I began work with a small startup last year, working as a consultant. Consulting didn't last long because I saw great potential in the company and made it clear I wanted to be a part of it.
I ended up in a gross profit royalty share with the company. To summarize: I get X% of gross profit for 10 years (which included a short vesting period, since passed). The agreement also included a clause which forces my royalty to be bought out (for "fair value"/independently assessed) in the event of a buyout.
At the time they did not want to give me equity because they were in the midst of a client negotiation and did not want to complicate that negotiation, plus no doubt they had other worries.
A year of full-time work rolls past and we have not made any significant money yet. I am working from my savings. But a big contract is on the horizon that could be worth millions...
I have two worries:
- The royalty agreement is only 3 pages. Neither party wanted to get bogged down in complicated legal frameworks at the time, and in my experience a personally binding relationship (they are good friends) is worth more than any contract. But now with millions on the table I am worried that agreement is not tight enough or tested. I trust them, but things are open to interpretation
- In terms of tax, any royalty I get paid out will be regular income and could potentially come as huge lump sum. So I would lose out big time on tax (i.e. lose ~50%). I am anxious that another remuneration structure could be more tax effective.
Because of this I have recently discussed becoming a shareholder with them, and it turns out they happy for me now to join with them as a shareholder.
So now a new negotiation is on the cards.
- What percentage equity should I get?
- What type of equity?
- What are the pros and cons for me trading royalty for equity?
As far as equity percentage goes, it seems they are willing to offer a 1:1 royalty % for share %. But I am not sure how much each is worth in proportion. One of my friends tells me that gross profit share is worth more than equity.
The other thing they have made clear is they want to give me non-voting shares. Because there are only two shareholders (they each have 50%), if they give me a vote then I will effectively have the balance of power which neither of them want. OK, that seems fair enough for me, but at the same time my understanding is that if someone wants to take control of the company, they could ignore my shares thus bypassing my equity. Once they have control they could do things to make my shares less valuable (or even useless?).
So yeah, I guess I am just looking for some advice on this. Thanks