The article, "Should You Give Away Equity to Build Your App?", by Jennifer Marsh was originally published on Designli's blog and been republished below with permission.
Equity as a replacement for high-priced development is a tempting proposal for a new app owner with a small budget. Some developers – freelancers, especially – will give you an estimate on costs and offer to decrease that cost in exchange for equity. The problem is that equity can be a much higher cost than upfront development fees once you look at the big picture.
So…should you give away equity to build your app?
The answer is “it depends.” Every idea and startup has its own unique factors when it comes to making decisions on equity and costs. There is no black and white answer, but you can take these considerations into account as you determine if equity is a suitable solutions for your budget and development costs.
What Deal Does the Developer Want?
Some developers will offer you an equity deal when you don’t even ask for it. You should be careful with these types of estimates, because often the developer will inflate the costs to make the equity deal more attractive. It’s good that the developer sees your idea as a valuable, worthwhile venture but this type of deal is an immediate red flag for the app owner.
Usually, this means the app is still in its idea stage, so it isn’t worth much at this state. You’re basically trading equity in a $0 venture for development costs. The developer is truly taking the risk at this point unless you have a good business and marketing plan already in the works while you shop for a developer. Since your idea probably isn’t worth much at this state, that means you’re often looking at a sub-par developer (read: poor end product) or some other type of scheme where there developer will put in as little work as possible to roll our your app.
If the developer asks for money upfront, it’s probably not in your best interest to offer equity. When developers work for equity, they work with a vested interest in seeing the app thrive. Someone who takes money upfront is likely getting their development fees and have little interest in seeing the app survive.
How Much is the Current Startup Worth?
Some startups already have equity built and the app creation is complete and ready for scaling. This means that the developer you bring in, in exchange for equity, will be adding to the existing app through building out new features. At this point, your app has moved on from the idea stage to the actual “in progress” or true equity stage.
You know what your app and startup is worth at this point, so it’s difficult to say what amount of equity is worth the trade. However, you could save on costs for a low equity trade. You would need to calculate the percentage offered based on your app’s current valuation. Just remember that you’re taking a co-owner and partner in a development team when you give up equity. If it’s a new team that acts more like a freelancer, contractor or outsourced team, it’s probably best to decline this type of offer – as you’re becoming truly married to a single shop or company regardless of how the relationship unfolds from there.
In this type of situation, a single developer with an interest in your idea is a more attractive offer; someone you’ll be able to add to your core team as part of your everyday business, without other clients or any other workload to distract them from your common goal.
Are Development Costs Out of Your Budget?
Ideally, paying for development costs is much better than giving up equity. When you give anyone equity, you are relying on a stranger (assumingly) to have a vested interest in your idea. This doesn’t happen often, and taking on an equity partner is more likely to weigh you down rather than enrich your startup.
If development costs are within your budget, strongly consider paying the developers rather than offering equity. This gives you several options should you need to change development teams or you have any creative differences with your developers.
A good development team is hard to find, and you can’t just sever the relationship should it go sour if you offer equity. Without any type of relationship with the developers, you should pay the fees instead of offering equity. Once you get to know them, it’s possible to offer equity in the future but not blindly just to save on costs.
Are You Looking for a CTO?
As we said earlier in this post, an equity partner should more often than not be a single developer and not an agency. Good CTOs are hard to find, and this is where equity is good leverage when you have a limited budget but really need the expertise that only a trained CTO can bring. Not everyone is technically inclined, and a CTO can bring a valuable asset to your business.
This is the one time when equity might be a good trade in exchange for costs related to developing an app. At this point, you would need to perform a serious valuation of your business before you present an equity amount. Of course, you would need to negotiate the amount with a potential CTO, and this person should be someone you know so that the amount of equity is equal to the amount of benefits that one will bring to your startup.
Even with a CTO’s benefits, you should still determine if your startup is ready to take on a CTO. Whether you give them equity, a salary or both it’s still a big commitment and a high overhead in terms of cost. However, a vested CTO can bring valuable information, suggestions, a strong team leadership for your developers, and a CTO can drive your technology costs and efficiency down with the right business tactics.
Again – this consideration should only truly be made once your initial product is built, you have a business, and you have shown the value – as any truly qualified person ready to take this role would be hesitant to do so before you have anything to show for your app idea.
Is the Equity Owner Willing to Take Some of the Risk?
A startup is risky. No one writes about the failures, so you typically only see amazing stories from successful entrepreneurs. It’s risky, and a partial equity owner must be able to invest and take on some of the risk.
Talk to the developer about your app and find out if they will take some of the risk associated with the idea. Anyone who takes equity should understand that startups are risky businesses that have high rewards but these high rewards come at a cost.
All of these considerations have nuances based on your specific app or custom software project, where you are with the startup, and if you have the budget to pay upfront for its development costs. One common factor applies, though — only take equity partners that you trust and are willing to invest time and effort into your app’s success.
What is your experience with the big “E” word? Tweet to us at @DesignliCo – we’d love to hear your story.
(Time is money, text message on screen at hands take smartphone, black table with office supplies backdrop background . business concept. image by Shutterstock)
