Guide to taking equity instead of cash for projects

File this one away somewhere as it could make or save you lots of money someday. Seriously — this is perhaps the most valuable blog entry that I’ve written.

Equity is coming back in vogue as a form of payment for all sorts of services to companies. It is crucial that you do not become a sucker in these sorts of deals, as someone unschooled in equity compensation can easily get burned.

The following guidelines are principles in evaluating deals where you might take equity (e.g. stock or stock options) in lieu of cash payment. The fundamental principle is simple: The less attractive the equity portion of your payment structure, the more cash you should negotiate.

1. Free trading stock is the best of all worlds. Get free trading stock whenever you can. It is stock that you can trade in the open market.

2. Avoid taking equity from companies that are not publicly traded, or do not have a published schedule to become so. Stock is no good unless you have a market to sell your stock. Lots of companies offer equity, and structure it in a smart way — to ensure that they pay you little or no cash and then never have to deliver on the promised equity. The first step in not getting burned is saying no to companies that don’t appear to have any prospect of getting liquid (being bought or going public) soon.

3. Options (the right to buy stock at a set price) are fine, but be sure that they vest quickly (e.g. within a year). Insist on vesting up front for a portion of the compensation, or you risk the company terminating your contract before you are vested.

4. In any vesting situation (e.g. where you own the shares over time), negotiate a clause that if the company is bought or if the company terminates your contract for reasons other than cause/performance, all equity vests immediately. I myself was a sucker at one company where they terminated my contract just before the shares vested, and now the company has recovered and is doing well again — but I have no shares. Learn from my loss.

5. It is NOT the number of shares you own, but the value of the shares you own. I’d rather take 1 share of Berkshire Hathaway (priced around $90,000 per share) than 100 shares of IBM. Make sure you figure out the value of the company (an accountant or financial analyst can help you), divide the number of shares outstanding, and see what the shares are worth now and what you think they can be worth later on. I worked with a company that suckered people by offering tons of shares, when an analysis of share value showed they were worth pennies each at best.

6. Get an anti-dilution clause if you can. Otherwise, as the company raises more money, you will see the value of your shares decrease.

7. You can NEGOTIATE almost anything, if you know what you are doing.

Taking equity is risky, but it is also an excellent way to earn returns far in excess of your hourly wage.

Save this, and get educated on how to structure compensation with equity. In general, you want to avoid equity because most deals don’t meet the above criteria, but you also WANT TO BE READY IN CASE YOU FIND THE ONCE IN A LIFETIME COMPANY WHERE YOUR STAKE CAN GROW TO MAKE A MAJOR DIFFERENCE IN YOUR LIFE.

Trust me. I found mine this year, after lots of misses.

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  • http://www.oneafrikan.com oneafrikan

    Hmmm Andrew, that’s going to get a lot of people asking you with what!

    Good for you, and thanks for the rich content you give us…

  • http://www.dvd-software.info hurricane_sh

    Investment is very new to me, read something online recently, but dare not to dive into it.

  • DShaz

    So, if someone has a startup idea and wants me to build their product, I should probably walk away right? They can’t pay me in cash, and it is doubtful they will go public any time soon, even if they manage to do well.

    Are “pay me with interest when/if you get the money” contracts ever an option?

  • http://www.developedsitesales.com Cutter

    Excellant info; they don’t tell you this in school.

  • pmackey

    Andrew – great article. One add if I may be so bold – equity compensation may fall out of vogue due to new accounting rules taking effect in 2005. Companies that issue options will have to take a hit to the income statement – making some rethink issuing them.

  • jd

    Definitely food for thought. I am currently in the position of taking options in exchange for part of my compensation from a client, and I wish I had known #4 a few months ago. Thanks for the insight.

  • Andrew

    Hi, I was wondering if anyone might send me some sample deal documents where a service provider, such as a martketing or law firm, took less cash and some warrants/options/stock in lieu of full payment. Please send to andrewmwalsh2@hotmail.com. Thanks!

  • Mahesh Sawaiker

    What happens if when the company is sold (it is not public), but it is sold for cash rather than equity?? In this case only founders make money am I right?