Legal structures · Founder equity

How to structure equity deal with a new hire in US market?

Richard Pridham Investor, President & CEO at Retina Labs

August 9th, 2016

I have joined and invested in a Canadian telehealth software company that, since inception, has focused on the Canadian market exclusively. I see a much bigger opportunity for us in the US market. The big challenge is figuring out how to penetrate this market. It's large, complex and profit-driven which is very different from our socialized healthcare system in Canada. While I have experience in healthcare, I don't know the US market very well. So I'm currently evaluating different route to market approaches. We can try a direct sales approach, establish partnership channels or try to lure the right person on board (feet on the street) or combination thereof.

In my discussions with many people in the US I have come across an individual who might be a great fit for us. He possesses 20+ years in the telehealth field (business dev, sales...), knows the US healthcare market intimately, has a ton of contacts in the very target market we're going after. He also loves what we're doing, our products and sees a huge opportunity. He's currently working as a consultant, advising some healthcare startups but is looking for something permanent. 

The only problem is that we can't afford to pay him anything right now. He's open to exploring some creative solutions. One possibility might be stock options. But he's in the US and we're in Canada. Perhaps this might be complicated and might not provide a sufficient enough incentive. Of course, if he sells our products he'll get a good percentage of the deal but sales cycles are not quick and I'm not sure I can sway him to work on spec. 

I thought of another approach: We can set up a company in the US and give him actual equity. Maybe 10% to start with some performance-based option to earn more equity. We'd build in a minimum retention period for the equity. So out of the gate we own 90% and he owns 10% but has to work for no comp until sales result. All US sales go through the US subsidiarity and the Canadian company provides the IP, technical and marketing support. Maybe the parent company charges the US company a support and admin fee based on a % sales.

Does this approach make sense? Any downsides or pitfalls to avoid? If we went with this approach, what type of US corporation do you need? I understand that there are different types and jurisdictions in which to incorporate. 

Richard Reed

August 9th, 2016

An equity based approach can solve a lot of problems for both the company and the external party. A common route for this approach is to do exactly as you say, setup a new entity that you can allocate equity to advisors etc. Unfortunately there is no easy answer from a tax standpoint (either for your company or the advisors). The easiest entity to setup in the US is typically a LLC and allocate profit interests. The problem here is that it is often sub optimal from a tax standpoint during a sales/exit event. As a result, I have seen many groups opt to setup a C-Corp in Delaware (most favorable corporate law for a corporation) and issue some form of stock unit to the advisor. This can take on many forms such as a stock option (but you need to have a 409A friendly service manage this for you to avoid compliance issues) or a restricted stock unit. Whatever unit you select, it is important to have the stock vest on a performance basis so that if you need to part ways with the individual, then they only get equity for work completed. Also, it is common to have a cliff, but this may be a challenge for a purely equity based compensation package. Targeting for 2 or 3 year vesting with a 6 month cliff would be a typical structure for a grant if the advisor is amenable.

Mike Moyer

August 9th, 2016

You are opening up a new market in partnership with this guy. He is putting his compensation on the line. The new market is a gamble, he is, in effect, betting his compensation on the future outcome of the business.

What are you betting?

The bets will continue until the market becomes profitable. You have no way of knowing, for sure, when this will happen.

So, rather than guess the split (10/90) use the bets to caculcate the split using the Slicing Pie model. Slicing Pie is a formula for determining the right equity split based on the relative fair market value of the contributions of time, money, ideas or any other contributions that are unpaid. It is the only fair way to solve this problem. ALL other methods are guesses (at best).



Susan M.A. Strategy, Organizational Transformation, Talent Consultant, Capital Markets: Author & Presenter.

August 9th, 2016

Really good feedback. Keep Canada as your domicile. One of the most prevalent mistakes entrepreneurs make is forgetting that the vp of sales can change the growth pace and subsequent company image. Treat that individual as a significant partner. Be smart with the structure but be willing to offer 20% of the company at a minimum.  

Giles Crouch Digital Behavioural Economist | Speaker | Writer | Technology Strategist | on Twitter @Webconomist

August 9th, 2016

While I think Mike Moyer proposes an interesting and applicable model, it may not work well for US-Canadian operations. When actual money enters the situation, everything changes. Ideals are nice, money isn't. Having extensive US/Canadian experience with setting up offices in the U.S., a major mistake many Canadian startups make is to move into the U.S. market before they're really ready. The implications are taxes, warranties, guarantees, customer service etc., which few startups consider.

Perhaps ensure you can answer those issues first. When ready, register a Delaware LLC as suggested before. Have you contacted the Canadian Trade Commissioner offices in Silicon Valley, New York etc.? Can you find a U.S. partner (as in a company with actual reach) to partner with in the health care sector? Striking a deal with an individual can bring risk (especially if they ask for exclusivity) when/if things go wrong. I've seen both good and nightmare deals around Canadian startups entering the U.S. before they really understood what was happening. Most fail because the lure of the large market that isn't a monopsony is so tempting.

Richard Pridham Investor, President & CEO at Retina Labs

August 10th, 2016

I'm with Giles in that the Slicing Pie model, however interesting, may not be applicable here. Ideas and other forms of contribution are great but are not really quantifiable. Plus, this model is after the fact adjusted. This can get really complicated.

We are just at the beginning stages of how to approach the US market. I'm talking to potential partners. Partners makes sense but finding the "right one" that will actively promote your product is not easy when they're selling a bunch of other solutions. I've worked with partners in my past companies with mixed results. My gut feeling is that a hybrid approach is going to be what works best. That means getting a someone on board in the US market who really knows the system, who has the right contacts and who can frame the value prop in a manner that is compelling to healthcare execs. I think we may have stumbled on this individual but obviously we have to vet him properly. When you can't pay someone a salary, you need to come up with creative ways to make it work and incentivize them to take the risk.

On top of this, we also have other facets to explore such as FDA regulatory approval, HIPPA compliance, the need to integrate with HIS/EMR systems (EPI, Cerner...), hosting, Patriot Act issues...

Gillian Muessig COO, Board Chair at brettapproved, Inc.

August 10th, 2016

It is my experience that salespeople are motivated and get personal satisfaction from the close of the sale and financial remuneration at that time. While not in every case, in the great majority of cases, the finest salespeople prefer to elect where and how to invest or spend that capital themselves, rather than having the capital locked up in stock in the employing company. Something to consider - are you trying to compensate a salesperson in ways that may not meet their emotional and working style? ASK the salesperson how s/he would like to structure an agreement. You may be surprised by the simplicity of the answer. In the event, the salesperson does want stock - many people own stock in foreign corporations. If the salesperson is seriously interested, a call to her/his attorney or even tax accountant will enlighten them as to how that works and what taxes might be involved in order for her/him to determine the sum of shares s/he would like to request in exchange for long term services. Gillian Muessig Outlines Venture Group C: +1-206-930-8133 S: gmuessig @SEOmom