I don't think you want random entries. Why not interview respectable designers and offer 5% to the the one who agrees as well as has the best portfolio, references, and ideas you like? That's a much more sane thing to do (considering somebody mentioned here at least one law firm in California offered to incorporate some companies in exchange for small ownership of the new entity, and small independent game developers often offer game royalties to artists in exchange for artwork.)
But the best plan, and one most congruent to advice you would get from both the programmers (successful game developers, business-savvy hackers, etc.) as well as the artists themselves (designers: www.no-spec.com) is this:
1) ask around for recommendations on designers who've done related work before and how they were like to work with
2) establish what you are looking for, together with the designer, and let him or her create the art, of course making sure to have a contract that stipulates what is to be done and allows for a couple of additional levels of iterations
3) pay an agreed upon amount, not stock options. Yes, although I mentioned that some indie game developers go the route of offering royalties to artists, the real advice is to pay a flat amount to contractors for art, sound, and music and then keep full ownership of the game, and save lots of time and money managing royalties for the entire lifespan of the game, worrying about trust and tax issues, creating contracts with others, and more.
As well, on the hacker side of the equation, the author of the submission mistakingly equates "offering a few lottery tickets that might win five to seven digit figures" with "attracting the best designers." If you want to have a good design, you will have to do the leg work, and not throw it to chance and then say, "well, I tried! Let me offer 5 or 10 more percent."
You have to think about the expected valuation of the startup. What are the odds that this particular startup is going to exit. As a lifestreaming service, I'd say the odds are around .01% (sorry, lets be realistic, web 2.0 doesn't have that many exits).
Given an exit of about $1M, we're talking about an expected valuation of the company at about $1,000 at its current state.
Then the question is, will giving up 5% of the website at its current state increase the expected valuation by more than 5%. I think that with a "kick-ass design" we can raise the success rate to 0.05%. Which increases the overall valuation by more than 5% of the stock given up, which increases the overall expected exit price, ergo 5% is worthwhile.
This is going to go over really well in due diligence.
Edit: This might make more sense if you created a special class of stock without voting rights. If you're essentially giving away 5% of a potential exit someday that's one thing. Giving away 5% of control is another.
(1), a professional design job for a template costs $1000-$3000. You're setting your valuation at 20-30k?
(2), the equity you're offering isn't worth anything. In practical terms, all you're offering is the opportunity for a designer to work on contingency. They don't like that.
If you really want to give up almost as much equity as a CEO takes 2 years in, or almost as much equity as YC takes up front, don't trade it for a design; find a partner who can do solid design.
In general, good designers will not participate in contest as it is spec work which is always a bad way to do design work (or coding work, or anything else). If you value good design, pay for it. This is why there is controversy within the design community over sites like 99designs or the Sitepoint Design Contest forum.
It creates an underlying feeling that design is less important than the coding of the app - if you want a designer, bring them on as a co-founder and offer them equity. If your app requires a good user experience, you need a professional, not someone who spends a "few hours" to win a contest. I put "few hours" in quotes because that is a very low estimate for the amount of time it takes to create a great user interface.
Holding a contest is just a way to look at a bunch of free work and only reward one designer.
Seems to have missed a trick here, if you have a good application, but lacking an area (design), and its a small startup without many resources.
why not have the contest worded more to attract a design orientated co founder, 5% is a reasonable chunk of the company, for a template that can be knocked up in a few hours.
This is a great idea though overall. For one, it's an easy way to get a good design for "free" for the owner. From an up and coming designer's POV though, it's a great resume/portfolio addition that could actually have a payoff in future years.
Equity should not be a prize in a contest. When a company gives up equity, it should be for a specific purpose to get something one cannot otherwise, such 1) in exchange for investor money (YCombinator), 2) in exchange for a professional service from a top firm to file articles of incorporation, trademarks, and advice on setting up bookkeeping, and, 3) for a key hire. I hope somebody who's done more than run a shareware company chimes in if I'm wrong.
Equity in a company though is only worth what a company is worth. He's open in saying that this is a part time project with no real focus/push behind it, other than his desires. In other words, it isn't worth much at this point.
So, to relate:
2) in exchange for a professional service from a top firm to file articles of incorporation, trademarks, and advice on setting up bookkeeping,
I'd put website design on that list, as I'm sure you would. Of course, top firm is only relative if you can get a "top firm" to consider your company worth the investment. In this case, I think the owner realizes the value of his company, and just wants to present an option to someone who may find it acceptable.
But the best plan, and one most congruent to advice you would get from both the programmers (successful game developers, business-savvy hackers, etc.) as well as the artists themselves (designers: www.no-spec.com) is this:
1) ask around for recommendations on designers who've done related work before and how they were like to work with
2) establish what you are looking for, together with the designer, and let him or her create the art, of course making sure to have a contract that stipulates what is to be done and allows for a couple of additional levels of iterations
3) pay an agreed upon amount, not stock options. Yes, although I mentioned that some indie game developers go the route of offering royalties to artists, the real advice is to pay a flat amount to contractors for art, sound, and music and then keep full ownership of the game, and save lots of time and money managing royalties for the entire lifespan of the game, worrying about trust and tax issues, creating contracts with others, and more.
As well, on the hacker side of the equation, the author of the submission mistakingly equates "offering a few lottery tickets that might win five to seven digit figures" with "attracting the best designers." If you want to have a good design, you will have to do the leg work, and not throw it to chance and then say, "well, I tried! Let me offer 5 or 10 more percent."
And here's a new submission that design contests might not even be legal: http://news.ycombinator.com/item?id=443758