How Not to Divide Ownership

Here’s a case for discussion. You be the judge.

Mary comes up with a great idea for an iPhone application. She works on it for three months in her spare time. She develops sketches and designs, trying to figure out how it would work. She looks at other iPhone applications doing related things.

About three months into it, her enthusiasm has waned a bit, but she’s still thinking about it. She’s spent maybe 10 to 20 hours on it so far. Her best friend suggests she talk to Ralph about it. She doesn’t know Ralph, but her friend does. They meet for coffee. Ralph is a programmer. He works for a company in town doing web programming. He’s also an enthusiastic iPhone user and has been thinking about taking an online course on programming the iPhone. Ralph is excited, and his excitement rekindles Mary’s excitement. They agree to be partners in a new business based on this initial iPhone application.

Four months go by. Ralph takes Mary’s initial idea and starts developing. It turns out, as he gets into the code, that what Mary imagined isn’t quite possible on an iPhone. Ralph revises the idea radically, makes it practical and develops a prototype. Mary meets with him three times, they talk, she accepts his changes begrudgingly. At this point Mary’s total hours have gone to 15 to 25, but Ralph has worked a lot, probably 120 hours, on the programming.

At Ralph’s suggestion, he and Mary take the prototype to Terry. Both of them know Terry, but neither knows him well. Terry has been through a failed startup, has a business education and is looking for a startup to do again, this time the way it should be done. Terry’s skill is mostly marketing, but he knows how to develop a plan and seek investment. Terry does a business plan and networks with local business development groups to find angel investors. They win an opportunity to present to an angel investment group.

Another three months have gone by. Mary has now put in more like 40 hours, Ralph 250 hours, and Terry 120 hours.

The three of them meet to plan their approach with angel investors. Ralph wants to quit his job and work full-time on the new thing but needs to get paid. Mary doesn’t want to quit her job but wants to stay involved; she’s not quite sure how. Terry wants to lead the new company as soon as he can get financing.

The business plan indicates it’s going to take $250,000 to develop the business for the first year, after which it will probably need another $750,000 to become cash-flow self-sufficient.

During this meeting, Mary and Ralph and Terry come to an extremely awkward realization: They’ve never really talked about who should own how much of this company, much less how much they are willing to offer to investors in exchange for $250,000.

So what do you think? This is a typical case.

1. How would you suggest that Mary, Ralph and Terry divide up the 100 percent ownership of the company now, before they go to the angel investors. Who owns how much?
2. What do you think of the management team here? Ralph and Terry both want to work full-time on the business when there’s money to pay them. What titles should they take? How much salary?
3. How much of the company should these three offer to the seed investor for $250,000?

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