Part Three: Equity vs. Cash

Andrew Neitlich
Andrew Neitlich

In the last blog (Part II: Equity vs. Cash), a reader who has given a start up reduced fees writes:

I’m in a situation now where the client has engaged me in a startup project at about 1/3 my normal rate. there have been other factors that contributed to my accepting half my rate, but those factors have started to diminish. I recently informed him that my rate would be increasing, and he replied with a message about passion and taking a risk and the project soon being very profitable – and promises of sharing in that profit. is there any acceptable way to demand a contractual share in that phantom profit, or to somehow insure that i will receive a share if/when his project becomes profitable? I can see myself being involved and getting the shaft once the $ rolls in.

Here is my response:

First, it is becoming apparent that many readers of Sitepoint are very generous people. Too many of you don’t seem to mind being the doormats of entrepreneurial ventures. Thank you for keeping capitalism going! Your passion and willingness to take risk (the same risk that the capitalist has shifted to you, so that he no longer has as much) is helping to fund lots of ventures.

However, are you sure you are not confusing passion and willingness to take risk with low self-esteem and inability to negotiate?

If you want to start making money from these start-ups, you have to get smart and assertive.

In the case above, the reader has three options to “demand” a contractual share in the phantom profit, should it emerge:

– Insist on increased fees and cash up front. Tell the capitalist it is his problem how he finds cash to pay vendors. You as a web designer are not a principal in the venture, but a contractor. Your upside is low, and so your downside should be low as well.

– Create a loan to the company. This is a note that the company owes you, is a legal document, and appears on their balance sheet as a liability. It should specify how much they pay you and when (including interest), regardless of profit. It should also note that shareholders and principals will receive no compensation until the note is paid. Why should they get paid if you don’t? After all, they have a long term interest in the value of the enterprise that you do not.

– Create a contract specifying that you get x% of any income from the venture, with a clear mininum absolute dollar amount after a set date, regardless of the company’s profitability (so this arrangement is part loan part income participation). That way you limit your downside and have some upside. Be sure to explicitly define income as revenues minus expenses PLUS any principal compensation. Otherwise they will burn you by having zero income while taking lots of income (which is what Hollywood producers tend to do when they give points to actors). Personally, I oppose this kind of arrangement as it is complex and requires you to have access to the company’s books. Also, you might also specify that if the company is sold or issues any dividends, you are eligible for y% of any proceeds.

In my opinion, the best thing to do — and lots of great web design firms do it — is to establish yourself as valuable, and get paid up front. Raise your self-esteem and willingness/ability to negotiate and assert. And be willing to say no to deals that don’t meet your revenue expectations. (As noted in last blog, take a job for low pay if other factors come into play for you; but long term that won’t feed your family).