20% equity and CTO. (Story and details). Is this fair?

This is a long exposition.

Please bear with me, I think that I need to provide as much specifics as possible, while keeping it as short as possible. Thanks for reading, any feedback is much appreciated.

(I'm using a throwaway account for obvious reasons).

Precedents.

• One year ago I entered this startup as a partial time hire working remotely. A total of six programmers in the project. Four months later I left over disagreements of the development process and the business model.
• April this year. I'm contacted by the owner. The business model is a different one, I'll have full authority on technical matters. Two other programmers in the project. I'll work only for two months full-time, full payment. I accept.

To the current situation

• First month and a half. The new business model is incompatible with the system. I make some suggestions in how to present it to the clients, and I hack* the frontend to meet the minimum requirements asap. The payment is as promised.

(Why a hack? The system is written in a full JEE stack: Struts2, Spring, Hibernate... Very painful and slow to pivot - one of my initial disagreements)

• Some problems arise with a client. The owner can't pay me. I decide to stay and help maybe one more month if this means that the project can succeed.
• Next three months and a half (unsurprisingly, it wasn't one month). More clients start arriving, but their data have some unexpected requirements, and with the existent back-end system is a matter of days to capture only one client's information, and not even all of it.
• I rewrite approximately 70% of the back-end system, new requirements included, capture time is reduced to a tenth, the first clients get (finally) all of their data captured, and this week we are delivering.

So... the owner and I finally come and sit to talk about what happens next in our relationship.

We have talked and we agree in the following:

• The frontend is currently a hack, it delivers, can hold on for a while, but it needs to be rewritten. Soon.
• There is some real potential in the new model. Particularly valuable is the network that the owner has built during the last months.
• Right now he can't pay me for my work during the last three and a half months, so the back-end code belongs to me. All of this has been without any kind of contract, only good faith on both parties.
• Even if he would pay me in this moment my previous work, is almost sure that he won't be able to pay me a full salary in the next months. And any kind of payment will come from sales of the system, not from his money or any investor's money.
• There are no external investors.

Our first talk about a potential partnership as co-owners, has come out with some starting points:

a) 20% for me as co-owner and CTO. 80% for him.

b) He tells me that he doesn't want to be in a Craiglist-like situation (!?). So he wants to include a restriction to prevent me from selling my shares to any third party.

Rationale for a) is that he has been working in this for a year, and my contribution has been for three months and a half. He also spent all his savings when he was trying to starting it (the last months of last year), although with no success.

In b) I think that this is like getting equity without really getting it.

My questions:

1.- With all these facts, do you think a 20% is appropriate? (Taking into account his initial investment and he working on this for a year now). I am under-valuating my contribution? Initially this felt right but while thinking and writing all this I am having second thoughts.

2.- There is some kind of practice that allows you to block completely a "co-owner" to sell her equity, and can you call the person being blocked a "real co-owner"?

These last days I've been getting the feeling that this is a bad deal for me* (maybe a very bad one), but I need some feedback in what would you consider fair and appropriate. I don't want to feel like I'm taking advantage either.

*We are still talking, nothing has been settled yet.

20% is not unreasonable. Let's put it this way: it's significant. You have to decide if the business has serious potential. You should be able to tell, based on the early clients. Do you believe that more customers may be signed up soon, bringing significant revenue and growth?

Regarding the second clause, at least in the US, I would refuse. You could compromise with something called the right of first refusal, which would protect him and still give you the freedom to sell your shares if you want to.

I can't speak to the 20% being fair or not.

The prohibition on you selling your shares is not that uncommon. It is however worded more carefully and with a more limited scope in most case. The owner should also be subject tot he same restrictions you are in this together.

Here are some ways to modify that clause that might make the owner happy:

1. Replace it with a vesting clause, that way you are getting the shares over time and there is no chance of you selling them to a third party right away (The owner should also agree to a vesting clause).
2. Put a time limit on it, you are not allowed to sale your shares until a given date, anything from 1-4 years is reasonable. Ask for the same restriction from the owner.
3. Add in an exception if a majority stake in the company is sold. That way in-case part of the company is sold you are allowed to sell you shares
4. A combination of 1, 2, 3 or 2, 3

Here are good articles on the benefits of vesting founder shares:

http://venturebeat.com/2010/01/04/ask-the-attorney-founder-vesting/ http://startuplawyer.com/incorporation/why-your-startups-founders-stock-should-vest-over-time Hope this helps

The percentage sounds good, but don't get hung up on it. If he controls all of the other terms of the agreement, your 20% can be completely diluted.

You need to negotiate future salary payment, bonus, and/or some kind of payment he can pay. If you aren't going to get paid, maybe you should get paid in additional stock? Nothing will make him find the money to pay you more than you getting additional equity.

Finally, you seem to be holding the entire system together. He has walked after you once before, so he understands how important you are. You have the MOST power now, before you say yes. Once you agree, you lose all of your power. You need to get a good lawyer and think very long about what you want. Time is on your side. The longer you sit it out and think about the offer, the stronger your position gets (within reason).

In the UK there is something about having a minimum of 26% of equity that gives you further rights and security (you'll have to check this as I only know from watching Dragon's Den and they always try to get this amount or more).

Beyond that, ultimately you need to be happy with any deal if it's going to work. And your partner needs to understand that as well. It sounds like you may well being doing a lot more work for little financial reward so I would suggest you seek something higher. Bear in mind though that your partner has put a lot into the business and will of course be reluctant to give away any more of his 'baby'.

Go for 26-29%

Let's say that I'm this owner.

• How much money (and maybe time) did I invest
• How much of your time's worth did you put.
• What are my chances of succeeding with and without you
• Would I like to deal with you on difficult business questions - long term

For your second question, I would check with a smart experienced business lawyer.
Quick unprofessional idea: I would refuse that except if there was an agreement on how to give dividends. He would then have an incentive to buy back your actions at a (previously) fixed price and could not let them cold.

From the facts you present in my opinion it's high time you leave. The fact that there are clients and some cashflow and you haven't seen it is sure indicator that you never will see much, your boss is trying to entice you with a carrot. The business wont move a step forward without you, if not leave I would ask for an equal partnership but even that is a risk of loosing even more time, with no clear capital gains.

Your boss or future partner might not have ill intentions but these are the signs of a classic dreamer a person who is not connected to reality and feels his needs are more important than others.

Here is a framework for figuring out what is fair for your situation.

As far as ownership percentage, if the company were to start today, and you are going to design & build the app, and he is going to bring in customers and investors, then a 50/50 split would be the right way to go.

Since there is already a business going, the value of what has already been built can be compared to the future value. The business has an application concept, some early customers engaged to use / purchase the product, and some other programmers involved. So what has been built thus far might be worth 50% (going to him) and the remaining "future value" would split 50/50. That would be him 75% and you 25%.

Or maybe the future value is 30% him, 30% you, and 40% for future employees. That would look like 65% for him (50% + 30% of 50%), 15% for you (30% of 50%), and 20% for future employees = 100%. Before the future employees are added, your part is 15/(65+15) = 18.75%.

So on the whole, 20% looks reasonable.

You can then ask yourself these questions:

1. What kind of stock are you getting? If you have stock, but you are not allowed to sell it (until when?), then how does the stock have value? There are many ways around the "selling out to a hostile shareholder" problem. You can be allowed to sell up to a portion, say up to 25% of your shares. Or the company (or him) can have right of first refusal at a set price, e.g. $200k (valuing the company at an even $1 million). But it is worth asking how (if ever) he sees the stock being worth something. If this is a consulting company, maybe the plan is to distribute profits as dividends. And what about him? Can he not sell shares either? Maybe if he ever sells shares, you are allowed to sell yours to the same buyer at a pro rata (20/80) split to the same person at your option.
2. How strong is the business really? Getting customers signed up and willing to pay is a big deal, so this should not be undervalued. However if the company does not have any money to pay people, and none of the customers are willing to pay (yet), and all agreements are handshake "try-before-you-buy" deals with no signed contracts or product acceptance terms, then the "business" might not be worth so much relative to its future promise -- especially if you are expected to work for free for an indefinite period.
3. What about the work you've already done? What was the understanding there? Were you doing the work as a favor or was there a promise to pay? If a promise, was that in writing or not, and if not, it should get put in writing in conjunction with the partnership agreement. Or is part fo the 20% for that?
4. What is the time-frame / terms for ever getting paid going forward? Is he getting paid or not? Is he funding the other programmers from his savings? Do you accrue salary that is deferred pending customer revenue? How is customer revenue allocated? If you want to get paid, but he is not getting paid, then you get less stock on account of that.
5. What kind of stock would you get? Part ownership in an LLC? Shares of a C corp? Do you and he get the same type / class of stock? Is either your or his stock vesting? (it is best of all partners have 4-year vesting stock, and any investors will want that if they are smart, but an exception could be made for part representing the company built thus far). Does he foresee ever bringing in investors? Could that money be used to catch up some deferred compensation?

Good luck!

Forget the owner's happy talk about how great the future will be and also ignore the question of percentages. The core question is whether this company is ever going to be worth anything.

You can spend months arguing 20%, 30%, 50% etc but unless you see the company getting product sales quickly and succeeding then you are wasting your time and you will never get paid for past or future work.