Should I settle for a percentage or keep with an hourly rate?

Question

I work with an inventor who creates product lines and I do the design work for him. He's an engineer who is picky and wants it exactly his way so usually the projects take a while due to him not explaining what he wants clearly. In the past I have charged an hourly rate which has been great since, like I said, it takes him a while to figure out what exactly he wants. Recently he asked me to become an employee as opposed to a freelancer, and instead of charging hourly, I would get a percentage. We have not discussed a percent yet but currently I charge him $25/hr.

Here are my main questions:

• Would this transition be worth it?
• What percent would I charge?
• Would it be OK to ask for a small, upfront fee, then collect the percentage as sales begin?

Any other information about this subject would be great. Unfortunately I cannot really give out a lot of information due to the fact that the product has not been released yet. From the people I have talked to and the products of his in the past, I think that this product line will do well if he markets it right.

Answer 1

This really depends on the percentage and workload. Getting paid in percentage is overall more risky then paid by hour - if you want more profit, you must assume greater risk.

A bigger company will give you the option for percentage either to reduce their risk and their variable costs or most likely as the percentage model (%-model) would just cost less.

A smaller company or, for example, entrepreneurs which don't have much capital, mostly have to use things like participating interests models (including a %-model) as it reduces costs if f.e. the product doesn't sell as anticipated. However if the product sells well, there is a good chance of making a lot of profit and much more compared to if you would have been paid per hour.

Another factor to consider is the overall workload. If you would have to do a lot of work at the beginning and would have less to do over the product cycle, lifetime percentage is always a good choice. See this simple example:

Product: Couch
Hourly Rate: $25/hr
Percentage Rate: 10% on earnings

|                  |    Y1 |    Y2 |    Y3 |    Y4 |    Y5 |
------------------------------------------------------------
|         Workload |  500h |  400h |  100h |       |       |
| Company Earnings |  $30k | $150k | $100k |  $50k |  $50k |

Hourly Return:
  = (500 + 400 + 100) * 25
  = $25,000

Percentage Return:
  = (30000 * 0.1) + (150000 * 0.1) + (100000 * 0.1) + ...
  = $38,000

Given this simple example, you would end up with an additional $13,000. However, the main purpose of this exercise is to show that if you have a smaller workload and higher earnings later (especially long term) where you don't have work anymore, it's definitely worth taking the risk.

In conclusion, the %-model gives you the opportunity to earn more money compared to an hourly model, but it also has the potential to earn less instead. If you understand the business and its risks, it'd be worth opting for the %-model. As you said, you're working at the design, so this could be a good opportunity.

If you want to charge upfront as a basis, its totally up to you and your business partner. In Germany, it's not an unusual proposition.

As a personal tip, do take care of the legal part! Most business partners try to pull you out as soon they see that their %-model plan costs them too much. Do long-term contracts, not based on years. I've seen this dozens of times.

Answer 2

Sarah, this one's tricky.

What comes to mind for me instantly is the plight of recording artists that get signed to a label. The label, by legal statute, has to pay the artists a minimum amount for each year they're signed. But while the contracts will demand that the artists produce a certain number of titles, the same contract does not guarantee that the record companies must invest a single cent in manufacturing or promoting the finished titles once turned over. This sort of occurrence actually happens quite a bit.

That said, if you sign up for a percentage, you're in the same boat as these recording artists I've described. You can pour your work into the project, but contractually you may have no power to balk if this person decides to seek greener pastures at some time. What will you own or be entitled to? Since you didn't state it, I'm going to guess that it probably wasn't discussed. The answer from s1x is accurate in describing how in later stages, business partners will start to change their tune when a percentage deal is costing them too much. But I think the part left out is that RIGHT NOW, you might be perceived as costing too much so instead of continuing to pay you hourly, your client is hoping you'll issue a Sarah Mastercard. Risky.

You must do your due diligence. I wonder if this client has done the same thing with any other designers! Obviously he's got enough to pay you so far. But consider the notion that you work for free for a jolly good amount of time and maybe, just maybe, your client takes your work product and starts up production and sales of it off-the-books, i.e. with a different corporate entity that's out of your reach. If such a thing happens, depending on your financial situation, you may not even be in a position to legally assert your position because paying an attorney will take food off your table -- and just wash your hands of it.

I don't want to kill off your enthusiasm but I see this sort of pay-you-back-later arrangement being offered on Craigslist quite a bit. Your client might even be one of the well-intentioned ones but consider the fact that about 95% of business ventures don't succeed. That alone is a heck of a gamble.

Get something for your effort.

Answer 3

Both. If it is emotionally burdensome to work for this individual, and you know that his products make money in the marketplace. Then you would be wise to get both. An hourly wage to make it worth the energy and hassle and a percentage to be a bonus that compensates you for participating in the process.

I would suggest you make sure the houly rate is your base income, the amount you need to survive, and be pretty comfortable. If you have already been working with this person, you both know what that amount is.

The bonus should be a reflection of what you are not earning off the products they take to the marketplace.

If the last 2 or 3 products they took to market generated $200,000 and you earned a 10% bonus plus your hourly rate then your boss is probably losing money. And if the are not, then getting an extra $20,000 is a good deal for you and your bills were paid during the development process.

If the last 2 or 3 products they took to market generated 5 million dollars and you earned a 10% bonus plus your hourly rate then you and your boss are making a pretty good living, and the hourly rate helped you cope until the bonus came in and reminded you why you work for this person.

If you want to be a partner with your employer, you would need to be willing to make some investment in the overhead. Consider the things your employer does not get paide to do. Who works through christmas eve and christmas day putting together proposals and negotiating the deals? Who fronts the money for software upgrades and equipment. Who pays to travel to locations out of town to learn a little bit more about how things are done at the company who would be a competitor if they figured out there was money to be made with this product line?

When you decide to work on a percentage make sure you cover your costs. Either up front with an hourly rate, or after the fact by the size of your percentage. Remember that this person is not easy to work for, so the time between product releases to the market is going to be the time between doing the work, and getting paid. With an hourly wage you know you are paid on a set schedule, no matter how well the product development stage goes, and no matter how awful the product development stage goes. With a bonus percentage worked into the compensation deal, you will get to share in the benefit.

Typically the challenge to this type of proposal is people ask for an hourly wage and 50% profit sharing. As if they took all the risk, because they did most of the work. That is not how it works. You were hired to do all the work. That is why they pay you. The profit sharing should be something that is easy for your employer to grasp as a good idea, because they can easily measure what it will cost them in dollars and cents. They already know the goodwill and intangible benefits that come from the right proposal.