Should startup company give away % of gross revenue to product developer?

Great idea but there must be a trial period of some sort with stipulations and ongoing requirements. There must also be a time line of options – for example if after 3 years the deal isn’t working due to any number of reasons then a stipulation must be pre-set to reduce or hopefully eliminate legal issues and make for an amicable parting. It’s quite a serious contract especially if the project is successful. There should also be a bonus stipulation to create more passion and ownership from the developer. For example if it’s successful – receive something extra or if sells within 5 years for more than $x then developer receives y%.

What could be worse for a startup than giving away cash that you need to reinvest in the business? No investor would touch you if you had this arrangement with someone.

Lol at anyone who asks for or tells you that having a royalty is a good idea for your business! Hilarious.

Let me chime in for the “it depends” camp, offering my view as multiple startup founder and developer. First, note that there are a lot of missing variables in the OP, way too many to even think of starting a deplorable pissing contest over royalty vs. equity. In fact, the only figures we have are the 3% for 5 years…

Generally, as a prospective developer I consider monetizing my work in terms of up-front fee, royalty and equity. Usually is boils down to a mix of up-front and royalty, or upfront and equity.

It is interesting to realize that each of the three has its own raison d’etre and dynamics, and implications. For example, from the developer point of view, monetization is immediate and safe with up-front, deferred and risky with royalty, and very risky/volatile/nebulous with equity.

A normal startup feels the most pain with upfront, less with royalty, and even less with equity. These factors need to be balanced, and in the course of negotiations I tend to acquire the feel for the optimum balance point. I can also say that over the years, I learned that some amount of pain suffered by the startup can be highly beneficial to the project.

What is the developer bringing to the table? Potentially, her/his contribution can mean success or failure. Especially with hardware/firmware based products, the developer’s contribution can often translate to huge differentials in gross margin. Case in point, with one client I was able to cost-reduce his product from 32$ to 7$ while significantly increasing quality and performance. Keeping the average selling price at around 65$, the client almost doubled gross margin. Would a 2$ royalty have made any significant difference?

Come to think of it, for a startup it can be instructive to look at “royalty” as a fixed dollar amount, effectively part of a product’s Bill of Materials. It then gets “cost-optimized” over time (in the OP example after 5 years). Bundling it with the BOM also avoids potentially problematic definitions of “net” or “gross”.

Equity is a different beast. Before agreeing to an equity position, no matter how large, I want to be sure about the startup’s overall sanity and solidity. Its present level of funding is really immaterial. This means having to do my due diligence, interviews, reading their business plan etc.

In two recent cases I politely refused equity from two clients, because they did not pass my muster; instead, I went for full fee.

In some ways, equity can be treacherous: to the startup, it means essentially nothing, but it creates expectations for the developer. Many serious developers don’t need that kind of motivational-emotional burden.

On the other hand, you do not want to over-pamper a developer with full fees and unlimited time budget, unless you want to test his ethics 

Concluding this already long post with the most important factor of all, which also happens to be the most difficult to assess, the factor of trust. Let’s start a pissing contest over that!