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royalty model formula

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I'm starting a project and want to dispense royalties to all who helped based on how muchtime they contributed but I don't know what the formula would be to put on a contract. What I want to do is have contracts that would be sent to team members every three months stating that they have been on the team for that period of time. So the royalties should be divided up based on number of team members and time contributed. What would the formula be for something like this... say the project took six months to complete with 4 people working on it. But 2 people only worked on it for 3 months so they should get royalties of 12.5% while the people who worked for the complete six months would get royalties of 37.5%. What would the formula be for something like this? I thought I thought time divided by number of members times time contributed would work but that only works for people who worked for the minimal amount of time.

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You said put on a contract. A contract is a legal issue. Like all other legal issues, talk to a lawyer. The moment you and somebody else agree to a legally binding contract, both of you have to live with the potential legal consequences.



That being said, you can use whatever model you want.

There is a difficulty with using "time they have been on the team", in that different people contribute different amounts to the project and in different amounts of time.

One common method is shares. If you form a legal business (S-Corp, C-Corp, or LLC) you can easily use those as partial ownership of your company. With that model you can be more flexible about how and when payments affect ownership.

Every unit of work that is done gets a share. If one developer ends up doing the brunt of the work with 12953 shares, and another puts in 2493 shares, and your artist ends up with 9876 shares, you would just add it up and divide:

12963 + 2493 + 9875 = 25331 total shares
$150 total sales = 0.59216 cents per share.

Developer 1 gets 76.76
Developer 2 gets 14.76
Artist gets 58.48


Be very careful about how you define a unit of work. Is design time included? Is management time included? Are program modules counted in lines of code, or conceptual units done, or time spent? Are defects and bugs included, perhaps as a negative share? How much artwork is a unit? Who verifies the work units? Who tracks them? How do you handle a dispute? How do you handle somebody leaving the group? How do you handle natural problems like lost source code? How do you ...

Since you are using an actual contract, you will want to have a lawyer review with you in detail every aspect of the deal.

Later on you can adjust your model. Perhaps the original founders get 1.2 shares, or a newcomer gets 0.9 units. Perhaps people who left the team continue to get a ever-shrinking percentage of their full count of shares. Perhaps people can cash out all of their ownership rather than distributing profit, or keep the profit inside the company to purchase additional shares.

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Quick comment;

I really wouldn't advice giving out shares like that.

1) You'll scatter your shareholders, making things like holding an AGM difficult
2) Anyone looking to purchase your company will look at 200 mini-investors, and run away screaming.
3) You're setting yourself up for grief down the road because you dillute the control of the company (what happens when one of the level-designers with a grudget against you and a Boston Legal fetish decides to challenge you for control of the company, by convincing his friends to vote for him?)
4) Any commercial company dealing with you will perceive a system like that as potentially unstable. Unstable == risk == bad.

A better method is often the 'ship-share' model.

Each month you give out a pre-arranged number of shares for each person working on the project that month (by default, one person, one share, but if for example you bring in someone experienced as a fulltime lead, you could offer him 2.5 shares, for example). I don't think you need to resend a contract on that, as long as it's stated in the original contract. Notify everyone by email each month.

At the end of the project, when you're starting to see revenue (hopefully), each persons share becomes:

(Total Revenue - Costs) x (#personal shares / #total shares issued).

Nice and clean, and keeps the legal control (and responsibility) with the founders (who own the company, usually split equal ways).

Allan

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Our OP should read everything from this and other discussions, read other advice online, and then go visit with a lawyer. Hopefully we both agree on that point.


To give a clearer posting, I'm going to move some of your sequentially points around a little bit.

Quote:
Original post by __ODIN__
I really wouldn't advice giving out shares like that.


Performance shares are a common, well known, and studied out solution to the question he asked. Perhaps I didn't add enough emphasis it enough in my earlier post: shares don't need to be used exclusively for splitting up equity, and can just as easily be used for profit sharing as I described it above. When $150 is split up, it is send out based on performance rather than time with the group or with what job title you have. Again, shares don't necessarily mean that the total equity of the company is split up.

Quote:
Original post by __ODIN__
3) You're setting yourself up for grief down the road because you dillute the control of the company (what happens when one of the level-designers with a grudget against you and a Boston Legal fetish decides to challenge you for control of the company, by convincing his friends to vote for him?)
4) Any commercial company dealing with you will perceive a system like that as potentially unstable. Unstable == risk == bad.
True, it is possible to let that happen. But it certainly isn't a requirement. I am against the idea of surrendering control without thinking, and it sounds like you are as well.


Quote:
Original post by __ODIN__
1) You'll scatter your shareholders...
2) Anyone looking to purchase your company...

Not at all.

First, as I mentioned, performance shares are not equity shares. You can use performance shares to help decide how to split up equity, if that's what the owner wants. Or you can use them for profit sharing. Or you can use them to hand out tickets in the company raffle.

Second, distributing the equity among a group of workers is very common. In corporations it is called "preferred stock", in LLCs it is called "membership shares". Distributed equity is very common in business, representing about 30% (see below) of all companies. Done properly, your shareholders are not scattered, and anyone looking to buy the company will see that you are mindful about business practices and record keeping --- Or clearly see that you were careless about them if you do it poorly.



Quote:
This question was never asked.

So why not use the fixed rate shares based on time or job title?

Don't the people who have been there longer and are in more responsible positions DESERVE more?

Shouldn't the people who have been there for 3 months earn 12.5% while those who were there from the beginning get 37.5?

Doesn't the CEO deserve to be paid for a half hour of golf the same amount that a sweating laborer earns in a year?


Fixed rate groups of shares and options have a ton of well-known problems. (Google for papers by economists like Rick Harbaugh, D.L. Kruse, and M.L. Weitzman.) The person who is awarded with the 2.5 rate for the month gets it regardless of the actual work they perform, and have no incentive to perform better than the 1.0 or the 0.8 rate people. In fact, the 2.5 rate individual has an incentive to work less and do low quality work. The fixed 2.5 rate person wants to have fewer people around since it reduces the relative amount they get, which in turn decreases the gross and net returns across the board. They have a huge incentive to just 'lay low', do enough to keep and earn more shares for the minimum amount of work --- let other people do the work and redirect the rewards.

Performance shares directly reward the people who do a lot of work (they get a bigger slice of the pie) and force the old-timers to keep working rather than resting on their laurels and collect an overly large portion of the newcomers' due.

Slightly increasing the benefit from performance for the old players offers most of both worlds. They have to earn the benefit based on performance so a newcomer can compete or surpass them in terms of payments. But the slightly larger portions they are able to earn reflect that their history is important to the company.

Quote:
Original post by __ODIN__
A better method is often the 'ship-share' model.

Your "ship-share model" is something I searched for several ways and could not find. Do have some references? If it is often the preferred method as you claim, why can I not find out any information about it?

What you describe sounds like it is the same old fixed option compensation model. Those in the know try to find a gig that will offer in this case 2.5x the benefit of other work, put in less work, and wait for the company's proverbial ship to come in. Except it sounds like every month you are shuffling the person who gets the 2.5x rate.

Quote:
Original post by __ODIN__
At the end of the project, when you're starting to see revenue (hopefully), each persons share becomes:

(Total Revenue - Costs) x (#personal shares / #total shares issued).

That's how profit sharing generally work, yes. Except you forgot to subtract out "reserves", which is used for growth and continued viability of the company.

Quote:
Original post by __ODIN__
Nice and clean, and keeps the legal control (and responsibility) with the founders (who own the company, usually split equal ways).

Equally split equity is not usual. It is only found in about 3% of businesses.

The most common is all equity held by the one sole proprietor. ADP's December 2005 blurbs said that roughly 70% of all American businesses are sole proprietorships.

The SECOND most common is a limited partnership, where one or more person gets most of the rewards and most of the risk, and the limited partners do not. These are normally when a sole proprietor is looking for money from investors. This is a natural evolution from the most common form given above.

The THIRD most common business model at about 8% of all businesses is the general partnership, which is what you mentioned above. Among those, the majority of them (about 35%) are 50/50 split.

The big problem With a 50/50 partnership is what happens when things go bad. If the partners get into a fight and one wants out, it can require a court order to dissolve the company and let them out. A 51/49 is much better because it doesn't force the company to dissolve when the equal partners disagree; when it includes a simple mutual buy-out clause and dissolution trigger clauses, an unequal partnership is the way to go.


As always, take this and other business advice with liberal amounts of salt. Nobody else knows the details of your business like you do.

-frob

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