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DECEMBER 14, 1999

SMART ANSWERS
By Karen E. Klein

There's More Than One Way to Skin the Compensation Cat at a Startup
Creative partners have more leverage than ever in negotiating attractive terms


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Q: I have been offered a business partnership that would require me to put in the creativity and sweat to obtain a 50% share of virtually nothing. I bring to the equation what is needed to make something. My gut feeling is that the business owner should pay me a signing fee. Can you give me some basics on how to negotiate this?

---- E.P.M., Hillsborough, N.H.

A: Traditionally, if you contributed intangibles such as creativity and hard work, while your partner brought capital and an existing business structure, 50% of the company would be a pretty good deal. A few years or even a few months ago, someone going into a startup wouldn't expect to get half the company, let alone payment up front, unless he or she were bringing something of concrete value to the deal: i.e., software, artwork, patents, or copyrighted material. If you were simply going to work hard and use your expertise to get the company off the ground, you might be hard-pressed to get more than a salary.

In today's business atmosphere, however, the demand for technically skilled, creative people is so high that they can reasonably expect a bonus even from a startup — especially if they're being lured away from stable, high-paying jobs. "It used to be that if a programmer was earning $80,000 a year before, you'd offer him $60,000 and a chance to make $3 million. Now, you offer him $90,000 and the chance for $3 million," says William Victor May, an investment banker and president of Stonemark Business Brokers, based in Seattle.

There's another factor at work here beside the tight labor market. Many startups, especially those in high tech, have cash from venture capitalists, and they can afford to pay more. Still, May recommends that you look at the entire compensation package rather than get stuck on a signing fee. Does the company plan to fast-track toward an initial public offering (IPO)? Will you get bonuses at the various funding rounds along the way? Are the salary, benefits, and potential raises acceptable? Does the company really have a marketable idea, good management, and solid capitalization?

Assuming the answers are "yes" — especially to the latter question — consider the following compensation options, which could prove more beneficial in the long run than an up-front payment and easier to negotiate if the company is putting all its initial investment money into ramping up:

— You could structure an "earn-out," says Chip Austin, co-founder and managing principal of i-Hatch Ventures (www.i-Hatch.com), a New York City-based, early-stage venture-capital fund that focuses on Internet companies. "This is a cash consideration that is guaranteed to be paid out when the first round of funding comes through," Austin says. That might mean you get $50,000 from the first chunk of money that comes in from professional investors as a bonus for contributing your skills toward making the company fundable, he says.

— Another idea is for the company to accrue a pool of money that's paid out to the founders when the company is funded. "The only problem with this idea is that sometimes when sophisticated investors come in, they want to wipe the slate clean of all liens, debts, and credits that the founders have on the company's assets and future cash-flow streams," Austin says. "If they buy 20% of the company for $1 million, they don't want any encumbrances on the company. So there's a risk that that pool of bonus money will evaporate before the founders ever see any of it."

— If the company is really in tight straits financially, and the initial salary offer is low, you can ask to be paid at a higher rate once the first funds come in — retroactive to your hiring date. This kind of deal is more likely to survive VC funding. "Venture capitalists understand that the company has brought in people early on as a way to build up the company to a higher value," Austin says.

Be sure to protect yourself against the risk that you and the company part ways after it picks your brain for expertise and creative ideas. "If you're giving up your job to take this new position, and then they take the information that you bring to the table, and fire you after a short time — or you leave — you may be giving them more than you've been paid for," May says. Negotiate a severance package so that if things don't work out, you'll be fairly compensated for your technical expertise and creative contributions.



Have a question about running your business? Ask our small-business experts. Send us an e-mail at smartanswers@businessweek.com, or write to Smart Answers, BW Online, 6th Floor, 2 Penn Plaza, New York, NY 10121. Please include your real name and phone number in case we need more information; only your initials and city will be printed. Because of the volume of mail, we won't be able to respond to all questions personally.

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