Investors contributing services instead of cash: How is this regarded by other investors?

Joseph Galarneau Founder and CEO at Mezzobit, creating transparency and control for Internet data

August 19th, 2013

We have a potential investor -- a major offshore integrator -- who's thinking about investing in us by providing development services instead of cash.

There are well-established legal and tax methods to handle this and convert it into equity. But I wonder how the VC community views this type of investment. They usually aren't keen on strategics to begin with, and this is a further wrinkle (as the cost of those services is less than 50% of their FMV and there's a time value to them, unlike lump sum cash).

However, from my standpoint, if such an arrangement helps one of my investors make a 2x impact on my outbound cash flow, that seems like a win. In other words, I'd rather them give me development services that cost them $N (but worth 2.0-2.5 x $N)than a check for $N. Any experience with this that can be shared?

Jason Woodlee Sr. Director Cloud Products at Datapipe

August 19th, 2013

So you are giving up a % of your company to a company that will have a team working remote from you taking local direction from a local management team. At a minimum your ability to build your ideal culture will be stifled you may be prevented from hiring/firing at will. What about the protection of your assets that are being built? Who will own the code? I have worked with offshore teams in 3 companies over 9 years and I can tell you its not cheap, not easy and not better.

Seems like a potentially problematic relationship..

Mike Moyer

August 29th, 2013

Hi I wrote a book on exactly this subject. It's called Slicing Pie (www.SlicingPie.com) and you may have a copy if you shoot me an email to mike@slicingpie.com.

The book outlines a method for allocating exactly the right amount of equity to anyone who contributes something to your company. Contributions could be time, money, ideas, relationships, etc. It uses a dynamic equity split to allocate equity to the people who deserve it.

Winston Kotzan

August 19th, 2013

That really obscures the definition of investing! If your "investor" is not offering cash but services alone, then that person is not really investing, they are partnering. I think a good investor will provide a lot of advice on how to run your startup (it shows that the person is actively involved in the investment), but without a cash transaction than no investment is actually made.

John Litz Founder, CEO Thumbkandi

August 19th, 2013

Perhaps consider structuring it as " advisory equity," which should always vest over time.

Joseph Galarneau Founder and CEO at Mezzobit, creating transparency and control for Internet data

August 24th, 2013

Thanks for everyone's input. Lots of good ideas. Just a few quick words in response:

1) Winston: Investors have different value adds, particularly with a seasoned founder team like ours which may not need as much hand-holding. We would pick investors in part on how they can help us, and this particular candidate has lots of appeal in terms of providing in roads to a bunch of different potential customers as well as exposure to tech on our roadmap, in addition to helping add firepower to our engineering effort.

2) Jason: Managing geographically dispersed teams is always a challenge, but I've done it for more than a decade with a fair amount of success. I view using resources like this in the early stage as an easily scalable "force multiplier" to my core engineering team, as not everything you build is rocket science. Sometimes, you just need a factory to augment founder innovation. Also, because I'm constructing high-availability enterprise software, I'm able to do the necessary QA without blowing my budget. IP protection isn't an issue if you're dealing with a reputable firm in the right jurisdiction and know the IP issues going into it. All valid concerns, for sure, so thanks for that.

3) John: Interesting idea. One of the big issues is that service delivery would be over time, so you get into a bit of an NPV issue when compared to investors who are just cutting you a check. I think that we have the accounting and legal issues squared away, but we'll find out shortly how the other potential investors feel about it. I suspect that for a growth-stage investment, there may be more issues, but my gut is that seed investors would be more tolerant of creative investment forms as long as they receive the proper accounting treatment.

Anonymous

August 28th, 2013

My experience has been that investors putting cash into the business very heavily discount services or other "sweat equity" contributions. If it's a "big name", established, professional services firm providing the service contributions, this may be looked at a bit more favorably than individuals or small businesses, however I'd still expect the value to be discounted by investors contributing cash. I'd be very interested in hearing about the experiences of others who have had more favorable transactions with cash investors who don't heavily discount service contributions.

Duane Nickull Chief Marketing Officer, Co-Founder at Cheddar Labs

August 29th, 2013

Be very careful!

Contributing means your IP is no longer your IP. It also means that they have a say in your direction.