Taking Equity: How Much? How Often?
In her first stock-for-services deal, Sandra Gassman, CEO of MarketingFuel Inc., in New York City, took only 25% of MarketFuel's fee in cash, 75% in equity. "At that particular moment in our cash flow cycle, we were comfortable doing it," she says.
By contrast, Robyn Sachs of the $28 million advertising and public relations company, RMR & Associates, in Rockville, Md., would feel edgy forfeiting that much cash. As a rule, RMR takes at most 30% of its fee in equity. Moreover, Sachs limits RMR's equity participation to three customers, and $150,000 in fees, a year.
Compare that with the strategy of Scott Jamar, CEO of VisionStart Inc., a start-up consulting firm in Lafayette, Calif. Jamar takes up to 50% of his fees in equity and aims to take equity in all his clients. "It's a core component of what we do," he says.
The different approaches of those three CEOs reveal a marked trait of equity pacts: their individuality. Pacts vary widely not only from company to company but also from deal to deal. One factor has to be a priority: "Cash flow has to come first," says Linda Gill, managing director of the Cincinnati office of SS& G Financial Services. She suggests devising a formula for equity deals. One solid method is always taking enough cash to cover a project's out-of-pocket costs. "You still come out even on a cash basis if what you take in stock is equivalent to your profit margin," she says.
Elizabeth Horwitz, partner at law firm Cors & Bassett in Cincinnati, recommends diversifying your equity portfolio the same way you would other holdings. "Look at how angel investors do it," she says. "Most of them say, 'I'm better off investing $10,000 in each of 10 different start-ups than putting $100,000 in one basket."
Deciding what percentage of fees you'll take in equity is easy; assigning a cash value to private-company equity is not. In other words, just because you've agreed to take 25% of a $10,000 fee in equity doesn't mean you'll get stock worth $2,500. The value of private-company stock is a negotiable matter. "I worked with a consultant who, in exchange for $50,000 in services, got $40,000 in cash and options with an exercise price of 20¢ a share for 7,500 shares," says Horwitz. "It's interesting to figure how $1,500 worth of options relates to $10,000 in services, but the two parties simply reached an agreement."
Any equity-for-services discussion between you and a start-up should also cover how you want to receive the equity: as actual stock or as stock options. Many equity deals allow you to negotiate various terms, such as providing for a payout should an acquisition take place before you exercise the options. With options, taxes are deferred until the options are exercised. With stock, however, you have to report income right away. But Warren Goldenberg, partner at Hahn Loeser & Parks LLP in Cleveland, points out that getting actual stock can mean tax savings under certain circumstances. "If you think there's going to be a huge appreciation, you might take actual stock and pay the income tax up front. When you dispose of the stock, any appreciation will be taxed at the capital gains rate, which is far lower than the general income rate," he says.
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