How to compensate people that contributed code

1. YOU MUST have them first sign a waiver that grants you Ownership + Rights of the code. Why? Because in the future to come, before an investment or acquisition or any other capital distribution, they merely need to send you a letter claiming rights or ownership, and your whole deal is off. You then cannot pass any duo-diligence, and I personally know such a case here in Israel of a guy that helped carve the patents and were not signed on anything - later claiming that he added value into the original patents and claimed for % share of equity. The waiver also needs to say that they were free contractors (not employees), and that they were rewarded for their work (something - even $1).

2. I'd pay them something, or at most give them a letter of intent to grant them options, convertible to stocks in the first Employee Stock Option Plan. I wouldn't give a number because that might backfire later. Don't forget that whatever you do needs to be in line with acceptable corporate governance so that it passes any investor or acquirer duo-diligence. In any case, I would not recommend: a) giving them a liability for handing equity in a company not yet formed. b) giving them equity in a formed company (meaning they are full shareholders, and need to be summoned to meetings, decisions, reports, etc.

My 2cents.

P.S. I'm not a lawyer (although it sound so). I'm an entrepreneur... and I would advise you to consult a lawyer before you sign or grant anything. Best of luck.

The simple solution is to throw out their code and rewrite it.

Funny, as we created FairSoftware exactly for your purpose: with extremely low overhead (about 5 clicks for you, no paperwork, no fee, no nothing else), you can formalize a deal with your other buddies, creating in effect a virtual company with the 3 of you, each with your amount of equity. You could just go for 90% for you and 5% each for the other two.

However, to address your question about what is "fair": the consideration that matters most in business is looking into the future: will you need either of those contributors moving forward? From the sound of your question, I'm guessing not.

I would still assume that you are slightly exaggerating when you say that they contributed 5% each only. 5% is a very low number. Often, lines of code are not the right metric. For instance, someone may have contributed the original idea and never written a line of code.

So let's pretend that it's more like you deserve 75% and they should split the rest? Either way, your best course of action is to talk to them and see how they feel. Really, it's that simple.

They may say: "be our guest, create your company, good luck and mention us if you succeed". Or they could say: "we want 50% of any revenue you make, it was our idea". Or anything in between.

give them either a small amount of equity, or ideally, cash - and make sure you get them to waiver their rights and ownership of the code!

equity is good if you want them involved more, cash is good if that was their only contribution. I'd always go for cash if possible. Its hard to get equity back, and complicates stuff in the future.

Don't give them equity if they're not actively working with you, or interested in launching the business with you (and especially if you're not interested in launching the business with them).

As others mentioned, you'll need to get something in writing granting you ownership of the code. Try to get this by offering to buy them a year's supply of beer, or wash their cars once a week for the next 6 months.

Equity is extremely hard to get back once you give it away, and it's not as cheap as it might seem right now. If you value their contribution right now at 5%, think forward about how much work you'll be putting into the business until you get your first customers, much less until you start generating significant revenue.

Chances are that by then, the business will be drastically different than what you envision now, and I would be shocked if you even have any of the original code left. So what's 5% today is going to be 0.00000005% of your overall effort in building the business over the next year or so. And you probably won't want to be dealing with the hassles of keeping them updated, getting K-1s made, distributing dividends, etc.

I like Brice's suggestion to ditch their code altogether. Don't give them equity if they wrote such a small portion of the code. If you give them cash, they may not be satisfied with the amount if you are really successful. Perhaps give them an opportunity to continue working with you on a salary or contract rate?

If you keep their code, get a written waiver from them, and maybe a cash exchange is included in the signing of that waiver.

If I may ask, have you been continuing your work without their knowledge? Who came up with the original concept?

The answer to those two questions should determine your next step. I would recommend seeing if they want to help with the build-out of the business. Keep in mind that code alone isn't enough to make a business work.

Give theme some percent of future startup, end explain them that you write the most of the code, and the concept wouldn't be realized without your hard work, and now you have all rights for yield or suggest them to implement some other parts of system and involve them further in product or exclude them totally from product, there are no other options, it's not good to combine friendship and business.

I'd avoid giving equity to people who aren't involved in your startup going forward.
The first question you should ask yourself is whether you want those guys as partners. If you do, approach them and offer them that. If they want to be your partners, great - go into business together and there's no trouble (vesting for founders is important though - search for more info on it).
If they don't want to take part in your new venture, then just tell them that you've decided to go into business based on what you've built, and ask as a favor to use their code in it. Worse come to worse, offer to pay them (with money, not equity) once you have some income - value their contribution based on the time they put in - that's pretty easy to figure out, and if this is a class project it can't be much.
Make sure you do all of this in email - you want it in writing as proof that they agreed.
Note that this is an answer from a business, not a legal pov. For legalities consult with a lawyer, but don't make the mistake of letting legal issues determine how you shape the business.

When you give to others its always an investment either in cash or kind or in other ways. The more (in your life) you give, the more you get. I'm not trying to be sentimental but, I have practically experienced it. Always give, you will surely get back if not immediately but, for sure, you will get back.

Though they might have contributed AT MOST 5% but, 5% is worth 5% and you should also consider the ideas that you got, if any, from that 5% code and ideas that you got from discussions, if any, with them.

Equity is a good option. How much? It's very subjective and depends on lot many factors like: 1. though 5%, the code might be crux of the application. 2. may be you couldn't write that 5% code because it required some specialization which is not your strength and reasons like these.

I think you should consult at least 2 competent persons who could evaluate the worth considering above points and other related points. And, do not forget Yafit's points.

It's pretty simple. You don't want to get into the "forgotten founders" situation if you become successful, so you should give them something. Not a controlling interest but some based on their contributions.

The way this is usually done is to have them sign over their IP rights for the founders stock. Any new venture lawyer will be able to help you with the paperwork.

If they don't want to do that, then Brice's idea is a good one. The thing to be careful about is the ownership of the idea. If you file any patents on this idea and your friends did contribute to the idea, then they need to be given credit or the patent could be challenged. Again, a good new venture lawyer will be able to help you sort that out.