Equity distribution

How much equity for a consultant who also needs to be paid?

Allison Rosenberg, Ph.D.

June 30th, 2015

I have an invaluable consultant who has been helping me envision and source my product and product work.  We've reached a point where we need to discuss an equity stake in exchange for a reduced hourly fee, to ensure his continued participation.  I would be lost without him.  What guidelines, rules of thumb, models, or advice might you offer?


Thanks so much in advance, all.

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L. Marshall-Smith

July 1st, 2015

I have been on the other side of the table (the consultant's side) as well. Start up founders have asked me to join them for no cash, just equity, when there isn't even a company yet. Perhaps just a product. Anyone who is worth their salt in leading a project forward, whether from a business or technology standpoint, is worth some up front payment. If you are running out of the cash to continue paying this consultant's standard fees, but truly believe they are an invaluable force to getting your start up funded, or marketed, or your MVP built, etc, then yes, it's time to have the conversation with them asking if they would want to join the team officially for a piece of equity and a reduced paycheck. You could bring them on as a cofounder (with founders shares), you could offer them a position on your board of directors or your advisory board for a smaller share, depending on just how much time and energy they are putting into your project. I disagree with some of the others here suggesting you just cut this person loose. People do need to earn money to live, pay the bills, send their kids through college, etc. To put someone down or say they are not as committed as you to your project because they are asking for some compensation is, in my opinion, an uninformed view. So again, if you truly believe this person is crucial to your team, have that conversation and work something out that is mutually amenable. Here is a good article on how much equity an advisor should get based on their contributions level. techcrunch.com/2011/09/22/free-startup-docs-how-much-equity-should-advisors-get

Lee Curtis

July 3rd, 2015

You'd agree he deserves fair compensation for the value he clearly brings.
Did he engage solely because you paid his market rate?
He's likely got a family & bills to pay. Not everyone can work for equity. Even if they want to.

Is your team strong enough to succeed without him? can you replace him / supplement him?
If he's critical - he knows it - and wants to hedge his risk with fees & can negotiate strongly.
If he's truly "invaluable", then the equity should be commensurate with the risk of losing his skills.

Does he believe the equity is worth anything?
The product, market and co-founders are strong enough to break through?
Most don't. He knows that too.

Do a SWOT and reflect hard on whether you have what you need in-house or can realistically afford/acquire. Or walk away.

Whatever happens, good luck, stay true, believe in yourself.

Steve Madere Software Technology Consultant

July 4th, 2015

Why all the hand-wringing in this thread?

The answer seems pretty obvious to me if you just break it down to financial fundamentals:

1. The consultant's realistic market rate is X
2. You cannot afford X so you want to pay X - Discount
3. Your startup's current honest valuation if you took actual cash from investors would be V

The consultant is effectively investing Discount cash in your startup on
the day they commit to do the work.

Here is the absolute formula for equity compensation that should always be used:

Equity Stake = Discount / (V+Discount)

As long as X is realistic and V is realistic, everything is fair and everyone should be happy.

Example realistic scenarios:
* Company wants a $50k discount on a year worth of work from the consultant.
* Company just raised $200k on a $1M pre-money valuation.

V = 1.2M
Discount = 50k

Equity = 50000/1250000 = 4%

Done.

A few caveats:

1. For the consultant's market rate, do not assume a full-time-job-with-benefits salary.
They do not have a full time job with benefits at your company. They are a consultant.
Assume the market rate for consultants of their skill level. However, you should realize
that consultants typically have a discount from the on-demand rate for long-term high
volume engagements and apply that rate if it is indeed a reasonably guaranteed
long-term high-volume engagement.

2. Do not make them double-dip on risk by first paying them less than market rate in cash
and then expecting them to carry highly risky receivables while you scramble about
for cash. If that is going on, they are investing again in your company in the form
of a bridge loan every time you drag out payments. You should either just not do this
or at the very least, compensate them with additional equity equivalent to what a
cash investor would squeeze out of you for a hail-mary-pass bridge loan (which is
fairly usurious in my experience). Really, just do not do this. People have to eat.






Stefan Ski Owner/Founder at Vitality Extension Solutions, Promo Models United & Social Alpha Male

July 11th, 2015

Pay now or pay later. If the consultant is that good and invaluable, he should have a decent stake at the company in addition to his regular fee. Let's face it, sounds like without his experience, network, and intellectual property, you might not have a product or a company.

Any consultant who knows his worth and value to the client will make sure that the deal works out for all parties while being fairly compensated.

It's important to understand that anyone who is in the consulting business for themselves, got into it because they are an independent advisor - a free agent. Trying to turn them into an employee or to tie them down is counter intelligent.

My mentor who turns companies around get paid a hefty premium fee + 6-10% of all income for LIFE of the company (even with ownership change). Because let's face it... otherwise they'd
be out of business.

Ideas are a dime a dozen, but to bring the idea to market and to make it profitable takes skills, experience, and know-how. Anyone who plays a crucial role in that process deserves a solid compensation and a stake of the company. For all others who are so concerned about keeping the pie all to themselves... the right consultant will help you expand that pie, otherwise most others including you and your lack of experience simply burn through it.

Mary Camacho Product & Develoment Management | UI/UX

July 1st, 2015

Contribution is contribution at the end of the day. Whether it's from an employee, a consultant or founder. What's important is working out an equitable structure based on the contribution and based on the risk taken.  Of course a cofounder that takes no compensation from the company early on deserves a higher stake. But not all founders are full time and not all full time founders should be valued equally. So when it comes down to employees or contractors/consultants with equity, determine what you really need, what really works in terms of cash compensation and then what the long term upside and risk you want that person to share.

There isn't a magic formula. But it does matter about stage.  Have you incorporated yet? Are they getting shares upon incorporation for which they can submit an 83b form and avoid tax consequences? Or are you compensating after that in the form of stock (taxable income) or options (not immediately taxable but typically viewed by others as less than equal to stock).

Becky Flint Product & Program Executive | Scaffold Consulting

July 2nd, 2015

I have been on both sides in my career - as a founder and consultant. In the end equity and cash are both forms of compensation for work provided. From my experience, there are 3 rules critical to a successful professional relationship:
  1. you both enjoy working together, both in style of working, give and take from each other, and where the company is going. Compensation (money, equity, etc.) does not mean everything
  2. the compensation should be fair to both parties
  3. you both should feel comfortable to discuss term of engagement and duration, and work together to find the best solution for both sides.
As a few members called out, 
  1. first do a gap analysis on skillset within your company, and brainstorm best possible plan to fill them temporarily and longer term 
  2. having an honest discussion with your adviser about compensation and commitment to avoid all the assumptions and anxiety. 
Good luck!

David Crooke Serial entrepreneur and CTO

June 30th, 2015

I'd be wary of giving equity to non-employees, makes things messy for a VC. I have turned down consulting and contract firms because they wanted a piece of the pie.

Mike Masello

July 1st, 2015

I was in a similar position (the consultant side), asked to work 30-40% below market value.  I was offered stock options as an employee to make up the difference.  I decided it wasn't worth the risk given all the scenarios that could play out having never made up the difference.

As some here have said if the person is that vital to the venture (and early stage) it sounds like they should be offered founders stock.

Max Loukianov CTO and Co-Founder at Gimme!

June 30th, 2015

Allison,

I've been on the other side of the fence (a consultant); I would say it depends on the stage your startup is in, on whether a consultant will get founders stock with the same liquidation preferences as the founders, on how close you are to a funding event, etc.  Probably can give you a better idea if you can provide more details - here or just PM me.

Hope this helps,
-- Max

Rob Edenzon Acting Vice President, Sales at Armorway Inc.

July 13th, 2015

Allison, there is nothing wrong with you, your company or the relationship you have with your consultant.  I've been doing start-ups for 30 years.  I've been paid many different ways including stock options.

The comments about your consultant joining as a co-founder are ridiculous.  If I joined every start-up I've consulted for I'd be homeless.  A consultant that has values similar to yours and is willing to reduce their fees in exchange for options is the perfect match.  The options provide some skin in the game providing them with the opportunity to get some reward for their efforts.

I was told a long time ago that getting 3 options for each dollar of fees is good place to start.  You can adjust the ration depending on where you are with your valuation.

Finally, for the comments about consultants, consider that they are people.  Stereotypes are as useless when describing consultants as they are when describing any group of people.  If you've found a good one, keep building the relationship.  You would be hard pressed to find any of my clients describing me as some of the people on this string have described consultants.

Good luck.