How to Respond to Profit Share Offers
You’ve heard it many, many times before. A client (or potential client) approaches you with an “amazing” idea but they have limited resources. They can’t pay for your expertise but are happy to offer a profit share arrangement. You’ll become a multi-millionaire! You’ll praise the day they contacted you! When can you start?!
Artwork by SitePoint / Natalia Balska
Just Say “No”
Clients should have no shortage of investment offers if their idea is truly outstanding. What they’re really saying is:
We don’t know whether this project is viable. It could be huge. Or it could make nothing. Are you willing to take on all the risk even though we’re not?
The client is asking you to invest in their business. Unfortunately, you’re unlikely to be an expert in their industry. The project could be ground-breaking or terrible but you have little way of knowing. If they were asking for money, you’d expect a comprehensive business plan with projections, marketing details, ongoing costs and potential profits. Those are rarely forthcoming.
Profit-sharing clients rarely equate your time with money which is inherently patronizing. The old adage that “time is money” is untrue; time is worth more than money. It’s not always easy and may require some luck but you can always make more money. You can never make more time. The average working life is a mere 75,000 hours. It’ll take you 10,000 hours to become a proficient developer and perhaps another 10,000 to keep on top-form. Even if you offset some of that with schooling, you’re left with 60,000 hours to earn a living.
Gambling on a client’s idea has other financial impacts:
- It’s difficult to earn money while you’re working for them.
- The client will be more demanding than others because they have no budgetary or time constraints.
- The majority of new businesses fail. Those without a plan fare worse.
- You almost certainly have better ideas in industries you know well. You will understand how to start small and evolve a minimum viable product in reaction to user demand — why shouldn’t you work on that instead?
Until you invest, the client has no business. However, your contribution has no perceivable value because the client won’t pay for any of your work. Your effort is free.
Ignore the vast majority of approaches — especially those made by people who don’t know you yet are willing to share their business with a stranger. Don’t waste any time responding to their unworkable idea to combine Facebook and eBay. If they keep hassling or they’re an existing client with a dumb idea, state you can only consider an investment once you’ve received their five year business plan. It’ll never arrive.
But What If…
Once in a while you’ll encounter a promising idea from someone you know well. There’s no harm in discussing it but don’t rush into any agreements without careful consideration. In particular:
- People often apply an over-inflated value to their idea but be clear that ideas cost nothing. Implementation is another matter.
- Never proceed unless the client has a solid business plan. This must include an outline of the idea, market research, sales projections and investment details. Sign a non-disclosure agreement if they’re nervous.
- Don’t be swayed by fancy charts or glossy presentation — is the plan realistic? Conduct your own research. Ask colleagues, friends and family. Seek potential buyers and other investors.
- Identify the risks and rewards. How long will it take to build the product and get it to market? What are the ongoing operating costs? How many customers are required to break even? When can you expect your first repayment?
- Estimate your personal time commitment and don’t forget to include planning, support, training and upgrade costs. Convert that to investment monetary terms but don’t use your normal daily rate — add significant contingency for the risk you will incur.
- Forget profit share agreements: you should become a partner/director owning a percentage of the company according to your investment. That must be recorded as company capital or a loan so it’s repaid before any other dividends can be made.
- Consider counter offers to minimize the risk. For example, you will own 75% of the company on inception. Your holding will reduce to 50% if your investment is fully repaid within two years.
- It doesn’t matter who the other person is: form a separate company and sign legally-binding contracts. Do not start work until then.
In other words: don’t be duped into unfair agreements which leverage your skills and good nature for meager compensation.
Your investment in the company is likely to exceed that of your partner. If the business fails, you’ve lost considerable time which could have been better spent elsewhere. If the business succeeds, your initial involvement has just started and your career will progress on a different path. It’s uncertainty either way and you should be rewarded accordingly.
Trust your instincts. If it sounds too good to be true, it will be.
Best of luck.