Of course, I’m not a lawyer, but I’ve used this approach and I believe that it should cover most things adequately.
So, let’s say you are starting a new project with some friends and you think that after investing some time and money it will eventually make some money. You’re all friends but you’d also like to stay friends, so you’re looking to come to a simple, fair agreement ahead of time so you can get down to business.
So, what you need is just a simple plan about how to operate that you all agree on and that covers all the major bases. This is it. While verbal agreements are binding contracts in most places (again, IANAL), it’s nice to have a paper trail. Email is good for that. Spell everything out in an email to everyone (or just direct them to this post) and make sure everyone replies saying they agree. Done.
Lots of people think you should immediately rush down to City Hall or the Chamber of Commerce and incorporate and get a company bank account before you do anything. I think all that is just extra work and a distraction from the goal of a project, so I advise avoiding it as long as reasonable. This guide will address many of the things you would have to address when incorporating a company (ownership, funding, salaries, etc) while avoiding the paperwork and costs of one. Score!
Revenue – Expenses = Profit
This is how any business operates, so this is how you should operate. It’s not complicated:
Whenever you get revenue in and you agree to not save the cash for a future expense, pay off any outstanding costs. If there’s any left over, pay it out as profits.
But what’s a cost? Who should get paid first? But I’m going to be spending more time on this than them! Hold your horses, I’m getting to all that.
The table: People x Time & Cash
Make a spreadsheet like this:
Have it in Google Docs. Let everyone update it (don’t worry, there’s a record of changes). That’s all the intra-team book keeping you need to do.
This is actual cash that someone’s had to spent out of pocket as part of the project. Bought a domain name? Needed to rent a car and drive to Milan? Hired a boa constrictor for a children’s party (you crazy person you)? Those all go under Costs. Of course, your 7 day vacation in the Seychelles is not a cost. Costs should be reasonable and/or approved by the group (see later section).
Everyone should record the hours they spend on the project. This is essentially people’s salaries in a company, except we’re paying based upon how much people work and not flat salaries. Everyone’s hours should be valued equally (yes, this is a socialist capitalist enterprise). I like a rate of €100 an hour, since it’s probably pretty generous for most people and if any of your lucky dogs are used to earning more, well, just consider it the price to pay for doing whatever awesome creative project you’re doing.
What to do with revenue
Great, you’ve got some dough coming it! Make it rain! Whether your app is the next Angry Birds or if Cocoa Cola hired you to produce their next global campaign, money is money. Like I said before, first pay off expenses and then take your profit. As for expenses, first pay off cash costs and then hours invested. Why? Because costs directly reduce bank accounts, while hours spent ‘only’ represent opportunity costs (hours you could have spent on normal paid work). So pay off the Costs first.
You may want to wait until the project has finished before settling up if you get a fair bit of money upfront but still have to spend time and will have more costs. On the other hand, if your project is something like an app where you have money coming in over a longer period of time, you may want to regularly make payouts.
If someone doesn’t have anything in the column you’re paying off (like Person 2 under Costs), they don’t get any money until everyone’s costs have been paid and you’ve begun to pay off Hours.
Generally I would pay people off evenly: for instance, if we made $300 I’d pay Person 1 $150 and Person 3 $150. However, it may make sense to pay down someone’s amount before others if it’s out of disproportionally large, e.g. pay all $300 to Person 3. Just do what you agree is fair.
After you’re at zeros in both the Hours and Costs columns, you can now pay out profits. Pay everyone evenly. There’s no point in trying to decide that some people are worth more than others: that just leads to arguments and broken friendships, and the expenses columns already account for people putting in different levels of effort.
If you think that you’re about to have more costs in the future, you can hold off paying profits until after you’ve covered them. Just leave the cash in whatever accounts you’re using, whether people’s individual bank accounts – where they should make sure to account for the group’s money – or in a group account like Holvi.
One option, if you want to keep rewarding people according to what they invest even as you get more and more revenue in is to readjust your common hourly rate. Even €2000 an hour can work if it gives an outcome that you think is fair.
I’ve mentioned a few times to just do what is fair or you want to do. Who decides? Any important decision must be approved by at least 50.1% of the team. 1 person equals 1 vote.
This means that you should rarely have ties and one person can’t hold up everything – this isn’t the US Congress, for god’s sake! At the same time, on small teams a supermajority is usually necessary to have a majority at all, which is a good thing (e.g. on a team of 4, 3 people must be in favor to approve a decision). If you’re stuck then nothing happens, and you just stick to the original plan.
If you find that one person is not holding up their side of the bargin, or if you’re continually the odd man out, it’s time to leave. A person can voluntarily leave (of course) or the remaining team can force them out – again, they need that 50.1% mentioned earlier.
What happens when a person leaves? I’d recommend settling up their Costs and Hours as soon as possible, even at the expense of skipping other people. If that’s not possible, then you owe them the appropriate amounts when possible. As for profits, you owe the person any profits made based upon the project while they were a member.
What does this mean? If you’re making an iPhone app and someone leaves right when you launch the app (and thus before there were any profits), they deserve their equal share of any profits from subsequent app sales, since they were part of the team when it was made. As soon as there is a new version the remaining team doesn’t owe them anything (since of course they’ve already paid off expenses already if they’re paying out profits).
Yes, this means that updates could be quickly rushed out to minimize the profits due to the ex team member. This means that it would be a good idea to negotiate the specifics about the potential profits due someone when they leave. But the principle is that a person profits equally on the portion of the project they were involved in and no more.
I basically said it before. If someone is a problem or isn’t holding up their side of the bargin the other team members can remove them with a sufficient number of votes. Yes, that means that by accepting this way of working you’re accepting that the other team members can remove you if enough of them agree.
No one is indispensable, there are no first-among-equals.
Are you firing on all cylinders but need more people? Found someone that is totally awesome and would make the team better? Then it’s time for a new team member. Just add them to the spreadsheet and you’re good to go.
Since they’re starting with zeroes in their expenses columns they won’t be getting paid before the people who have been slaving away at the project for months and are responsible for the success that’s starting to occur. Simple.
If you’re starting to pay out profits, the usual rules apply: every team member shares equally in profits. Using the iPhone app example again, if you bring on a new person for Version 2, they share in the profits from Version 2 onward but not for Version 1. Of course, they keep sharing in profits until they leave and the things they worked on are no longer making profit.
You may think that this is overly generous to new team members. In that case, just hire them as an outside contracter (ie an expense in the Costs column). If you’re ready to bring them on board as a full team member – and there is no other type! – then you’re ready to share profits with them.
Heck, bump up your hourly rate to avoid profits for a bit in order to reward the original members if it bothers you so much. Don’t try to do various share holdings, this is all about equality. Determining where unequal share ratios tip from fair to unfair is too hard and prone to disagreement. Don’t go there.
The value of the idea
What about intellectual property (IP) and things like that? Generally I would just say that it’s nothing special, and it doesn’t matter who had the idea. At the same time, if someone had the original idea then presumably they spent time developing it and those hours should be included under their time worked in the Hours column.
Still not happy with that? I really wouldn’t recommend going beyond this, but if you really have to have some sort of additional monetary compensation for the person or people who had the original idea, then have that person charge the project royalties (ie this is an additional expense). For instance, 6-10% is apparently the normal rate in the product design world.
As a team at the beginning of your project, decide at what point royalties should be paid. I’d be inclined to pay them after Hours and just before paying out profits. However, if you’re someone that cares that much about royalties then you probably think you should be paid earlier. After Costs and before Hours is acceptable. Don’t put them before Costs, Costs must always be paid off first.
If more than one team member is charging the project royalties then you’re doing it wrong. Presumably what’s happened is that royalties have been used as a backdoor for people to say that they’re more equal than others, and that isn’t allowed. Only one member can charge the project royalties. Naturally you may need to pay royalties to several outside parties and that’s fine (though that doesn’t sound like a good business situation to me).
All this is just to give you a reasonable set of ground rules. If you feel a need to do something different, like pay someone’s hours before other people’s costs because they’re broke and need the money, just do it (provided enough people agree).
The project can end in two ways: either it’s not working, in which everyone decides to move on and you settle up expenses as best as possible according to the methods outlined in this post, or you’ve moved beyond the point of a simple partnership.
If you want to hire people, enter into contracts, all that jazz, then it’s time to incorporate. There’s a time and place for that; the whole point of the mechanisms here is just to enable you to work together as a team as long as possible and only incorporate when it really makes sense and solves a lot of pain points. And remember what I said before, if there’s someone you want to work with but don’t want to make them an equal team member, just hire them as a contractor (a Cost).
Whew, that’s a lot. Hope it helps!