Royalty based partnering agreements

I'm working on defining a partnering agreement to be the technical co-founder on a SaaS startup. The founder/CEO has the experience in the service industry which we are targeting, but found that she wasn't able to get her idea up and running because of her lack of IT knowledge and experience. She's looking to keep 100% equity, and I'm looking for a commitment of less than 5 years, so we think a partnership where I simply get royalties on the company's sales is a good model. Has anyone done a partnership like this and have any ideas of how it might look? What percentage is standard? How does the percentage vary based on whether I personally do the programming vs hiring consultants to write the code & get the product to market faster? Is there generally a time expiration on how long I receive royalties, or does it continue indefinitely?

Any feedback on this type of partnership would be greatly appreciated!

Generally the royalty percentage will increase as your demand for minimum payments or up-front payments decrease.

That is, the more you're willing to risk -- risking that this won't work and you won't get significant royalties -- the more reward you require if the company is indeed successful.

In the limiting case, if you were being paid market-rate for consulting work, you would of course receive no royalties at all!

Royalties are tricky because you're not in control of the price. What if the business owner decides that giving away the product for free for a year is a good idea? Before you say "that's impossible," let's say the owner raises some angel money to do it?

Here's how I would compute it: First decide for yourself what would be a reasonable amount of compensation for doing this for up-front cash without royalty. Then project (I know, almost impossible) company revenues for the next 2 years (i.e. how many customers each month paying how much). Try to take a middle road between conservative and optimistic.

Then what's the royalty percentage on that revenue you need to "break even," meaning match your consultant rate?

Of course that projection is bullshit, but this is at least a ballpark -- if the other person wants something very much different, you have a problem.

Typical deals like this consist of:

• Upfront NRE: Typically some amount of money is put up to start work. If not, then this can effect the royalty stream.
• Pre-Paid Royalty: A pre-paid royalty is usually put in place to entice the person (or persons) to start working. This is in advance of royalties or in lieu of an NRE.
• Royalties: Percentage and time vary a lot. It all depends on the deal and how it's structured. The thing I would do is figure out how much you want to make on this deal and then back out the royalties based on some measurable metric that both of you agree too. It's critical that the royalty basis be measurable and audited.
• Duration: All deals like this have a duration. This duration is how long the royalties or non-compete lasts for. Typically, it's between 3-5 years after the product ships (or makes revenue). Make sure that the duration start is triggered by an event you both agree to and you can start earning royalties on.
• Other Terms: These run the gambit from exclusivity, to royalty buy out to IP ownership.

In your case, I don't think it matters if you do the work or hire. If you are bidding for a job, then the founder/CEO is doing the deal with you and should only care about getting it done.

As for percentages, the only example I recall is hardware related. That is typically 1%-5% of the retail price, depending on the amount of IP involved. Again, I would figure out how much you want to make on the deal and then back out the percentages, etc.

I am not sure I would go with all royalties. You could end up spending a year and getting nothing. Get some kind of salary or retainer at least.

The cap on royalties is done any number of ways. Peter Norton essentially had an endless stream of revenue when he sold out to Symantec.

Other deals do limit by total payout or number of years.

Do what works best for you.

Again, if you are not getting a cut at equity or even options, then how is this any different than just being a salesperson for another company?

When we typically do royalty agreements (Most often to reduce costs, and thus risk) we usually do a cut of around 10-30 percent, along with payments at a discounted rate. (usually 50-75%) Some times we will do a agreement where the general outsourced costs are 100% waived, but picked up on the backside, meaning the outsourced work is paid back at 100%, until such time the debt is clear and their royalty rate adjusts down to 5-30%. We usually do infinite duration on our royalties.

This can work out well in that it can save us lots of upfront funds in a unpredictable hit driven market. Of course we ultimately end up paying out more if the product is a success, but given our royalties are based on essentially net sales income after distribution, packaging, and so forth, even if we are giving away 10-30% we are still making a profit on the actual sale.

We've also found many of our partners to be more vested in the interest and success of the project, as they have the potential to make far more than they would on simple hourly rates alone.