A new way of thinking about the nature of compensation between businesses is promising to transform the relationship between service providers and their clients as the century draws to a close.
It's an idea espoused by a visionary breed of business owners who see its central tenet -- the exchange between companies of work for equity -- as an important step in the quest to unleash creativity and build enduring wealth for their companies and employees. In this model it is stock -- not cash -- that emerges as the catalyst for creating value.
Definition:
"Venture design" refers to an arrangement whereby a business forgoes all or part of its normal fee for an equity stake in a project or a company. The assumption is that shared risk will draw intensified efforts from all players, thus ensuring a venture's ultimate success and profitability. A hot topic among professional service providers such as consultants, lawyers, designers, and public-relations specialists. |
Lunar Design -- profiled by Inc. senior writer Edward O. Welles in April 1999's cover story, " How to Get Rich in America," -- calls this principle "venture design." When circumstances warrant, the industrial designer forgoes cash compensation and instead offers its expertise -- and that of its homegrown network of business experts -- in return for stock in a client's budding idea or start-up company. The hope? That "a dollar in equity taken in exchange for services rendered could someday multiply into $5, $10, or even $20," writes Welles.
Venture design clearly has the potential to add some serious sizzle to a company's earnings statement. But not every business will profit from taking stock in lieu of cash, cautions Karl Ulrich, a professor of product development at the Wharton School at the University of Pennsylvania. Ulrich, one of Lunar's virtual advisors, outlined the attendant risks of this new business model in an interview with Inc. Online's Mike McLoughlin.
Inc. Online: What types of companies are most likely to reap the benefits of venture design?
Ulrich: My basic sense is that it works for either very small or very large service companies.
It often works very well for one- or two-person firms to take equity in lieu of cash ... if you have skills that are in enough demand that you can really be paid market rates for them and you can keep your overhead real low. These companies can use the balance of their time for venture-related activities.
Larger companies of 40 or more professionals can get away with it because they can earmark 1% or 2% of revenues for venture design and still have that be a significant sum, while not subtracting too much from the basic business model.
The problem would be if you were a firm of say, eight or nine people, where 1% is not really enough time to do anything substantial, and yet to devote 10% really puts your business at risk.
Inc. Online: Are there any specific industries that can use venture design?
Ulrich: There are certainly some industries where it's more common. Two examples are furniture and toys. But I can see it working in a lot of industries.
It makes the most sense to me when the design aspect of the overall effort is really important and the designer is making an important contribution to the final product. If you are the client company, you want to choose projects where there's going to be a good reason for the design firm to have equity. You want the designers to have skin in the game -- to have a big incentive to do a great job where it is going to make a real difference to the commercial success of the project.
Conversely, if you are the design firm or other service provider, you don't want to enter into a relationship where your contribution is not material to the success of the product.
I don't think it makes very much sense to do it unless the service is integral to the success of the venture. For example, it doesn't make sense to exchange equity for janitorial services. No matter how well the janitor cleans your office, it doesn't make you more or less likely to succeed. And just because the janitor has stock in your company, that doesn't make him want to clean your office any better.
On the other hand, if you do e-commerce and your Web designer has stock in your company, that designer is going to think more about how to make it easy to use that Web site than how artistically perfect it is. And that's what you want that person thinking about. There, it makes sense.
Inc. Online: How might this affect the culture and management style of the company?
Ulrich: I think there are definitely some cultural and organizational factors that matter. You want this to be out in the open because in professional service firms compensation is tied very directly to profitability. If people think that the management of the firm is diverting resources toward crazy schemes, there are going to be incentive and morale problems in the organization. I think this is the kind of thing that should really be done by consensus of the key professionals of the firm so everyone knows what's going on and agrees on the basic strategic direction the company's taking.
Inc. Online: So, when does it make sense for a company to begin thinking about swapping work for equity?
Ulrich: Let's assume we're talking about larger companies and not the one- or two-person operations. If you have a company of 20 professionals, then you probably have revenues of something like $2.5 million per year. If you take 1% of that, it's $25,000 worth of services. That's just about enough so you can have a significant stake in a new venture if you invest in one of them -- a $25,000 project that you would do for someone in exchange for equity. Below [the 20-person threshold], you're either having to invest more than a few percent of your resources, or you're not able to ever devote a big enough chunk to be able to have a substantial impact on the project.
Inc. Online: What are some of the questions a company should ask itself about a deal, or ask a client, before entering into a venture design deal? Is there a due diligence process?
Ulrich: You should ask the same questions that any savvy investor would ask about a new venture. The basic ones that I would ask are:
