We're all familiar with the traditional shared equity arrangements in a startup; Some contribution = Some % of shares (thus equity) in the company, which may or may not payoff down the road at either buyout, acquisition, going public, or some other appropriate exit/stay stage for the investors. We also know that equity can be acquired by the employees in return for services, or a discount on those services.
Rather than offer equity in the company to prospective talent, I'd like to come up with an arrangement where I obtain services in return for a share in future revenues for only the specific products that person actually contributes toward. On the surface, it would appear I'm describing royalties, but I'm fast forwarding a bit and wondering how I might deal with evolving team makeup and ongoing product revisions in such an arrangement, as royalties tend to deal with static products. In our tech world - specifically software - the product is ever evolving.
Anyone have knowledge on an alternative to traditional equity arrangements that is more along the lines of what I'm looking for, or have advice on the subject?
BTW - I have not dismissed entirely the idea that I may ultimately have to carve out company equity in the form of stocks for valuable key talent. I'm just want to consider other creative alternatives.
You will have to convince the prospective employees that you are committed to the product. How can I be sure, if I develop a product for you, that you will invest time and money in marketing, selling and distributing it? You might have a more profitable product you want to sell instead of mine.
Or if I only build part of the product I'll have to believe the rest of the team will also contribute and finish it off, put it in a box and sell it.
A comparable example - I saw a systems integration project get really ugly when one vendor wouldn't finish their deliverable and the customer decided no-one gets paid until it was all completed.
Consider Employee Stock Options. As the employees excercise the option, you can have some aggreement that the company is allowed to buy the shares back if you really don't want them to have ownership. You can require certain vesting periods if your goal is to give them an incentive to stay with the company. The options are not transferable, so you have some protection there.
I guess all of this depends on how the company is structured. There should be some way to have a financial incentive plan similar to this that is tied to the project performance without giving stock.
What you propose may not be a good idea from a tax perspective. If you give employees options or other types of equity, the tax treatment can be favorable. If you pay straight cash to the people, they'll have to pay ordinary income tax rates, which are usually higher.
So I'd expect a lot of resistance to your idea.
To add, I have seen option arrangements by which a set percentage of options vest upon the company meeting revenue or product development threshholds. For example, if the person you want to hire develops a product, the person would get 20% of the options to vest when the product launches, and 20% when it generates $100k in revenues. I'd recommend that approach, which is not commonplace, but it's not unheard-of either.