Equity share in product not company

thanks for taking the time to read this, any advise is welcomed.

A friend of mine is trying to get launch a new piece of software. As we work well together and he wants to keep initial development costs down he's asked me (as a developer) to assist in creating part of the software. In return he's offering a small share (10%) of the income generated by the product. Whilst this sounds great I have some reservations about the approach.

The product has only ever been at proof of concept stages, and requires significant time to complete.

I will effectively giving up a large amount of spare time, should I be asking for a larger share as i will effectively be like a co-founder? I don't believe much capital has been required to date.

Secondly does having share in a product and not a company make it much more complicated? Is this a common approach?

The specific arrangement can work, you can basically say your getting royalities for your contribution. Same as inventors get royalties for companies using their patented designs to build products.

Typically I have seen values of 5% to 8% per product sold.

DO NOT do on profits. Because profits can be manipulated by accountants, do it on units sold. They sold 1 item for $100, you get paid your $10 end of story.

When should OR shouldn't you do this?

If you are just doing one specific component and are not going to be building and supporting the system long term. Then its a good model because you have a passive income and no risk.

If you are building large slabs of the system and then, ongoing becoming a developer for the new company, then you want to work out a base line set of wages ... You should be going for shares in the company at this point.

IF you want to build a business and invest your time and skill long term then you should be targeting the company.

What to consider

• You want to have the agreement in writing that you are getting royalities per product sale.
• You want this while any of your code still exists in the product.
• This includes sale to a 3rd party entity.
• What happens if they build a new version quickly and discontinue your work? This is where you would have wanted shares in the company.

Summary Royalties are great because you get your money early as possible and without having to worry about all the business risks and issues.

Company shares are great because you get a say in what goes on and you build more than just the product, you have say in your own future and you can build many products over time for the business.

It comes down to what you want to do in the next few years.

To Robin's great (and superior) answer I would add:

Your time and energy is still worth something. Don't sweep it under the bush. Bank the total time and deffer receipt of the total compensation. Allow the deferred compensation to be paid against product sale. I would propose a higher percentage until the balance of your time investment has been paid, and then an ongoing revenue stream after that.

In this way the amount you are owned is posted as a liability against the company. It will give you real legal standing. If at some point the company really grows and they want to capture the revenue they are paying you to fuel the growth-- there will be a debt/equity swap opportunity. if the company goes down, then you will have a vendor lean against the business.

You could go further and post your code as the collateral against your receivable, then if the business goes down you can take the product back as payment and try to re-market it with different partners.

There are tax/legal implications for deferring compensation both for you and the company, so checking with your accountant would be advisable.