Is it better to have a formal contract on ownership prior to accepting external investment?

In a nutshell is it better to have a formal contract in place stating exactly what we each get (from equity standpoint), before there is any investing?

Well, I do not trust anybody if it is around money. People - even in family - are sometimes doing very nasty shit when it comes to money. I bet you could go to a lawyer when it comes to a situation they kick you out. But this costs money, time and nerves.

I have made the experience that it is no problem for serious people to say what they want and sign this on a sheet of paper. Only people who are not serious on their decision are afraid to put something on paper.

If your business partners say: "Hey all cool, lets do some money and share afterwards" it could easily be like: programmers are exchangable, you get 10%, we the rest. Who knows? Better discuss now before you have the trouble later.

If your partners cannot disucss that with you in a proper and fair way, how can you trust them to discuss with other business partners later?

Other people may have other opinions, but I would never partner up without making things clear. Except if it is for charity or if it is -really- small stuff.

While I would recommend hammering out a contract among the co-founders asap before delving into business matters, the risk is actually more on your partners than on you. Why? The code is written by you (and therefore protected by copyright) so you are holding the cards, so long as you don't accidentally give away the rights to your code by signing some unfavorable contract.

• If it is a legit business ventrue get the contractual stuff out of the way early

You don't want any confusion, and once people see that it's viable they will often become more greedy. You will also want to protect yourself by setting up some type of expectations from the partners. I've seen 3 people go into business together where the accounting person didn't have to really do anything except file some quarterly taxes yet was reaping the rewards and it didn't make the other two partners very happy.

Not assigning equity until you get funding would a be major mistake. For one, there is a serious tax issue: you won't be able to issue cheap stock just before a financing event, so most founders won't even be able to buy the stock they deserve (even when issuing common vs. preferred).

And then there are so many issues about conflicts between co-founders and who owns what, IP assignments... My recommendation is to formally incorporate within a month of work having started when there are more than one founder.

A vesting schedule that awards each of you based on milestones and performance would be a better solution. Just make sure that you clearly outline how the equity will be calculated.