Handing out shares in a startup

skeen08

Hi all,

I am currently employed full time, but I am starting up an web-based venture. I am a software developer by trade, and I am bringing on another software developer to develop the first version of my product with me.

As payment, I am giving said developer 10% of the business.

We had a chat this evening, and we seem to be on a different page with regard to what 10% of the business means.

From my standpoint, it means a 10% share of the company. From his standpoint, it means him getting 10% of the profits, or something like that.

This makes no sense to me, because that would entail that I am taking 90% of the profits, but why would I dilute the company every month or year?

I will, however, pay myself in the form of a salary. I will be the first employee.

The way I want to run the business, is to get out my first version, bring money into the business in the form of profits, and reinvest this money into the business in order to...make more money.

I have other colleagues who are involved, however, I have not assigned them any shares as of yet.

Could someone provide me with some clarity please? Thanks! :beer:

Errata

10% in shares? What is the company capitalised at? 10% of the business? How much is the business worth and how will the 10% be paid, because a business is worth 0p until it's sold or goes to the stock market?
No wonder he's confused.

skeen08

Errata wrote: »

10% in shares? What is the company capitalised at? 10% of the business? How much is the business worth and how will the 10% be paid, because a business is worth 0p until it's sold or goes to the stock market?
No wonder he's confused.

The way I see it, I am giving him a 10% share holding, meaning that if the business sells, he will get 10% of that. It's capitalised at, and worth nothing at this stage.

Is this non-standard? I thought it was quite a simple agreement. He invests a little of his time, and in return, he gets a 10% holding. Clearly I'm missing something...

Errata

It's still not very clear. Do you mean

If the business sells = if the business makes a profit he gets 10% of the gross or net profit
or
If the business sells = he gets 10% of the selling price

Annisele

skeen08 wrote: »

The way I want to run the business, is to get out my first version, bring money into the business in the form of profits, and reinvest this money into the business in order to...make more money.

You don't appear to have an exit strategy (eg a plan to sell your business to a bigger company, or to float, or whatever). Given that, how is your developer going to get any actual money out of his 10% shareholding? It doesn't sound like a very good deal for him.

Software companies very often make no money at all for the first few months or years - until you've actually created a product that people will pay for, all you're doing is burning through cash. So - where is the money going to come from to pay you a salary? Do you have other investors who will expect some sort of return? Bank loans?

skeen08

Annisele wrote: »

You don't appear to have an exit strategy (eg a plan to sell your business to a bigger company, or to float, or whatever). Given that, how is your developer going to get any actual money out of his 10% shareholding? It doesn't sound like a very good deal for him.

Software companies very often make no money at all for the first few months or years - until you've actually created a product that people will pay for, all you're doing is burning through cash. So - where is the money going to come from to pay you a salary? Do you have other investors who will expect some sort of return? Bank loans?

All this developer is doing is helping me to build the first version of the software. I am requiring not more than perhaps 5 days work from him.

From that point, myself and my colleagues will work to build this into a business, and make it profitable.

I'm a little confused - surely it's not as if every time a business makes a profit, all of that profit is divided equally amongst the owners of the company, and the company is diluted of all cash?

How else should I compensate him for his 10% if not through the sale of the company? Clearly I'm still missing something, but I have no idea what!

Surely 10% of a business I am going to be building for years in return for a weeks work is a good deal?

Errata

But it's all hot air. 10% of it at that. The only way you can sell the idea to him is by asking him if he's happy to take a gamble that the 10% will have some value at some unspecified point in the future.
I've assumed you are paying him the going rate for his work alongside the 10% of whatever it turns out to be.

skeen08

Errata wrote: »

But it's all hot air. 10% of it at that. The only way you can sell the idea to him is by asking him if he's happy to take a gamble that the 10% will have some value at some unspecified point in the future.

I'm well aware of hot air - as a developer, I've had lots of "idea men" come to me with an "idea for the next Facebook" in return for X%!

I have formed this idea over 3 years, and I have a solid team behind me. I have offered to pay this developer outright, instead of a share holding...but he wants to take my 10% offer. And yes, he is willing to take a gamble on this. It's an investment, after-all!

So does this kind of agreement make sense? How do I phrase this? Is it a simple share holding?

Horace

I think that you need to speak to an accountant and more importantly speak to a solicitor to get the legalities sorted out.

I wouldnt have offered him 10% of anything - I would have paid him for his time. At the moment the 10% is meaningless because you have no company nor profits and are worth zero. 10% of nothing is nothing.

See an accountant about company formation - they will know what is best and then see a solicitor (one specialising in contract/business law) and get proper legal advice and a proper contract drawn up.

skeen08

Horace wrote: »

I wouldnt have offered him 10% of anything - I would have paid him for his time. At the moment the 10% is meaningless because you have no company nor profits and are worth zero. 10% of nothing is nothing.

Well, assuming this business will go nowhere, I've made a good deal then haven't I? And how is this any different then anyone making an investment in a startup?

The fact is, if he has some ownership of this business, he'll be more inclined to do a good job, and continually contribute in order to bring value to the product.

Is this unheard of...?

See an accountant about company formation - they will know what is best and then see a solicitor (one specialising in contract/business law) and get proper legal advice and a proper contract drawn up.

Yes, certainly. But I have a tough time believing this is a non-standard kind of agreement in this age of internet startups.

Premier_2

skeen08 wrote: »

The way I see it, I am giving him a 10% share holding, meaning that if the business sells, he will get 10% of that. It's capitalised at, and worth nothing at this stage.

Is this non-standard? I thought it was quite a simple agreement. He invests a little of his time, and in return, he gets a 10% holding. Clearly I'm missing something...

You are using a web developer to provide you a service.

You wish to pay him the princely sum of 10% of the business in compensation for the services the web developer is providing you.

By your own admission, the value of your company at present is nil

10% of nothing is ...? :eek: No wonder the web developer wants a different deal.

Even if your company makes a profit in year 1, if you don't declare a dividend then the web developer will still get nothing. Have a look at how long Microsoft traded without ever declaring a dividend. Unlike Microsoft, as you are presumably not a plc, then there may not be a market for the shares even if the company is worth something after 1 year.

The web developer is taking a punt that you will turn a profit in year 1, and wants 10% of that which is very reasonable I would suggest.