What percent of equity can be shared with a company that develops the prototype of the product?

See if you can pay in cash. Only if it is just not possible to make cash available to pay for prototype, then consider paying in equity. At the prototype stage, when the risk is the highest, the vendor should have a significant upside in case the venture takes off as expected. 

 

If on an equity model, I would suggest you look at the total amount required to build the prototype, and give a 3x – 5x of that in equity value at the time of the 1st round of funding. E.g. if the estimated cost of prototype is $10,000, and if the equity is agreed at a 5x, then if the angel1st round is raised at a valuation of $500,000, then the vendor should get 10% equity at the time of the funding. Ordinary shares.

(The negotiations get complicated and difficult to value if the equity if the basis of returns are for the 2nd round of funding… i.e. if the vendor and you agree that he should get about 5x or 10x of the cost of prototype development in the 2nd round, then the amount of equity will vary significantly based on what the expected valuation of the venture at that stage would be… and that’s a difficult one to agree on… the entrepreneur, naturally, will be super optimistic while the vendor may be a bit more modest in estimating valuation in 2nd round).

However, before you embark on your prototype stage, I would urge you to think hard about the business case, validate the concept with potential customers/users, work out your cash flow and fund flow needs, think of what this is likely to scale to and see what the financial outcomes of this are likely to be for all involved… including the vendor.

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Author: Prajakt Raut

Prajakt Raut is the founder of Applyifi.com, and author of the book for startups - ‘Starting Up & Fund Raising’ Prajakt personal goal in life is to encourage and assist a 100,000 people to become entrepreneurs. _____________ Prajakt is the founder of Applyifi - an online platform that provides startups a 36-point scorecard and assessment report on the venture's investment readiness [www.applyifi.com], and helps them improve their odds of getting funded. Prajakt is also the founding partner of The Growth Labs, a platform where growth-stage companies get sharp, incisive advice from senior professionals and experienced entrepreneurs. [www.thegrowthlabs.in] Before starting Applyifi, Prajakt was the head of operations at IAN, founding member of a leading incubator, and the Asia-Director for TiE (2004 - 2007). Previously Prajakt had co-founded Orange Cross, a healthcare services company, and was part of the founding team member of Idealake Technologies. While in college Prajakt had founded a printing business and has spent over 10 years working in leading advertising agencies. Prajakt’s book, ‘Starting Up & Fund Raising’, helps startups understand an investor’s perspective, and helps them improve their odds of getting funded. The book also helps entrepreneurs understand the building blocks of a business.

1 thought on “What percent of equity can be shared with a company that develops the prototype of the product?”

  1. Another option, consider the amount as an angel investment and issue a convertible debt note. So, amount converts to equity at x% discount at time of funding. Add a cap to keep number in sanity.

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