Equity advice regarding paid contractors wanting equity instead
Looking for some advice. I'm currently developing a product, I've done all product design, financing, market fit analysis, marketing, and business development. My intention is to operate the company by myself after it's been built.
I have connected with a visual designer, backend, and frontend dev who are interested in helping build the MVP for payment.
They are now, assuming after having seen value in the product, prefer to take equity rather than cash to build the product. Or maybe a mix.
My original plan was just to use them to build it, and part ways effectively, and maintain a retainer relationship if needed.
With this recent turn of events, I'm considering the equity route in lieu of payment.
What recommendations would you give for this situation? These contractors are good people, and not strangers, so I don't foresee much risk or trust concerns.
Any tips on percentages, voting/non voting, vesting periods would be helpful too!!
If you can pay $$ and not equity, and you intended to pay $ and not equity, and you didn't have any long term plan on selling equity, than don't sell equity.
Just be honest, say it's not for you to sell equity ask for a full $$ offer and get that contract.
If this starts to get problematic, find another provider.
There is a lot of extra stuff you'd have to deal with having partners you didn't plan for or wanted to have..
Also the negotiation and everything around is more complicated.
You'd spend a lot of time on this, and if you don't need it, just don't
There is only few reasons to give someone equity.
They're going to join the team and they will be good assets in the future as the company grows. In other words, you intend to have a long term relationship with them as partners or employees.
You don't have cash to spend on contractors and need help getting an MVP put together. As long as the equity is small (10% or less), future acquires or investors will understand.
Someone is investing money into your company.
Percentages all comes down to how much effort each person is expecting to dedicate to the startup. If you went to an investor for a seed round of funding at the idea stage, then you should expect to let go of up to 20% of your company. This is like getting an investment at that stage. I'd highly recommend keeping it below 10%, unless they're joining as co-founders.
In terms of vesting periods, voting rights, etc, please get a lawyer to help you iron it out and provide agreements. It's worth the money.
Hi Jay,
Regarding the 10% limit suggestion, is that per individual or in total? Currently it is 3 people, so potentially 30%, while I'd have 70%.
I do like the idea of using a vesting period with a one year cliff.
How is equity divestment handled should one with equity resigns or is terminated? For a resignation, are they paid out, and how and who determines the rate? For a termination, do they forfeit some or all of the equity or get paid out?
Thanks
10% limit for all three. Unless of course you decide to bring them on as partners or they invest money. Then that value increases. In the end, you can increase that figure to whatever you feel comfortable with. I'd use it as soft limit for yourself as a target for negotiations.
Equity divestment is handled in the stock options agreement, which should cover any forms of termination or resignation. In that agreement, it would also specify when and how the shares become vested, including after termination. There would also be a period in which they'd need to exercise any shares that are vested after leaving the company (typically 90 days), or they'd be forfeited.
This agreement should be drafted by a lawyer that specializes in business law. I know it sucks to dish out the money, but you'll be thankful down the road if things go sideways.
Thanks for the explanation, Jay.
Regarding equity divestment terms, how would one determine the valuation of each stock, assuming the business isn't self sustaining yet? And if it becomes so in the future, does stock value adjust again?
You'll need to determine a valuation for your company. Since it sounds like the company is just starting, that value will be very low, allowing for limited tax liability. You'd need to work with your lawyer to determine how many shares will be allocated for the company. The number of outstanding shares and the current company valuation will provide you the value of each stock. As the value of the company increases, so will the value of the shares. Keep in mind, valuations typically only happen when a company is initially started and during major events (investments, acquisitions, etc.).
I can't really speak to specifics on what best to choose, since it needs to be tailored to your needs and the laws of the country you're setting up your company in.
That helps a lot, Jay.
I'm considering setting aside a reserved block of equity for future needs or investments, after splitting equity between founder and first-employees/co-founders.
Do you have any recommendations on how big that reserved block should be? 10%?
Thanks
Two ways to handle that.
Reserved block, as you've already suggested. This is most typically done for employee stock options for future hires, since it's easier to plan for it. How much you set aside really depends on how generous you are, since it will likely come out of your percentage. 10% seems to be an average number I've seen.
Wait until future needs arise and then create more shares. This is what typically is done for investment rounds, but can be done for employee reserved options. This will cause existing share holders to get diluted, unless share holders have anti-dilution clauses in their agreements that restrict it.
Personally I'd hold off for now on #1 unless you know for sure that you'll be hiring employees in the near term.
I would say no unless they want to be a team member focusing "100%" on the product. Equity can be costly, very fast, if you get any success. Having dead equity in the cap table is a big red flag for future acquires and investors alike. Even if you go with the equity path, use vesting for equity option instead with a standard schedule (4 years with 1-year cliff).
Are you planning on selling the company / exiting? If not, there's no reason they would want equity.
This has been especially helpful feedback. Thanks everyone.
Some clarification on my part. I don't plan to pursue any investments, rather bootstrap it myself, so I don't think there should be much risk of scaring off investors down the road. Acquisition though, as one of you kind people noted, could be a possibility (dead equity).
I would consider acquisition down the road should it ever get to that. Regarding dead equity, I'd assume they would be bought out at that point, no? The company can also reserve the right buy them out at any point?
Regarding the less than 10% suggestion, is that per individual or total? I'd be currently looking at sharing equity with 3 others, so total equity split should not exceed 30% for all of them?
I do like the idea of the standard 4 year with 1 year cliff.
I understand the idea of keeping the question of cash/equity open, but I'd like to formalize something so that they feel comfortable either proceeding or leaving. I'm not sure how to proceed with the open question suggestion.
Hard question. Giving equity away now can create massive momentum and speed but will always to lead to struggle and hassle in the end. Every relationship will end at some point. Another strategy is keep the notion means to keep this question open, neither saying no or yes.
Unless you’re very tight on cash, I wouldn’t give up equity unless this person has the ability to make the product successful beyond what you can already do.
Plenty of guys needing to make cash. Equity is precious if you’ve got the capital stored up already.