Early stage startup, first customer wants equity?
We have been working with company X to develop our beta. So far, it has been very productive, but no money has exchanged hands and only NDA's have been signed. There was a handshake-level agreement that our product would be tailor made to their exact situation, and they'd be our first customer.
Now that we're closing in on an initial beta release, company X suggests out of the blue that, in order for us to keep working together, they'd want a piece of our company. (No specifics yet, but we're expecting the discussion to be 5-10 points). The equity would be vesting over a few years, and would have no 'privileges' like voting/etc (only value will be at exit). In exchange, they'd continue working with us to develop our core product, be our first paying customers, and also work as our sales team. And, in their, words, "align our interests".
The last part, helping us sell, is compelling to us because we don't have many connections in the industry, whereas the company is multifaceted and deals with many of our potential customers.
The crux of the matter is: if we do go through with such an arrangement, how do we structure such a contract? Company X has assured us that if they don't meet certain 'benchmarks', they'd return our shares. What would these benchmarks look like? For example, is it appropriate to ask that they help us sell to, say, X leads per year? agree to commit to purchase Y licenses per year directly? Help us launch ancillary services? Provide us with access to certain sensitive data?
And, in exchange, what do we offer them, besides developing the services to their needs?
Sorry for rambling on, but all of this is new to us and any insight is appreciated.
13 comments
[ 42.3 ms ] story [ 377 ms ] threadTake it as a compliment that they want your technology very badly to make such an offer. You should try to talk to their competitors immediately to get some validation and try to sell to them at the same time. Never indicate that they are your only customer. If you're a startup, try to win a market. Do not develop bespoke technology for a handful of major players. You will quickly find out that you are beholden to them.
I'd be happy to tell you more of our experience if you'd like (email me)
We've made it clear to them that our complete ownership of the IP is non-negotiable, and they haven't challenged it. That doesn't preclude them from trying something legally clever obviously, but we would get any contracts reviewed by our own lawyers.
The scaring-away of other investors is a strong concern, though we don't plan on raising funding... not sure if a VC would raise eyebrows if 5-10% has already been carved out, even if it were done cleanly.
Also, I'm hoping they won't ask for access to our communications and plans with other customers. That has not come up. Actually we did talk about us selling to their competitors, and they claimed, because they have multiple business arms, a lot of our other customers will also be their customers. It's hard to figure out how true this is.
I'll definitely take you up on your offer after I digest the situation more, thanks!
In the end, in the name of "aligning our interests", they forced us to work exclusively with them, follow their protocols and nothing else, work on a single code base, etc. In the end, everyone was just so frustrated, we decided to ditch it to them instead at a less than stellar expected valuation.
The equity requirement is a version of "if you do it for free, I will tell all my friends about you."
At best, that is an offer to tell all their friends about how you did it for free.
To put it another way, the potential client ran you around in circles instead of being forthright.
Is that who you want to bring on as a partner?
Good luck
From the information provided, it does not appear the potential customer has paid for the value already provided. In fact, the potential customer is now requiring you to pay them.
And your company is over a barrel. In much of the world, 10-20k per year is a small fraction of what a business needs to be sustainable. Even a small consultancy needs between 10x and 100x that turnover to be a minimally viable business.
Outsourcing sales doesn't make it any better because the potential client does not have a significant incentive to go out and sell your product because selling your product is not their primary business. Selling your product is your primary business.
The dependency on outside sales means that your business does not control staffing, pricing, and customer relations.
Why am I pessimistic? Red flags in your potential client's behavior. The behavior is win-lose not win-win. Every piece of it is at your loss and the potential client's gain. None of it is to insure the stability of your business.
Assuming the potential client isn't stupid, that means that their strategy does not require your business to stay in business. The simplest explanation for that strategy is that the potential client doesn't actually need your product or that the potential client expects to acquire your product in whole when your non-viable business liquidates.
I could be wrong. I hope I am. And I admit that I am stupid enough to have come to my conclusions by my own hard and sad experience. I paid the dumb tax to learn to recognize bad clients. I learned human behavior unprofitably. Your experience may be different. Again I hope so. Good luck.
Like the other commenter said, treat this as an incredible compliment. They see the value of your product and want a slice of the pie. Please approach your other potential customers (ie their competitors), and start removing their leverage on you.
Best of luck! Good problems to have!
I run a SAAS and some of our very early customers have become almost a sales person for our company. They recommend us all the time to people they think could be good fit for us and they also are more than happy to be a reference for new prospects. We are happy to give them additional discounts, free customizations (our saas is customizable) etc and keep them happy.
I would focus on making this early customer very happy and keeping the focus on solving their problem. It seems like they are trying to kill 2 birds with 1 stone and that would mess things up. Never mix customer and equity.
There are other problems with this...
1. People who actually have connections and power typically also have money, and understand the rules of investing. Respectfully, I think you're dealing with lower-level people who may not be able to deliver on their promises.
2. Once you start bribing it's never enough. People who extort bribes from you in any form will always ask for more. In my experience, this is rooted both in their greed and desire to conceal their inability to actually add value. Rather than saying... "sorry I can't actually make valuable connections" they will ask for bigger incentives.
3. It will hinder your company long term, other investors and/or clients who become aware that someone got equity for free will then be anchored at free. Be confident, you're worth something.
4. There are rules around this, blame the rules. Laugh it off with them and say unless they are accredited investors individually and/or their company wants to pay $70K for the legal it's a no go. Say this nicely and they may back off. The "shit sandwich" is a great way to deliver bad news like this... say something nice, say no, say something else nice.
5. I handle most the sales for our company and you can take heart that you are probably onto something valuable, congrats. Most people have a logic flaw I exploit as a salesperson that when they want something they want it completely. Humans are very bad at indexing desire, further if you have something unique they can't get anywhere else then you are in charge. That's great, part of what you're going to have to learn is how to get customers excited enough to try/use/buy your product without being so crazed with it they insist on owning it.
6. If you can't beat back people's desire to own a piece of your company stall. Tell them you'd love to have them as a partner but all the legal details would cost a fortune. Make it clear to them that you can't "paper" a deal of any kind without money. This might make it their idea to get you some money.
I hope some/all of that is helpful. Sorry I didn't distill it better. Others may disagree with some or all of this and they are entitled to their view. Best of luck!