Can a Software Development Company Be Your Co-Founder?
If you’re like most of today’s startups, an app is a critical part of your journey. But unless you know how to design and build an app, it can cost a lot to have it done professionally: between $100,000 and $500,000
That said, there are a growing number of talented design, development and digital-media shops who may value equity -- and a chance to contributing at making a dent in a market -- over getting another $100 to 500K in revenue via traditional work for hire.
On one side, you’re the budding entrepreneur with a great idea and the hustle to out-execute anyone with a similar idea. On the other side, there are shops that build apps for a living and would love to take a stab at more than just service-based revenue.
Can the two sides work together as partners, not as client and provider? What are the benefits? The risks? What do those who have tried it before have to say about it?
I spoke with experts at a number of software development shops to get their insights on this topic, leaders at DarwinApps, Casual Corp, HappyFunCorp, OAB Studios, Coventure (a VC with its own software development team), and World Accelerator (an accelerator focused on premium domain names). Below is a summary. (You can read the full details of these conversations here.)
How can it work?
Instead of paying a dev shop in cash, you replace that with equity -- or blend the two.
Let’s say that you’re planning for your Minimum Viable Product to cost $250,000 to design and build.
You can take the traditional route of paying for the work to be done -- for example, you raise $200,000 at a $1 million post-money valuation (i.e. you give up 20 percent). Then, you spend that entire $200,000 on paying for product to be built.
The alternative: give up 20 percent to the development shop, in exchange, they will build the product and forego charging you any cash for it. (This example is for comparative purposes; if you were raising outside capital, you’d want to raise more than just what was being spent on product).
Other solutions can include blending cash and equity, or more complicated terms that give the founders or the shop choices between cash or equity in future financing rounds.
Either way, you’d want to stage out the equity vesting. Much in the same way that you wouldn’t pay the entire cash sum at once, you’d want to stagger out equity vesting along key milestones in building the MVP.
What are the benefits?
Most importantly, risks and rewards become further aligned. The dev shop is no longer motivated to simply carry out the statement of work at a minimum quality level. They are motivated to help build the foundation of a successful company.
Additionally, less time, or no time, is focused on (initially) raising money. You can also continue to pair with the dev shop for talent if things go well. (Hiring great talent isn’t easy.)
What are the risks?
You cannot rely on the MVP, or the shop who builds it, to sustain the business forever. An outside VC like my firm ff Venture Capital almost certainly will not. If things go well, you will need to build out your own product team. This risk isn’t any different than paying for a company to build your first product; they’re gone unless you pay them to keep going. This is something that needs to be considered carefully at the start: What happens when the MVP is done? Weigh this decision carefully, in terms of your long term strategy and the vesting structure of the “hire for equity” partners.
Those I consulted on this topic warned that the model is great in theory, but it is very difficult to make it work in practice. Be extremely careful in setting up the working process, the vesting structure and the exit procedures.
The soul of a company is still in its founders. You will have more impact on the long-term success of your company than any shop -- paid in cash or equity -- ever will. Do not rely on outsiders -- paid in cash or equity -- to be the soul.
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