Contracting Risks on Projects
A twitter follower - Doug Barger prefers to work on ventures where he can get a percentage of the royalties. There are a variety of risks with various contracting approaches when supporting a project. Lets look at two types of contracting approaches - percentage on royalties and work for hire. Lets start with the risks associated with Doug’s preferred contracting approach - percentage on royalties. Here are the associated risks:
1. You are depending on your counterparts to carry through on their end of the work. If they don’t, the time and effort you put in expecting a good return on your efforts won’t materialize.
2. You become tied to them for the life of your royalty relationship. This gets very cumbersome as new ventures often go through numerous evolutions of their accounting system. You need to either be a very good auditor or have very good auditors working for you so that you can “trust but verify” that their accounting system is providing adequate records of revenue for royalty calculations.
3. If you’re a start up and you are offering people preferred stock (a form of % royalties) in exchange for their cheap labor, you make it incredibly difficult for an exit strategy that involves outside investors. The more hands you have in the pot, the more complex it makes to cut an exit strategy deal (share holder liquidation, capital acquisition, IPO). Setting up stock ownership incentive plans for early contributors is very complex and requires the work of legal experts. Be wary of people who offer you this without the requisite legal support.
Percent royalty arrangements transfer risk from the company for whom you are working to the person doing the work. They require tremendous due diligence in supporting.
The next arrangement - work for hire. Work for hire means the company for whom you are providing the work owns the rights to the work you are doing. You do not get the legal rights to own that work once it is complete. The risks associated with this contract type are:
1. If you use even part of the work you do in a work for hire for another client, especially a competitor, you open yourself up to costly litigation. Read the fine print in these contracts very carefully and know what it is you’re agreeing to - especially if you are a programmer.
2. The majority of risk for performance in these contracts is placed on the company hiring the work for hire contractors, if the contract is done on a time and material basis. To reduce the risk to the company, they may require the contractor gets paid only after specific milestones are achieved. The contractor then assumes the risk for achieving the milestones. If the milestones are not clearly defined, and the scope of the project is rather vague, this presents tremendous risk to the contractor.
I have just had too many problems on both sides of the fence (company owner, and contractor) with the percentage royalty arrangements and will very reluctantly enter them. Prior to engaging anyone who wants a percent royalty arrangement, I make sure that my accounting system can adequately track the performance of their efforts, and that we make sure that the time frame is of a reasonable nature so they can’t exit stage right and still continue to collect royalties. On the flip side, I just won’t take on royalty arrangements any longer as a contractor. First, I found that some company’s actually have governance requirements that forbid this (especially defense contractors). Second, I just don’t like to enter into that type of relationship with clients where I have to depend on their financial management to insure I get my fair share of the gains made from my efforts.
When I negotiate with contractors, I want all parties to feel like they leave the table spoiled. But sometimes what contractors want really isn’t in either parties long term interests. A little bit of preparation by all sides goes a long way in creating a much more harmonious working relationship. To develop negotiation practices that generate great outcomes and develop good long term relationships, check out http://www.cheetahnegotiations.com.