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Early stage startup, first customer wants equity?
12 points by wheresmycraisin 15 days ago | hide | past | web | favorite | 13 comments
We're a team of 2 building a SaaS service for a niche industry. The product/service is subscription-based SaaS -- we have hopes of charging $10k-$20k per year. (We've validated this price-range). We've not taken any funding from anyone, but both have savings to last for a while.

We have been working with company X to develop our beta. So far, it has been very productive, but no money has exchanged hands and only NDA's have been signed. There was a handshake-level agreement that our product would be tailor made to their exact situation, and they'd be our first customer.

Now that we're closing in on an initial beta release, company X suggests out of the blue that, in order for us to keep working together, they'd want a piece of our company. (No specifics yet, but we're expecting the discussion to be 5-10 points). The equity would be vesting over a few years, and would have no 'privileges' like voting/etc (only value will be at exit). In exchange, they'd continue working with us to develop our core product, be our first paying customers, and also work as our sales team. And, in their, words, "align our interests".

The last part, helping us sell, is compelling to us because we don't have many connections in the industry, whereas the company is multifaceted and deals with many of our potential customers.

The crux of the matter is: if we do go through with such an arrangement, how do we structure such a contract? Company X has assured us that if they don't meet certain 'benchmarks', they'd return our shares. What would these benchmarks look like? For example, is it appropriate to ask that they help us sell to, say, X leads per year? agree to commit to purchase Y licenses per year directly? Help us launch ancillary services? Provide us with access to certain sensitive data?

And, in exchange, what do we offer them, besides developing the services to their needs?

Sorry for rambling on, but all of this is new to us and any insight is appreciated.

My startup was offered this by a very well known large enterprise. We said no because they would have insight on what we do with our other customers (their competitors). We sought the council of several lawyers and law firms in the valley and every single one told us to walk away immediately. An infant startup should do whatever it takes to keep the legalities as clean as possible. If your situation was similar to ours, your customer is bound to try to put IP ownership language in the contract. If you are seeking future investment, this can quickly make potential investors run away.

Take it as a compliment that they want your technology very badly to make such an offer. You should try to talk to their competitors immediately to get some validation and try to sell to them at the same time. Never indicate that they are your only customer. If you're a startup, try to win a market. Do not develop bespoke technology for a handful of major players. You will quickly find out that you are beholden to them.

I'd be happy to tell you more of our experience if you'd like (email me)

Thanks for your response. Yes, I didn't really want to be thinking about complicating the legal structure this early.

We've made it clear to them that our complete ownership of the IP is non-negotiable, and they haven't challenged it. That doesn't preclude them from trying something legally clever obviously, but we would get any contracts reviewed by our own lawyers.

The scaring-away of other investors is a strong concern, though we don't plan on raising funding... not sure if a VC would raise eyebrows if 5-10% has already been carved out, even if it were done cleanly.

Also, I'm hoping they won't ask for access to our communications and plans with other customers. That has not come up. Actually we did talk about us selling to their competitors, and they claimed, because they have multiple business arms, a lot of our other customers will also be their customers. It's hard to figure out how true this is.

I'll definitely take you up on your offer after I digest the situation more, thanks!

The top paragraph is really good advice that I would have appreciated back in the day we were starting up (at my former startup).

In the end, in the name of "aligning our interests", they forced us to work exclusively with them, follow their protocols and nothing else, work on a single code base, etc. In the end, everyone was just so frustrated, we decided to ditch it to them instead at a less than stellar expected valuation.

That's an interesting scenario. Does the well known large enterprise have a venture arm? We see a plethora of corporate venture firms who are intrigued by what we're working on. For us to work with them to get access to a larger customer base seems appealing but I wonder if it would create issues later down the line.

A late response. They do not have a corporate venture arm.

"Thank you for your offer. We are not looking to sell any portion of the company at this time. However, in order to further align our interests, after your successful onboarding with the beta release we are willing to consider offering a commission to your sales team for new customers."

This. Interests cannot be aligned if they get equity. That changes the game completely.

I run a SAAS and some of our very early customers have become almost a sales person for our company. They recommend us all the time to people they think could be good fit for us and they also are more than happy to be a reference for new prospects. We are happy to give them additional discounts, free customizations (our saas is customizable) etc and keep them happy.

I would focus on making this early customer very happy and keeping the focus on solving their problem. It seems like they are trying to kill 2 birds with 1 stone and that would mess things up. Never mix customer and equity.

This is the best way to go. They are completely changing the initial agreement. Offering them a commission on sales their team makes aligns better with your initial handshake agreement.

If they are not paying you they are not a customer.

The equity requirement is a version of "if you do it for free, I will tell all my friends about you."

At best, that is an offer to tell all their friends about how you did it for free.

To put it another way, the potential client ran you around in circles instead of being forthright.

Is that who you want to bring on as a partner?

Good luck

I don't know why you are so pessimistic, they are going to pay our standard annual fee once out of beta. It would not benefit them to spent so much time helping us develop things to their spec and not be able to use it.

Ordinarily, companies pay for someone to develop software bespoke to their needs. They hire consultants to do it. Hell, ordinarily companies pay consultants just for the process of figuring out what the needs are, never mind the solution.

From the information provided, it does not appear the potential customer has paid for the value already provided. In fact, the potential customer is now requiring you to pay them.

And your company is over a barrel. In much of the world, 10-20k per year is a small fraction of what a business needs to be sustainable. Even a small consultancy needs between 10x and 100x that turnover to be a minimally viable business.

Outsourcing sales doesn't make it any better because the potential client does not have a significant incentive to go out and sell your product because selling your product is not their primary business. Selling your product is your primary business.

The dependency on outside sales means that your business does not control staffing, pricing, and customer relations.

Why am I pessimistic? Red flags in your potential client's behavior. The behavior is win-lose not win-win. Every piece of it is at your loss and the potential client's gain. None of it is to insure the stability of your business.

Assuming the potential client isn't stupid, that means that their strategy does not require your business to stay in business. The simplest explanation for that strategy is that the potential client doesn't actually need your product or that the potential client expects to acquire your product in whole when your non-viable business liquidates.

I could be wrong. I hope I am. And I admit that I am stupid enough to have come to my conclusions by my own hard and sad experience. I paid the dumb tax to learn to recognize bad clients. I learned human behavior unprofitably. Your experience may be different. Again I hope so. Good luck.

I'd stay far away from company X. If they are randomly trying to change the deal out of the blue, would you want to be in a deeper relationship with them?

Like the other commenter said, treat this as an incredible compliment. They see the value of your product and want a slice of the pie. Please approach your other potential customers (ie their competitors), and start removing their leverage on you.

Best of luck! Good problems to have!

I feel for you, that's an unfortunate situation. We are around that price point and selling into a niche industry and also got these types of offers/demands earlier in our journey. I am very thankful we declined them although they were tempting. Part of building a company is building a customer acquisition process that is repeatable and scalable and bribery doesn't qualify. If you build a product without a repeatable and scalable sales system you will fail. If anything the customer acquisition is more important than the product. This is why companies like Dropbox famously faked the product demo video, got a big waitlist of customers and then made the product. You can solve just about any problem a company has so long as it has scalable + repeatable system for profitable customer acquisition.

There are other problems with this...

1. People who actually have connections and power typically also have money, and understand the rules of investing. Respectfully, I think you're dealing with lower-level people who may not be able to deliver on their promises.

2. Once you start bribing it's never enough. People who extort bribes from you in any form will always ask for more. In my experience, this is rooted both in their greed and desire to conceal their inability to actually add value. Rather than saying... "sorry I can't actually make valuable connections" they will ask for bigger incentives.

3. It will hinder your company long term, other investors and/or clients who become aware that someone got equity for free will then be anchored at free. Be confident, you're worth something.

4. There are rules around this, blame the rules. Laugh it off with them and say unless they are accredited investors individually and/or their company wants to pay $70K for the legal it's a no go. Say this nicely and they may back off. The "shit sandwich" is a great way to deliver bad news like this... say something nice, say no, say something else nice.

5. I handle most the sales for our company and you can take heart that you are probably onto something valuable, congrats. Most people have a logic flaw I exploit as a salesperson that when they want something they want it completely. Humans are very bad at indexing desire, further if you have something unique they can't get anywhere else then you are in charge. That's great, part of what you're going to have to learn is how to get customers excited enough to try/use/buy your product without being so crazed with it they insist on owning it.

6. If you can't beat back people's desire to own a piece of your company stall. Tell them you'd love to have them as a partner but all the legal details would cost a fortune. Make it clear to them that you can't "paper" a deal of any kind without money. This might make it their idea to get you some money.

I hope some/all of that is helpful. Sorry I didn't distill it better. Others may disagree with some or all of this and they are entitled to their view. Best of luck!

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