Need opinions: equity, salaries and risk with partners in a startup

Hi all,

let me give you a brief run down of my case: a couple of other people and I are thinking about creating a technology startup for a niche marketing product. It would involve an initial ~8 month period of research and development which would cost ~$70k, after which we could begin to actually start selling and (hopefully) see income. These other 2 potential partners have the tech know-how required for this project, and I know them to be skilled and capable people in their fields, while I have the running-a-business know-how (I'm a business major).

However I don't like the initial investment proposition they made to me: They want to split shares ~52% for me and 24% for each of them, but since they have no cash to invest they propose I put up the entirety of the R&D investment required in the form of an investor's loan to the company, which would be accruing an yet-to-be-determined-but-fair interest rate until there was income that the company could use to pay me back the loan. Additionally they would both dedicate themselves as technical directors during the R&D phase as a part time job (~4 hours per day each), and would pay themselves wages for this during the ~8 month period. After the R&D period is over, the wages would end, although they'd continue working in the company.

So obviously I don't feel comfortable assuming all the risk (because if the company goes tits-up, there would be little assets left to liquidate) yet getting only half the shares , although I am not opposed to having them paid fair market wages for their work during the duration of the R&D period, given that admittedly I will be doing little during that phase. I'm having my own ideas about a counter offer, and I do want them to have participation in shares in some form because they're needed for the long haul and shares provide a great incentive to give 110%, but I want to hear opinions on what others here would think is fair or workable.
Suggestions please?

I agree with you. They want to have their cake and eat it too.

Equity is for the people who work for free (or at a less-than-industry-standard salary) when there's no guarantee of success. These two people want none of the risk and all of the reward, and it's a deal I'd never do, myself.

Under these conditions, they should be getting no equity at all, or perhaps a small amount in line with what early employees get, which is what they'd be under their proposition. 0.25% to maybe 5% (if you're feeling particularly generous) is fair.

I'd make choose one of a few counterproposals.

First, I might suggest that they quit and work on the project full time, and that you'd then do the investor's loan thing. That ought to cut the time to market in half (or more, depending on how many hours people actually work) and so it reduces the risk for you. Also, they have to take a risk by quitting their jobs, so they'll be forced to be more serious about it. I'd say that since you're putting in all of the financial risk, even though it's their know-how and technical skills, the original equity split is still fair here. (And I'm a technical guy myself.)

Second, I might propose what they were initially proposing, but give them the 0.25-5% equity that is normal for early employees, and explain to them how little risk they're taking if they're still working their day jobs full time and getting paid for their time in the new startup.

For the third option, I'd split up the $70K into salary vs. everything else, and drop the salary component out entirely. If you're building software, that will be most of the costs. (If you're building hardware or something else physical, it may not change that much.) The two could still work full-time elsewhere and work on the startup part time, and not get paid. Under these conditions, it might be more like splitting the equity equally three ways.

In any of these scenarios, you'd have to work out the specifics. The bottom line is that it's hard to do a startup when some of the cofounders are getting paid salary while others are not (or are paying others).

On a slightly unrelated note, 8 months is quite a long time to be working in the dark. You may already be accounting for this, but you want to bring your product/idea into contact with customers as early as possible, even in some sort of beta or MVP state. No idea survives contact with the customer, so the sooner you can do it and start refining your idea and business plan, the better. Don't go 8 months in the dark unless you're planning on at least another 8 months of refinement after that before getting it right and beginning to make real sales.