We just launched our startup with a designer helping us pro bono to spruce up the design of it. He's asking for compensation now (which is fair) and is willing to trade in his service for equity. Just wondering if it's better to pay than to trade equity for the service.
Before I get to your question, let me give you a tip: always aim settle questions of payment before the work happens. It is ten times easier to agree on a price beforehand, and having done that doesn't stop you from changing it by mutual agreement later.
The problem with paying cash is pretty obvious: you don't have a lot of it. The problems with paying equity are subtler. The first one is that early-stage equity is extremely hard to value. A second is that equity transactions require a lot of paperwork. Third is that entrepreneurs tend to value their equity much higher than other people would; if not, they wouldn't be starting the company. And fourth, people like designers are rarely expert in valuing businesses or the customs of of startup equity valuation. In the past, I've both given and received equity compensation, and it's a lot more of a pain than I expected.
In the future, what I think I'd try is convertible debt. That is, I'd talk with the designer and agree on a fair-market wage. E.g. 100 hours x $100/hr = $10k. The next time we take investment, the $10k turns into stock at whatever price we agree with our investors, plus a discount because he was in before the investors.
Note, though, that this will increase your legal costs and your deal complexity, so I'd personally only do this for a pretty significant amount of work. And I'd only do it for somebody I trusted and respected enough to have them around for the life of my business.
Problem #1: virtually no freelance/independent contractors psychologically value the equity as equal to (let alone greater than) cash. To most people, 5% equity in a startup sounds like a very small amount, so they may demand 10% or accept 5%, but view it as a token amount. That leads to not prioritizing your business/project over cash-in-hand opportunities.
This means you could give 5% to a web developer, who you have to harass endlessly to prioritize your work, resulting in your being 3 months later to market. Eventually, if you succeed via your hard work, the company is worth $1M, so you ultimately paid $50k for a website and the developer never valued the equity anywhere close to what it's worth.
Note: it's not just undervaluing equity that leads to a lack of priority, many freelancers live on a short financial leash. The ones who are rolling in cash and charging top rates often don't have much incentive to take equity in a startup or they'll take equity alongside a reduced cash rate.
Problem #2: very few specialists are good long-term business partners. Do you want them seeing your financial statements? Do you want to explain financial projections and business decisions to your web developer? Want your accountant involved in management, marketing or hiring decisions? Would you put them in front of an investor or let them review a term sheet? Would you want them voting on your board of directors?
As the majority owner, you can't simply ignore minority owners: http://venturebeat.com/2011/07/18/what-are-the-rights-of-minority-stockholders/
Problem #3: most people (founding entrepreneurs included) are impatient. Everyone thinks their equity is going to be measurably more valuable in 6-12 months and the reality is it usually takes 3 years or longer to build a company that anyone would acquire. Is that service provider with equity going to be frustrated by the actual timeframe and constantly pester you to buy him/her out?
Problem #4: if you complicate your cap table with a few people who were short-term assets, that sends potential investors a message: you didn't value your equity, so they are going to grind you in valuation negotiations. They will also include term sheet clauses that are lopsided (including stronger than usual board representation) because they figure you're not savvy enough to negotiate them out. Also, if the cap table is perceived as too complicated, some angel / VC investors simply will pass because they don't want the hassle.
Conclusion: I've seen these situations pretty often and most go badly, so if you think I'm generally down on the concept, you'd be right. I would be remiss if I didn't say it can work well, but only if you are gaining a true long-term partner who wants to be involved in ownership of the business long-term. If the person simply has some non-billable capacity and is viewing your equity as a lottery ticket, definitely pass.
Right now I'm working on the concept of minimum viable design - what is truly needed to get your business going and to the next level. First – make sure you aren't designing for design's sake. Customer acquisition is numero uno and that usually doesn't take a lot of design out of the gates to start selling.
At any rate if you're not there yet – I've found paying for design always results in a better result than "equity". Your company isn't worth anything (yet) and as soon as something else comes along for your designer "partner" he could jump ship and you'll be hosed.
I've always found people work harder for money unless they are an original co-founder or partner.
Hope this helps!
I've offered deferred compensation, because often the issue isn't whether you can pay cash *ever*, it's a matter of whether you can pay cash *now*.
The way to structure that is to offer cash payments due at a time in the future (like every month, quarter) that can be converted to stock if they aren't paid out.
The reason I prefer this is because if cash is available, I prefer to pay it in any amount, even if if reduces the stock payout only a bit.
Felix Dennis, one of the world's wealthiest people (until he died recently), emphatically said in How To Get Rich to NEVER give away equity. Fight to keep every percentage you can.
Why? A small percent of equity now can be worth millions of dollars later. Give gifts, bonuses, salaries...but never equity, he advised. And I agree with him.
Give a payment and it's over and done with. Give equity and it goes on forever.
William explained the basics of the problem, so it's really up to you.
It's a matter of risk and initial investment. If you believe that your startup is a winner (which is logical, otherwise why spend time on it?), then you'll probably expect it to grow to a $1M/$10M company. You can calculate the equity then, or the rough amount of work based on time spent * hourly rate.
The other part is the risk. If you're wrong, equity will cost you less. If you rely on a loan/mortgage, this could pay back later or you'll be debt-dependent later on. It's a matter of calculations, risk, planning and connections.
While you already have received some good advice, let me try and add further. The right answer to your question depends upon the nature of your business and its dependency on having a designer onboard. If your business, by any chance, is related to offering designing service then you can consider exploring the goodness of fit. But, if it's something different then it doesn't makes any sense trying to fit sheep with lions.
However, trading equity for cash may not be a bright idea as long as everyone with equity in hand doesn't share similar vision, intent, integrity, and values. The white- collared-weekend-party crowd has created a sort of love affair for equity option, and wannabe entrepreneurs with no sense of entrepreneurship finds them appealing, even if that holds no value. Ask your designer why he/she is willing to get compensated in equity? He may be looking at it wearing glorified goggles than true one.
Some obvious pitfalls in equity sharing is as follows:
1. It requires a lot of record keeping and absence of proper paperwork may crop up issues down the road.
2. Paying in equity isn't just compensating but, diluting your business. The equity may become worth many in near future.
3. If you're too short on cash and anticipate availing the designers service for times to come then, make your agreement terminable at will. That way if you find the individual isn't adding much value then you compensate him/her and save your equity. Otherwise, there's no harm in retaining an exceptional individual with impeccable skills.
4. If your business is S Corporation then you would need to verify the IRS rules.
Hope this helps. All the best!!
I wouldn't trade equity for a service like this unless they were going to become a long-term contributing member. You're much better off finding a way to pay for the service. You can also do things like find ways to lower the price as much as possible such as a link at the bottom of your site that says, "Designed by [designer name]," but I wouldn't give up equity for design services.
I've worked with over 1000 business start-ups and the same issues continue to rise to the top of questions entrepreneurs ask. When you are bootstrapping a start-up money is always an issue. Having said that non-essential work must be paid for from your existing capital. I'm amazed that yo car happy to pay for the designer after he agreed to work pro bono. That should not have escalated to a request for compensation.
I agree with William it is not a cut and dried question. It's easy to give away bits and pieces of your company for contract work but you need to keep as much of it as close to your chest as possible. It is also very important that any work is prioritized and price/payment is determined prior to the start of the work.
It's a different story when you are a software co and you need a head designer. I've had clients with this issue and the logical expectation is that the founder would bring the engineer on as a partner or major shareholder.
I think entrepreneurs must be careful with shares early in the process. Without expert help you could get into trouble fast by offering shares to everyone who shows an interest or does work for you.
Try to be careful this is only your First Round financing.
As a designer and entrepreneur myself, I would absolutely pay for design and development services rather than give away equity.
I guess I could depend on the nature of your startup, but having worked with a lot of startups, I think you're much better keeping as much equity as possible.
The answer to this question lies in the details of how far along you are in the launch process. Early in my career I chose to outsource the design of the branding elements and website UI/UX to an outside firm only to reverse course and take the company (successfully) in another direction rendering the original designs almost completely obsolete. We paid in cash and when we decided to change things I was forced to design the website myself. Especially in the early stages it may make sense to give the person you are working with equity as they may need to make several revisions as your product changes with the preference of your customers. Deciding to give someone equity changes your relationship with the freelancer and what you are looking for in them and from them. When paying someone you are solely focused on the quality of the design. When distributing equity you need to ask yourself "Is this someone that I feel comfortable going into business with?" as the person will own a percentage of your company you must feel comfortable with them taking a more active role in your business as you will be relying on them for some time to come.
Hope this helps.
such a massively situational item. Sometimes it is just obvious, and am assuming that the question is about those times when either way feel to be a viable option.
In that case, I'd look out a few years and the needs for when the venture is at least 10 times the present size. Do we want this partner, or any partner, or cash, or ... fill in the blank, at that future point? Answer that and the choice can become a little bit easier to see
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Best wishes on your journey!!
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Find a way to pay for it. Giving up equity is an option of last resort and should only be reserved for very rare people and circumstances. When your business becomes valuable you will be very happy that you're not sharing it with your first web designer.
There are several avenues for startups to connect with designers. Platforms are dedicated exclusively for design professionals - enviro, theme forest, oDesk to name a few. Depending on your project & size you get work done for a reasonable price.
As long as your are cash strapped, I would reserve equity for employees. Equity serves as a great incentive to grow your company in the years to come.
With that said, I know of tech/dev companies that partner with startups to work for equity until they can be paid at a future time
You need to understand what equity is and what it isn't. Equity should be used to launch your company and get you to revenue. It should not be used for one time expenses.
So you use equity for talent, because talent is difficult to find and you want people who are willing to stay with you to reach your goals. Or you use equity to obtain cash, since you need cash to pay for talent, and for developing the company.
Furthermore, equity is finite -- there is only 100% of it. At the point when you have given away all of it, you have zero left to give for the life of the company. Obviously, you want to avoid giving away equity as much as possible.
You do not want to use equity for one-time expenses, such as office furniture, or ongoing overhead, such as rent. Paying rent adds no value to your company, and neither does furniture. They may be necessary expenses, but they themselves add no value.
So now you should understand that a company that sets up your website is an ordinary business expense and you should not use up your equity