Q: As a start-up founder, what is the best way to develop an equity-based vendor agreement? For example, when working with IT developers, marketing consultants, etc., how can we structure an equity payment plan? What are the norms and best practices?
Bobby Valentine
Co-founder, FitRaise
Sociercise
A: It's no mystery that start-ups are strapped for cash. If you've been through the process of building a Web or mobile application, then you're familiar with the cost of IT development. To bridge the cash gap and get the development needed, entrepreneurs will often "compensate" developers with stock in lieu of a market wage. There are several factors to consider, but the following represents three typical current practices.
My experience and that of many seasoned entrepreneurs suggests that there should be both a cash and stock incentive. In the long, late and difficult hours of writing code, for example, stock will quickly become an uninteresting form of reward. Work output can slow to a snail's pace because the right incentive is not in place. For instance, you may decide to pay a developer $10,000 and give 5 percent equity to deliver 250 hours of work. At a market rate of $85 an hour, that is $21,250 of work for $10,000, plus the equity.
As with any relationship where performance over time is essential, it's important to tie the equity and cash to milestones. At the signing of the contract, you could give an initial payment of $3,500 and 1 percent of the stock. Upon meeting various agreed-upon milestones, additional cash and stock are issued. This puts cash in the developer's pocket, but keeps the incentive in place.
A "scope of work" document must be well refined, clear and agreed upon by all parties. This document describes agreed-upon work, timelines, quality, deliverables, etc. This may sound simple, but in IT development work there are far more trap doors to fall in than I have space in this column to list.
About the author
Alec Johnson is an associate professor of entrepreneurship at the University of St. Thomas Opus College of Business. To tweet questions for the Outside Consultant column, tweet to @USTbusiness.
