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Monday
Oct042010

Dividing Ownership in a Group Project

This post contains suggestions on how to effectively divide ownership in a group project - prior to taking on the burden of launching and operating a legal corporation.
 
The tasks within this post may seem like a lot of work.  However the process described below is essential to building a motivated organization…regardless of the legal structure (and legal minds) you employ.

If you are working with equals that you know and trust, the group should be able to read this document, negotiate the items on the ownership earn-in spreadsheet, and then construct a signed letter of intent in under three hours; it doesn’t get much easier than that.
 
Fictional scenario:  a group of professionals are about to create and promote a new media website that will attract and entertain a slice of humanity; as visitors come to this website, the business goals will be to convert visitors into fans (subscribers and repeat visitors), and then to eventually sell something that has perceived value to a percentage of the fan base. 
 
Everyone involved desires to protect their investment (time, money, art, etc.) and to preserve their ownership rights until the day arrives when the group decides to turn the project into a real company.  The following is a list of people involved in the (fictional) project and a brief description of the assets that each person proposes to contribute to the project:

  • The Originator:  The Originator has original art (intellectual property) that he or she has been working on (part time) for the last six months.  The originator has already invested 500 hours, and she plans to invest 200 additional hours over the next six months.
  • The Video Person:  The Video Person has a track-record of, and the skills necessary to, produce compelling video footage.  The Video Person is willing to invest 200 hours over the next six months.
  • The Tech Person:  The Tech Person has proven software, website or mobile application development skills.  The Tech Person can invest 400 hours over the next six months.  However the Tech Person’s personal financial situation requires him to charge a reduced hourly fee that equates to 25% of his normal, billable, hourly rate of $100 per hour.
  • The Business Person:  The Business Person is proposing to handle daily operating chores, and to develop strategic partnerships that will rapidly grow the fan base and/or increase gross profit margins.  The Business Person can invest 500 hours over the next six months.
  • The Instant Traffic Person:  The Instant Traffic Person is stating that he or she has the capacity to bring almost instantaneous and significant attention (traffic) to the project once it launches.
  • The Money Person:  The Money Person is proposing to invest $15,000.

The Challenge:  The six people involved are bringing assorted value (assets) to the project; each person is willing to invest an allotment of time, traffic or investment capital; one person needs to earn a spot of money (an income) right away; nobody knows for sure how quickly this project will take off; but everyone involved wants to move forward as quickly and as inexpensively as possible. 
 
You need three things to get going quickly and inexpensively.

  • The second thing you need is a binding letter of intent that covers stop-dates, triggers, the ownership earn-in spreadsheet, and a method that dictates how all debatable matters are resolved.
  • The third thing you need is an attorney to take a quick look at what you are proposing to cover with this “thin” set of documents.

In my experience, dividing ownership equally is mistake. Without fail, things always happen that prevent or enable project participants from contributing more or less resources than they originally pledged.  You want a plastic (cable of expanding and contracting) ownership structure that enables participants to contribute as much or as little as their ever-changing (financial, time, family, health, etc.) situation dictates.  A plastic ownership structure, governed by an ownership earn-in formula, is the best way to align motivation, commitment, value delivery, timing and expectations.

Step One - All contributions have to be valuated / appraised…
Everything (time, art, inventions, equipment, website traffic, etc.) that is being contributed to the project has to be translated (valuated) into a uniform monetary unit such a U.S. Dollars; this will enable a math-ready apples-to-apples comparison of all contributions. 
 
Once you have completed the valuation process, copy and update the accompanying ownership earn-in spreadsheet to determine ownership of the project.
 
Here are some suggestions for appraising value:

Art, inventions and intellectual property have to be assigned a value.
Originators (artists, inventors) often over-valuate their creations.  My best advice is to sum up the actual hours invested (in the art, or the invention/idea) over the last year or so, and then multiply the hours by a reasonable hourly rate to arrive at a valuation.  If you have created something that is truly remarkable, increase the value of your creation accordingly.  Note: if you assign too much value to your creation, it will be proportionately difficult to negotiate an ownership agreement with your prospective partners.
 
Labor contributions have to be assigned an hourly rate.
When you are forming a team of equals, one of the easiest points to negotiate is hourly (wage) rate.  If you can agree that you are all equals in the marketplace (in your prospective fields), then assigning everyone the same hourly rate makes this part of the negotiation simple.  However, if a team member works in a field where demand for a certain skill is red hot (example: iPhone app developers), you will probably have to bump up his or her hourly rate to reflect current market rates / market demand; the same logic applies to assigning hourly rates to those that bring significant experience to the table. 
 
You may also have a team member that can contribute labor at a reduced hourly rate, but he or she must also be compensated to justify participating in the project.  The accompanying ownership earn-in spreadsheet accommodates this (reduced compensation / paid out) scenario.
 
Non-cash contributions have to be assigned a cash value.
If someone is pledging a significant non-cash contribution to the project, it’s not unreasonable to offer (additional) ownership in the project in consideration for the contribution.  Non-cash contributions are things like: six months of office space, the use of a vehicle, equipment, or even measurable Internet traffic.  Non-cash contributions should be valued at the cost of substituting the contribution with a market-priced, comparable alternative.
 
If someone is pledging something like “Internet traffic”, “strategic relationships”, or “mass-media mentions”, proceed with caution.  All of the above are valuable.  However they should be (somewhat) measurable (for example: by using Google Analytics or internal sales figures) and accounted for at the end of the project term.  Your goal should be to create an incentive whereby the person supplying these (promotional) contributions is highly motivated to demonstrate (ongoing) measurable results.
 
Investment cash contributions and the risk multiplier.
It’s obvious that cash contributions are easy to quantify - it’s cash!  However within the ownership earn-in spreadsheet, there is the option of multiplying the impact of a cash contribution (a loan or an investment) by a “risk multiplier”.  The risk multiplier is a simple mechanism that you can use to motivate a cash investor.
 
Investment money (any money) is hard to obtain.  There are three criteria that motivate investors: the first is a compelling business plan, the second is a great team, the third is the potential for significant upside.  If you have criteria one and two locked down, the risk multiplier helps to telegraph a significant ownership and upside message to the investor. 

Note: if an investor is loaning the project money, versus directly investing in the project, and the investor is charging an annual interest rate on the loan, I would negotiate a risk multiplier that is substantially less (or none at all) than the risk multiplier that I would offer someone that is directly investing (cash for ownership; no loan documents).   

Step Two - Create a binding letter of intent…
Here’s a partial list of items you can use to construct your letter of intent.

  • Ownership, voting, tax, and profit sharing rights shall be accumulated on a monthly basis and calculated at the end of each month - using the ownership earn-in spreadsheet.  The more resources a team member invests on a monthly basis, the more ownership, voting, tax, and profit sharing rights - the team member acquires.
  • Unless noted otherwise, intellectual property pledged to the project, and intellectual property created during the term of the project, including URLs used for the project, will be owned according to the ownership acquisition methods outlined in this document.
  • All team members shall report their monthly contributions (time, accomplishments, resources) to the entire team at the end of each month.
  • All disputes and all debatable matters will be settled by a vote whereby a simple majority (more than 50%) rules; in the event of a tie, a coin toss will resolve any dispute.
  • Primary contact, day-to-day management, bookkeeping, and all communications shall be the responsibility of an elected Project Manager. 
  • At some point (a date or a trigger) initial ownership should be finalized.  For example: six months from day one, and/or triggers such as raising a certain amount of investment capital, or acquiring a specified quantity of subscribers. 
  • Briefly document the methods, incentives and values you are placing on non-cash contributions such as art, inventions, Internet traffic and strategic relationships.
  • Bills / liabilities are the responsibility of the project’s owners.

Step Three - Consider hiring an attorney…
Before you launch your project, consider hiring an attorney to review your letter of intent and your ownership earn-in spreadsheet.   I would direct the attorney accordingly:

  • The attorney is representing the project team and not any single member of the team. 
  • The attorney should transcribe your documents into the simplest set of legal documents that he or she can create - given what you have already negotiated with your team.
  • The team is not interested in getting bogged down negotiating the particulars of launching and operating a corporation and/or negotiating investment terms at this time.
  • All items pertaining to creating a corporation (in the future) will be stipulated by the persons controlling ownership in the project once the initial ownership is finalized.

This document (Google Docs version) and the ownership earn-in spreadsheet is for rapidly launching and for managing ownership in (smaller) projects.  If you are looking to do something more ambitious (complicated) that calls for raising larger amounts of money, consider using the legal documents provided by TechStars as an alternative starting point.

 

About Bruce Warilaon Twitter

Reader Comments (8)

Bruce, there you go again - being so damn helpful, providing advice with specific implementation steps - that you're liable to put a whole bunch of attorneys out of work, who would reap tidy profits from almost ALL of those artists who DON"T do something like you are suggesting, when they have disagreements - which WILL occur ANYTIME several people get together for profit, especially creatives.

It's when the money starts flowing that the fun begins!! ("well all he did was put the money in - we did all the work", "well what you did is easily replaceable, my part is WAY more valuable", "Well I risk hard dollars and you only spent a little time!!", etc etc ad nauseum).

But then again, almost all will likely ignore your advice, figuring "oh that's too much work, we all get along, it'll be allright". Then they WILL be wrong and the suffer the consequences (I speak from my own PAINFUL experience and that of many friends over the years).

Virtually EVERY band that is based on a relatively democratic system either implodes (most), or at the very least, have to deal with the fallout from NOT structuring intelligently from the start.

Frankly, I think a benevolent dictatorship (basically own your band and hire the rest, EVEN if you're not the frontperson), is THE way to go - but for those situations where it simply isn't feasible, then ya better be on the type of plan Bruce has laid out. Or pay the price. It really is one or the other.

October 4 | Unregistered CommenterDg.

Thanks for this post. Increasingly musicians are turning to collaborations to create salable items, yet there is very little public discussion about how everyone is going to be paid. Your article will be very helpful to people working on collaborative projects.

I wrote this in June about music collaborations and I will add a link that points readers here.

Collaborating on "Creative Things"

October 5 | Registered CommenterSuzanne Lainson

Loved this article. There going to be a follow-up with a band example?

A friend of mine who is a bass player quit a band for not getting his songwriting credit. The argument went:
Songwriter: You played obvious parts that I could've written!
Bass Player: But the fact is you didn't write them.
Songwriter: (no response)
Bass Player: I'm not demanding half-credit. I want 20% & all the publishing can be yours.
Songwriter : You did these work for hire!
Bass Player: Really? Then you owe me $75 an hour for every rehearsal & gig. Do you want me to calculate that?
Songwriter: (no response)
Bass Player: I'll tell you what, I'm out of the band. Get someone else to record new bass lines on your album.

Wow, Yes,Thankyou!!

Perfect timing, kinda weird actually, was going through a similar topic with one of my band members this week and has been running through my brain while at work.

Can i say "Wow, Yes, Thankyou!" again? =]

October 7 | Registered CommenterMartin Toole

I'm grateful for this breakdown as well. I've got a question about the risk multiplier. Is it a "standard practice" to assume DOUBLED returns due to the risk upon your initial investment? I'm curious about the thought into that entry. I like the spreadsheet as a whole, but before I use it, I would like to determine what is fair for all parties involved.

October 7 | Unregistered CommenterDJ Blak Majik

DJ, You should Google "Angel Investing Returns" and "Venture Capital Returns". I believe you will find that the expectation is far higher than 2X. I used 2X just as an example. Is there a rule of thumb? The higher the perceived risk, the higher the expected return will be.

October 7 | Unregistered CommenterBruce Warila

I've drawn up music business plans and while I would never ask anyone to invest if I didn't think I could at least return their money, I don't think you can pitch investing in the typical band or artist project as a high return business. Yes, the risk is high, but I don't think there will ever be enough return to present a high risk/high reward proposition. I think band/artist investments are more along the line of angel investors for theater, where the people who invest do it more because they want to be involved in the project or what to support the arts than as a good way to put money to work.

So while VCs will use a much higher risk multiplier, the music business probably has to be realistic and keep its multiplier low.

October 8 | Registered CommenterSuzanne Lainson

This is truly one of the Top 5 most helpful articles on this site for creatives. Thank you again Bruce. Oh how many creative projects could have resulted in better outcomes if these steps had been discussed up front.

This answered so many questions for me because prior to a project - especially where the commitments are thin and the time lines plastic (I love that word) - you don't have a business. Yet once things get serious where money or potential money enters into the picture, people get crazy. If you don't have a prior agreement in place, you have a debacle.

October 16 | Unregistered CommenterJeff Dolan

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