Episode 174: Trading Services for Equity with Corey Kupfer
Back in the early 2000s, artist David Choe graffitied Facebook headquarters and charged $60,000. One of Facebook’s founders convinced him he should take Facebook equity over the money. Fortunately, David did. As it turned out to be worth over $200 million.
In this solocast episode, we’ll go through the benefits, harms, and how to trade services for equity. I’m putting this episode out there, especially for those who are in the service business as consultants, trainers, or lawyers who always asked me whether I would take equity instead of a fee.
How Equity Works
Equity is an ownership in a company, whether it’s stock in a corporation or a membership in an LLC. You can own 3%, 1%, or 10% of the company and receive the corresponding percentage of the profit. From the company’s point of view, equity for service is a brilliant solution when you need certain services and are in an early stage of the business where cash is tight.
From the service provider’s point of view, you will be offered equity instead of cash - it could be for consulting, training, or technical, as it’s more often services - because the company doesn’t have cash for a start-up or because you are going to be an ongoing partner.
What To Consider?
The real question is how to decide whether to accept equity over cash. First, there are a few things I would advise you to consider if you choose equity:
1 - If you’re getting a small percentage of equity, you will not end up controlling any company decisions just by the ownership percentage. Unless you own 51% of the company, the company has contractual rights to have veto power over certain major transactions. You are most likely going into a situation without having a say in decisions. For this reason, you need to be confident and comfortable that you trust the company’s management.
2 - You don’t have any guaranteed distribution. This money might be distributed or quarterly. However, that’s not guaranteed because the executives, founders, and employees can be getting paid compensation that could zero out the profit, making nothing available for distribution. The solution is to give yourself some protection and make sure they can somehow guarantee distribution legally.
3 - You will be taxed. When choosing equity, make sure that there is a requirement to distribute at least enough capital to cover your tax liability, because in those types of entities you’re going to get taxed on your relative share of the taxable income.
4 - You can take part in an exit capital transaction when they sell the company or when they monetize their events in some way. If they’re going to sell the company for $10 million and you’re entitled to 2%, you can get $200 of profit.
5 - The equity may get diluted at lower valuations. If the company is not doing quite as well as they projected, they might have to raise capital which can dilute you disproportionate to the value you bought it originally. If you exchange your services for equity and you own 2% of the company, maybe you can be diluted down to 0.2%. It’s a risk.
Treat Equity Like An investment
If you find yourself in a situation where equity seems like the best solution, my advice is: treat equity for services the same way as if you got paid in full and then made an investment. That’s actually what is happening.
Ask yourself, “If I get $60,000, would I invest all this money in this company?” A determining factor is whether you need the cash or not. This will tell you a lot about your risk profile and whether it will be the best option for you. One thing that is also valid is to do the hybrid. Consider taking a discount on your fees for a portion of equity, so you can get paid enough to at least cover your costs.
If you’re not an investor or don’t have investment experience, one thing to keep in mind is: you’re just providing services to this company, which doesn’t mean you know the industry enough to evaluate it as an investor. In this case, it is better to play safe and choose the money.
You Can’t Be Too Careful
In my career, many times I’ve had clients who regretted their decisions because the amount of equity they gave away for the cash was worth a lot more. At the same time, many people get excited about the company, thinking they’re going to get rich. In most cases, those investments don’t turn out too well.
In order not to fall into a not very advantageous negotiation, it takes a lot of analysis, understanding the CAP table, and figuring out whether the evaluation is fair. For the best decision, get some professional advice.
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