When a startup-new business offers equity as payment for services, why/when is it valuable v cash?

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December 18th, 2015

Equity offers, for services, work, advisory or consulting particularly in a startup, idea stage or new businesses  always makes me wonder why it is worth accepting as payment.

How does equity in lieu of cash payment translate into real cash payment for services, consulting, taking charge of a section of the business?

When is the equity actually worth real cash?

Why is equity in a new, unproven business worth accepting?

Please help me and others understand this and even, how to structure an equity deal so its going to actually become real cash as payment.

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Mike Moyer

December 18th, 2015

Equity only has value when someone offers to buy it. This only happens when the company proves that it has the ability to generate income using a reliable and sustainable business model (in most cases).

It is not worth what someone tells you it is worth. It is only worth what someone pays you for it. If there isn't anyone buying then...probably not worth much.

When someone accepts equity, instead of cash, for their contribution of time, money, ideas, advice or anything else in a startup it means they are willing to accept risk. The amount they are risking is equal to the fair market value of their contribution. They are, in effect, betting the fair market value of their contribution on the future outcome of the company. Because most bootstrapped companies have no value, it is impossible to calculate shares based on absolute value. 

The only way to do it is to use relative value. So, equity should always be calculated by dividing one person's risk relative to all the other people in the company.

I've written a book about how this works. You may have a copy if you contact me through SlicingPie.com 

John Seiffer Business Advisor to growing companies

December 18th, 2015

As Mike said, equity only has value when someone offers to buy it. In most cases that won't happen till the company gets acquired or goes public. The way most term sheets are written, even when a company is profitable it often doesn't benefit the share holders (who own the equity) because the profit is used for growth not dividends. 

Taking equity in exchange for services is like taking a lottery ticket in exchange for services - only probably with less of a shot at a pay off. If you'd be happy doing that because you want to work with these people or just need something to keep you off the golf course then do it. But don't expect it to pay the rent. 

Thomas PhD Director of Operations & Growth at Brighterion

December 18th, 2015

I used to run a company that built minimum viable mobile apps for non-technical founders to shop to investors in exchange for equity positions in those companies (also some paying customers). Although several of these companies went on to raise funding rounds, not one of them ever had an exit event. As a result, we never made any revenue off these customers. It's important to keep in mind that the expected value of shares in a startup is exactly $0. It makes sense to take shares as “sweaquity” when you have input into the direction and actions of the company; however, in my opinion, it makes no sense to take equity in lieu of payment in the context of accounts receivable for services/goods rendered.

Neil Gordon Board Member, Corporate Finance Advisor and Strategy Consultant

December 18th, 2015

Accepting equity in exchange for services is essentially friend/family/angel financing where the service provider invests time rather than cash. With some up front due diligence, value in and value out can be (and should be) about the same. A lack of liquidity does not in and of itself suggest a lack of value.


December 18th, 2015

I'm making this up- does anyone disagree?

You should be able to create an agreement that your shares will be purchased by the company at some point. I'm considering agreeing that 1/4 of revenues will go towards buying their equity at a certain price. We're using Slicing Pie, so if this before we slice the pie, they'll be able to get cash for some of the "value" they put into the pie.

Also, one family-investor wants to give us a loan instead of an investment, so that will be paid back from revenue or other investment (if the investor agrees.) We'll probably get donations as well, so I'll designate that 10% of donations can go to pay this loan back as well.

Rob G

December 18th, 2015

There is a significant secondary market that has developed over the past 5+ years such that founders now have a third option - acquisition, IPO, sell some shares on the secondary market.  This is only a real option for companies with real traction and significant equity funding. I do not have experience with this secondary market personally, but my assumption is that this is really targeted toward getting founders some liquidity so they can breath a bit and stay focused on growing the business. It may also offer some liquidity opportunity for early investors/equity partners.  It is also feasible to structure a service for equity exchange that can be liquidated upon funding.  Why it is worth accepting is the same reason angels and VCs invest in startups - the chance for home runs. 

Umesh Sethi

December 19th, 2015

An offer which is simply equity for cash would make me nervous. We build software solutions - primarily for large pharma but have helped some startups as well. But i don't think a zero cash model would work out for application development for startups - what'd be a workable solution is more of a hybrid model. A marginal cash component which generally covers the cost of the vendor- the difference b/w normal market rate and this component can be the equity the vendor invests in that startup. Even here the vendor should have a transparent view of the company's future and equity dilutions etc. possible in future. Basically even this equity model will only work  in long term - if it gradually transforms to a proper client vendor relationship once the startup is fully funded and on its feet.

Scott McGregor Advisor, co-founder, consultant and part time executive to Tech Start-ups. Based in Silicon Valley.

December 19th, 2015

Equity is only worth real cash when there is a market for it, that is, when shares of stock can be sold. This is called "liquidity". When a company goes public there is such a market. Then the value of the equity is determined by the share price it is currently trading at. When a company is private, the market is very limited, and there may be additional restrictions on who you can sell your stock to and when. For the most desirable of such companies (think Facebook before its IPO) there is a small market of qualified investors who may be eager to acquire shares and there are a few places like SecondMarket.com where these secondary market trades can take place. But for early stage, unproven startups there may be no interest, and it may be difficult to find a buyer. Equity in a new, unproven business may be worth accepting for the same reason that so called junk bonds may be worth accepting - they offer the potential for higher than normal returns. But the risk that the company will fail is high, so there is also the potential for losing the full investment. Each investor needs to make their judgement as to what their personal risk to reward ratio is. The willing buyers collectively determine what the market valuation of the company is, and therefore a risk adjusted share price. If you think the amount of shares you are being offered are valued more than the cash you would normally be paid for your work, you might consider the equity worth taking. However, if you are highly risk adverse (i.e. you can't afford to lose it all), it may be worth nothing to you, and yet it might have more value to a speculator who can afford the loss, but is looking for an exceptional routine if the company succeeds.

John Currie ITERATE Ventures - Accelerating Science & Technology Ventures www.iterateventures.com

December 20th, 2015

Neil - this is a good question, as I get it all the time (and people do think I'm crazy for accepting equity in lieu of cash). It is indeed extremely risky, and difficult to value shares with early stage.

#1 is the Context - I INVEST in companies [by providing some key value they need]. The investor perspective is very important. I like to work with ver-early-statge, mostly as a cofounder.  The ball is in my court to be able to pick winners. This model is now very common btw, used by most of the early stage accelerators out there [std. deal = 6% of co. equity at Series A, hopefully on graduation day].  This bunch has replaced the pre-revenue VC, and you can research their numbers.

Your question about services provided or taking charge of a section of the business has to do with the Operational scope of the venture's needs, the provider's goals, etc.

[When is the equity actually worth real cash?]  Early Founders, investors, & equity holders' bet pays off at some liquidity event, usually 3-5 years in, such as an acquisition or re-capitalization by a much larger investor. There are circumstances to get liquid earlier (Rob points out a good one)

]Why is equity in a new, unproven business worth accepting?]  Because you see something of real value, ahead of the curve, and know who will acquire it and why.  Or, perhaps the team is top-notch, needs what you bring to the table, and would be a lot of fun to work on.  There are other reasons - for INVESTING.

[How to structure an equity deal so its going to actually become real cash as payment]  You get your cash when the investors and founders - alongside you - get their cash.  (The topic of Preferences is sidely discussed in early stage investment docs.)

Hope this helps.  Be glad to have an offline convo about it.

David Siegel

December 26th, 2015

Keep in mind that if you work for equity you can incur a tax liability in that year if there is a benchmark for valuing the company above zero, like a funding round. This has gotten plenty of people in trouble with the IRS.