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Finishing a product for equity

A friend and I contracted last October-January for a medium size ($40 mill/year) healthcare consulting firm.  We built a Windows application to replace an existing product.  The old product was used internally and had also been sold to a few clients.  The new product was built for internal use and the users like it.  5 weeks after we finished, our manager asked us to come back to commercialize the product for external sale.  We've been back a couple weeks and interviewed a tester last week.  Our manager told us today that the company had a bad first quarter and they need to cut costs, so the tester won't be coming, layoffs are impending and our project may be cancelled.  He asked if we would take a lower rate, but we won't.  We mentioned that we would consider finished the product for a percentage of its sales once it is done.  He hasn't taken that to the CEO yet, but he thinks the CEO will consider it.

Does anyone have experience with something like this?  I'm looking for gotchas, advice, warnings, etc.  My current list of considerations:
1)  They may decide not to bother selling it.  Possible solution: If they make no sales in a year, ownership reverts to us and we can try and sell it ourselves.
2)  What percentage should we get?  And what is it a percentage of?  Answering the second question first, we want a percentage of "top-line" sales (gross revenue, before any costs).
3)  If continuing development doesn't cost them anything, how do we know when we are done?  Possible solution:  There is a healthcare trade show in early May, they are planning on distributing demo cds there, so we can stop development after that if there is no interest.
4)  How will support be handled?  Once the product starts selling, should we be paid for support?  Our manager has been supporting the old project for years and would probably do most of the support for the new project.

Thanks,
Ted

Ted
Thursday, March 20, 2003

Development expenses are chump change compared to the many expenses of releasing a new product - QA, packaging, marketing, technical documentation, advertising, etc among them.


The point is, a contribution of sweat equity in most product environments would make almost no difference in the expense incurred by the sponsoring company in getting that product out to paying customers. And you have no way of compelling the client to ever do anything with the work you produce.


Don't do it, because it's an extremely poor use of your time.  It would eat your time up that could be spent on revenue producing activities. You would be wasting your effort on what will probably end up as never released internal "shelfware" to the client.


I could be wrong, but considering that the overheads listed above are probably several times greater than what you'd save the client in development costs - I would say that if they can afford to market the product, they can CERTAINLY afford to pay developers. The reverse would hold true for each such assertion, too. If they can't afford to pay you, they can't afford to market the thing.

Bored Bystander
Thursday, March 20, 2003

This is a tricky question.

It's almost always a good idea to invest your effort into producing income-generating assets rather than investing your time in just getting a paycheck (if you can get both, by being the owner of an established company, for example), that's especially great.

But investing your time in a _potential_ asset is almost always a waste of time, since the potential assets very rarely turn into real assets.

Back in the days when I used to do web programming full-time, I got offers three times a week from people who wanted me to do work for them in exchange for stock in their company. Not in a million years would I ever take up such an offer, unless it came from a company that already existed and had at least $1 million in revenue on the books for over five years.

Benji Smith
Thursday, March 20, 2003

If I decided to finish the product. I would let the healthcare company act as a reseller or partner and license the finished product to them. You own everything but they act as your sales rep. Then you can get other resellers just like the big boys.

bdw
Thursday, March 20, 2003

If you go ahead with this, you must completely change your relationshp with them so that you are an independent software developer and exercise all management decisions. If they are to contribute any money, get it as instalments against the product - nothing else.

There are all sorts of ways you can get screwed in the situation as it stands. They could just refuse to market it but commission a similar project and claim full ownership.

You seriously need to find an experienced business exec to give you advice. Not a lawyer. A business exec with software experience.

Must be a manager
Thursday, March 20, 2003

Ted: I agree conditionally with the three comments made by others. In order for this to be profitable for you, you must control the relationship and the product, not simply pay in sweat equity and leave the product in someone else's hands to market on an exclusive basis.


However, my initial comment - dont' do it - was based upon your statements that you've developed most of this product under contract. My assumption therefore is that the client will most likely assert control over any potential product that results (since they will own 90+% of it), and therefore the leverage that you could hope to exert will be as small as the portion of deferred compensation that you would be contributing (in relation to the overall developmental cost of the product, and not to mention the expenses needed to sell it.)

I just don't see how it could be made to work as a profitable venture, unless you redeveloped the product as your own nonderivative work.


Or if a miracle occurred and the client "gave" you rights to the existing code base. And why should they do that?

Bored Bystander
Thursday, March 20, 2003

"Not in a million years would I ever take up such an offer, unless it came from a company that already existed and had at least $1 million in revenue on the books for over five years."

Dear sir:
We are a small software company developing a new disk operating system that we like to think will be the Next Big Thing. Our pay rate isn't the greatest, but we anticipate offering you a significant percentage of the company for your efforts. Please respond as soon as possible.
Sincerely,
B. Gates

My point is that working for equity is a gamble. It can pay off big or you can lose. The trick is to hedge your bets:
a) make sure it's an informed decision.
b) work with a known quantity (try to work on a project for pay with the principals to get a feeling for their abilities)
c) Leverage the experience - if the situation folds try to walk away with *something* (resume fodder, new techniques, a new technology under your belt, etc)

And never say never. ;-)

Philo

Philo
Thursday, March 20, 2003

Except that MS was already profitable when it "built" (bought) DOS from all the Basic interpreters it sold, and it actually paid its programmers - admittedly poorly.

If a company won't pay you at all, except in equity, it says a lot about the state of that company. Avoid it like the plague.

Matthew Lock
Thursday, March 20, 2003

In fact thanks to the power of Google here's an advert MS put on Usenet in 1984, showing their package at the time:


Microsoft needs Wizards
...
Like the variety of small startups, Microsoft offers its key technical people stock options.  We can offer technical challenges as good as or better than startups, financial packages ditto, and, since we're > 90% owned by ourselves, we have no outside investors to restrict or
direct our development efforts.

http://groups.google.com/groups?selm=8685%40microsoft.UUCP&oe=UTF-8&output=gplain

Matthew Lock
Thursday, March 20, 2003

Did microsoft really pay poorly at the time? People tend to forget that Bill's dad was one of the most successful bankers on the west coast... Bill had more money in his trust fund (about $10M, if you believe the biographers) than most startups raise in their funding stages. He could have easily paid a small team real wages out of his own pocket...

clipart
Friday, March 21, 2003

I work for a "start-up" that has been a start up for 4 years, but it was spun off, so if someone told you that we have had $1 mil in revenue every year for the last 5 (or even 6), that would, from a certain perspective, be true.

On the other hand, my paycheck is always late, my staff has dwindled from 2 to 0, the company staff has dwindled from 50 to 5, and I'm only here because when they do pay me, its more than the current going rate in my area, and its hard to find a job without taking a steep paycut.

But hey - at my last review (a year and a half ago), I was awarded 30,000 shares (via email, so I can't even use them for toliet paper).

If the dot-bust has taught us anything - never assume that revenue means PROFITABILITY.  I'd rather work for a company with $100 in net profit than one with $1,000,000,000 in revenue and a (continuous) net loss...

Eric K
Friday, March 21, 2003

Thanks to those who responded relevantly.

As Bored Bystander concluded in his second message, I don't think there is any way my partner and I will end up owning this product and having our client sell it as a VAR.  They have paid for all development so far, and will need to pay for testing, marketing and sales going forwards.  We are just considering doing the rest of development in exchange for a percentage of sales of the finished product. 

The company, while having a bad quarter, has been around and profitable for years.  It is not a dotcom.  Giving up 2-3 months pay will not hurt me financially, so the chance for a percentage of sales in the future is tempting. 

Ted

Ted

Ted
Friday, March 21, 2003

Ted, not to beat a dead horse... but what would compel your client to release the program as a resalable product? Right now it is an internal application.  There's a lot of non development work that has to take place in order to sell a program.


My thinking is that worse case, you would be donating free time to polish the client's internal application which never gets marketed.


If you can answer these questions to your satisfaction, then go for it. I'd probably seek some kind of agreement that says that if they don't actively market the product  outside the company within a defined period of time, then IP rights go to you. That would be a fair exchange for your effort.

Bored Bystander
Friday, March 21, 2003

Thanks for your continuing responses.  The client would be motivated to sell the new product by the profit they would make.  Even if my partner and I have 25%, that leaves 75% of revenue for them.  One external customer has already agreed to buy the new product, and several other external customers who are using the old product are eager to upgrade. 

I appreciate your responses, and we will definetely try for ownership transfer if they don't sell within a year, but I can't imagine we will get it.

Ted

Ted
Friday, March 21, 2003

Ted - one other option. Instead of looking for ownership transfer, try to get licensing rights to resell it. They still own it, but you have the right to sell it if they haven't made [x] sales within twelve months from the date of contract signing. (Making the number of sales the criteria prevents you from going to court over whether or not giving a few brochures to the CEO's golf buddies counts as "actively marketing")

Philo

Philo
Friday, March 21, 2003

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