity. So, ~$20K per 1% equity. MP admitted not wanting to pay my quoted price. MP suggests it is an extremely overvalued stake. His version of failure here is 2,000 businesses paying $400&#x2F;mo, totalling just under $10M in annual revenue (times whatever multiple he has in his head for selling at $XXX million).<p>I&#x27;ve learned there are 6-7 partners who already divided up equity. Friend has been promised 30% (divided 3 ways 12.5&#x2F;12.5&#x2F;5 among him, his wife, &amp; a minor partner). MP splitting remaining 70% among 3 or 4 others, unknown distribution. No revenue, no software, etc. MP has ~30 years experience building&#x2F;selling businesses, made millions. MP financing the endeavor. Others putting up $0 &amp; time&#x2F;experience in business, sales, marketing, strategy, etc. Entire strategy is build &amp; sell in 3-5 years.<p>Based on 1% @ ~$20K, friend&#x27;s portion is valued at $600K for giving up $0 &amp; supplying marketing&#x2F;strategy. Other 65% at ~$1.3M. Right? With the offered 5% for 100K, initial valuation of the company--with no clients, revenue, software, anything--to $2M total for 100%. Being soberly realistic, it&#x27;s just an idea that could be wildly successful or mediocre at best. Only individuals discussing cash in the business right now are MP @ ~$100K (paid to me to develop the platform), &amp; me @ $100K in the form of foregoing half my rate as a consultant. That means we should be starting at equal equity since we&#x27;re the ones discussing real money, right?<p>Am I reading this all wrong? I&#x27;ve never taken equity, completely inexperienced in evaluating anything like this.
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mattm
I would dive in deeper as to why MP wants to give away equity so easily
especially if he has made millions. If he really believes the business can
sell for 9 figures in a few years the extra 100k that he would pay you would
be a steal. Maybe he is not as confident as he says he is.

Also, if you are considering this treat it like an investment. You are
essentially investing $100k into the business. You have a right to know the
full details. Ask for the distribution numbers and ask hard questions about
his motivation and get references. Look into what he says to see if he's
reliable. How well does your friend know him?

Have the 7 partners worked together before? Team dynamics are hugely
important.

You will be partners for the next few years. Treat it as if you were getting
married. Don't let yourself be rushed into making a decision.

~~~
disposable_me
Thanks for your reply.

 _I would dive in deeper as to why MP wants to give away equity so easily
especially if he has made millions._

How would you go about this?

 _If he really believes the business can sell for 9 figures in a few years the
extra 100k that he would pay you would be a steal._

I actually said this during our meeting yesterday (which lasted _5 hours_ with
no conclusion). His response was that he simply did not want to pay my full
rate and wasn't considering that as an option. It was a very weird moment.

 _How well does your friend know him? Have the 7 partners worked together
before? Team dynamics are hugely important._

MP is my friend's client, so friend knows MP well as a businessman whom
friend's company services. Friend & 2 partners are all partners in friend's
company, so they work together and have good dynamics. MP and other 3 partners
have all worked on businesses together for last couple of decades.

------
brudgers
Your quote is a tool for screening sales leads.

Keep in mind that a majority partner can structure the sale of a company in
such a way that places their interests beyond those of the other stockholders
- e.g. a majority stockholder can sell the corporation or some or all of its
assets at a discount to another company, including one in which they also hold
a majority interest.

Your friend's partners have an idea that requires complex software and no way
to execute it themselves. This is indicative of a perception that software
development is just a line item expense.

Their objection to your fee is an indication that they perceive cutting
software development costs as good business.

Empirically and despite past events not necessarily determining future events,
the single data point upon which you must make predictions about their future
behavior consists of trying to get you to take a financial hit.

I will add that if they cannot afford the $250,000 it will cost to execute the
software portion of their idea, they are _ipso facto_ undercapitalized. This
may indicate that they are undercapitalized in other key areas.

To put it another way, would you ordinarily take a contract where $100,000 was
not payable for three to five years and only payable if the company was still
around?

My advice:

\+ If you're a consultant, run a consulting business. I've never read anything
on HN about a one-man band getting rich by taking equity in lieu of consulting
fees. Not that I'm saying it hasn't happened, only that it doesn't appear to
happen often.

\+ If you're an entrepreneur, be an entrepreneur. Pick your co-founders
carefully. Build a business you understand and control.

\+ Don't confuse the two.

Basically the deal you are being offered is you pay $100,000 to someone who
doesn't want to pay you now, on the expectation that at some nebulous time in
the future they might want to pay you a big pile of money.

~~~
disposable_me
Thank you for your reply. You make many good points.

 _If you 're a consultant ..._

I like being a consultant. I don't particularly have any latent strong
interest in being an entrepreneur. Do I sometimes think it'd be fun/cool to
build something that winds up being worth millions? Sure, we all probably do.
But it doesn't really drive me. I enjoy picking up projects, building new
things, and then moving on.

 _To put it another way, would you ordinarily take a contract where $100,000
was not payable for three to five years and only payable if the company was
still around?_

Absolutely not.

 _Basically the deal you are being offered is you pay $100,000 to someone who
doesn 't want to pay you now, on the expectation that at some nebulous time in
the future they might want to pay you a big pile of money._

That's how it feels, yes.

------
onion2k
You're suggesting that the only things that will make the business a success
are the financial and technology aspects. In my experience that's not the case
_at all_. Money and tech are important, but the marketing and strategy are
equally, if not more, important. You can build the best tech in the world, but
without marketing and sales to get it to customers it's worth zero. Don't be
so quick to discount your friend's marketing/strategy input.

As for the $100k you'd be losing, it's an opportunity cost of doing this
startup. As far as the other people involved are concerned it's not relevant
to them, so there's no reason why they should compensate you for it. After
all, you might have an offer to work for the next year at $100,000,000 - would
that mean they need to be offering you more equity because you'd be giving
that up? No. The value you represent to the startup doesn't change. You alone
have to work out whether or not the deal on the table is enough compensation
for what you'll 'lose'. If it's not enough compared to what you could get
elsewhere renegotiate or turn the deal down, but don't expect them to
'overpay' (in their mind) for what you'll bring to the table simply because of
what you could earn somewhere else.

All that said though, it seems odd to me that the group have left so little
equity for the technical founder. Do they actually understand what they're
getting in to?

~~~
disposable_me
Thanks for your reply. It was difficult to limit explanation to 2000 chars, so
a lot of my thinking/feeling was left out.

 _You 're suggesting that the only things that will make the business a
success are the financial and technology aspects. In my experience that's not
the case at all. Money and tech are important, but the marketing and strategy
are equally, if not more, important. You can build the best tech in the world,
but without marketing and sales to get it to customers it's worth zero. Don't
be so quick to discount your friend's marketing/strategy input._

I'm not at all suggesting, even to myself, the financial & tech aspects are
the only things that will make it a success. I'm certainly not discounting my
friend's marketing/strategy input. What his company, as the 30% holder, brings
to the table is largely the _deliverable_ of this endeavor--it just can't be
brought profitably (in their minds) without the tech that automates as much as
possible, which has turned into a lot of complexity. I was only trying to
question if the tech input being valued at 5% was out of line (and included
the 30% figure of my friend's pre-existing stake because it's the only number
I know). At least, that's why I posted here, but I'll be sure to further check
my assumptions to ensure I'm not mentally undervaluing others' contributions
(I don't think I am, but it's difficult to express that within 2000 chars).

What I could not express in 2000 chars was that there appears to be a strong
resistance, by MP, my friend, and the others who have already been established
as partners to give up as little equity as possible (because they've already
divided it up and are happy with their own numbers) while also wanting to
drive down the cost of software as much as possible. It's difficult to express
how that resistance is communicated, but I feel it rather strongly in
conversation with both my friend and MP.

Anyway, thanks for taking the time to respond.

------
hcho
"Halve the offer and start negotiating under that number" is quite a common
approach to transactions involving rarely traded items. Your counter party is
signalling you that he never dealt with a software developer before. You are a
rarely traded item to him and he's trying to twist your arm.

Working with people who don't know about software and appreciate the effort
that goes into it is never a good idea.

------
alain94040
Do you trust these people (and especially the MP)? I'm always suspicious when
I hear about startups with many partners, none of them apparently doing
anything. Who are those 6+ people and why are they on board? What value do
they bring? I'm also suspicious when wives get shares.

That being said, you are using the wrong metrics: 1% @ $20K is not what you
should focus on. Neither is your argument to split equally, your $100K
discount is not real cash you are putting in.

What happens in a year when your software is not finished, do you continue to
develop and improve it for free, or do you send a new quote? That will tell
you whether you consider yourself a founder or a consultant. I'm guessing you
feel like a consultant.

~~~
disposable_me
I trust my friend as a friend, but I've never done business with him. MP is,
before this began, my friend's client. My friend trusts MP. Therefore, I'm
extending a lot of trust for MP through my friend's professional relationship
with him. I do not know MP well enough to have developed significant feeling
of trust or mistrust on my own.

The pre-existing 6-7 partners is what has made me suspicious to begin with,
which prompted my post here. But they aren't doing nothing _per se_.

\- My friend and his company (3 partners), the 30% holders, are bringing
content/marketing/strategy not just to the company, but also as a primary
_deliverable_ of the company to its potential clients. \- The other 4 partners
are apparently bringing their own combined years of experience building &
scaling (non-technical) businesses. They are going to be focused on building &
managing a _human salesforce_ that will expand the reach of the business to
get its services in as many business hands as possible. They comprise the
other 70% equity holding at an unknown distribution.

 _That being said, you are using the wrong metrics_

What are the right metrics? That's why I've posted the question. I'm not sure
what the right metrics are. This is new territory for me. That said, I do
disagree that the $100K discount is not real cash. MP has made it clear he
does not want to pay my full rate, and wants me to exchange half that rate for
a small equity stake. It strikes me as no different from being paid my full
rate and turning around and handing half of it back to the company to purchase
a stake. But I could be wrong in that assessment (which, again, is why I've
posted the question to see things properly).

 _What happens in a year when your software is not finished, do you continue
to develop and improve it for free, or do you send a new quote?_

In a year, if there is more work to be done, I believe I'd be expected to do
the work without a quote. They express wanting to have me feel
committed/invested/responsible to the company & the tech.

------
fsk
$100k for 5% implies a valuation of $2M. Is the business (with no customers
and no product) worth $2M RIGHT NOW?

But it isn't 5%. If it's typical 4 year vesting 1 year cliff, you can be fired
after 11 months or 2 years.

You will be diluted when they raise money. As a minority shareholder, there
are too many ways to be diluted. For example, your shares have no liquidation
preference, but shares from investors usually have a liquidation preference.
So you're in a worse spot than a typical angel investing $100k cash.

