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I am one of 3 founders of a very small startup company. We want to make rule that says, even if a founding partner leaves, they can still receive a 3% royalty from the company in perpetuity.
Here's my question: If Partner A leaves, gets that 3% royalty-- but then the company is sold for 100 million dollars. Do they get to collect 3 million (3%)? Or would that only be the case if they owned equity instead?
Caveat: we're all very new to this. Most of my knowledge comes from watching Shark Tank ;)
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It would depend on the contract, but it's unlikely to be 3% of any income the company gets for any reason (eg interest on investments) and even less likely to be 3% of any money that shareholder get in exchange for their shares.
In most cases the company makes widget or product X, and the royalty is 3% of money for selling instances or copies or whatever of that X. It may even specifically exclude some such revenue: for example my book royalty contracts allowed me to get half the normal royalty, or even nothing at all, on certain high-volume, deep-discount sales (eg to Walmart). (This sort of thing is easily gamed if the remaining founders decide not to sell A any more, or to make A free and sell B instead. Royalty contracts need to be very carefully written.)
The way to compensate founders even after they leave is to give them shares. When the company is acquired, what is actually bought and sold is the shares. If you had been given 10% of the company, when it sold for 100 million, your shares would sell for 10 of that 100 million.
A contract like this is not something you should make up based on what you've seen on TV. A good lawyer at a time like this will earn their fee many times over.
Normally when startups get creative over things like this instead of just doing this the tried and tested way...... everyone ends up broke blaming each other, at best someone got even more creative and is in the Bahamas under a new name enjoying themselves.
Royalties are a percentage of sales revenue, in no way related to company ownership or even profits usually. So no lump sum like you think. Also, it's extremely unlikely that anyone would buy a company where they would have to turn over 9% of the sales revenue in perpetuity to the previous owners.
No, he does not. He has a contract with the company for 3% royalty (however this is calculated). The sale of the company does not create a new legal entity. He still has a contract with the company. The sales price is not royalty, it is not company revenue etc.
