Swapping Equity for Services

Before going ahead with an equity trade, consider alternatives, and be sure to formalize the arrangement with an attorney

By Karen E. Klein

How do I advertise and implement an arrangement to trade equity in a company for skills or work? I'm looking for a Web developer who wants a stake in my new business. —C.W., Mountain View, Calif.

Swapping equity for services became popular during the 1990s dot-com boom, when stocks in startup firms were a hot item, says Rohit Shukla, CEO of Larta Institute, a nonprofit commercialization services company based in Los Angeles.

Even after the dot-com bubble burst, such arrangements continued. And it is likely they will become increasingly common as emerging companies bootstrap their way into this economy, Shukla says. "Two factors will make this more prevalent: One, the number of unemployed service providers who are unemployable in this economy; and two, the fact that they are floating around, looking for something to sink their teeth into rather than do nothing," he says.

For instance, his firm posted an ad at Monster.com (MWW) for a Web designer and had 150 hits within 20 minutes, he says. "A cursory look at a broad sample of them shows they're all extremely qualified."

Of course, cash is king during a recession, and you might find some reluctance to an all-equity swap, says Peter Justen, CEO of MyBizHomePage.com. "It's great in theory, but it might be tough to arrange in this market," he says. Another approach he suggests would be a delayed payment schedule, where you'd either elongate the terms of the invoice (90 days rather than 30, say) or arrange to start payment 90 or 180 days after the project closes, when presumably your firm has begun attracting revenue.

Or you could use a hybrid model, where you agree to pay a substantially discounted fee in exchange for equity. "The issue is that the startups always think they're going to be the next multimillion-dollar success, and the odds are against that," says Rod Underhill, a serial entrepreneur, author, and law professor. "So the service provider is taking on a hell of a lot of risk, and [most] startups are trying to offer way too low an equity position for these people."

Making Your Case

Your first challenge is to convince the Web designer that your company is likely to grow and profit, making the stock that you're swapping valuable at some point in the future, Shukla says. "Obviously, the more inevitable the growth scenario and trajectory and the more compelling the value proposition, the more attractive the swap becomes to the recipient."

Your second—and probably tougher—challenge is to value your company so you can price the stock accurately. "This is difficult for a startup with no revenue. You have to look at your intellectual property, sustainable unfair advantage, and other factors, and reach an understanding on value," says Underhill. "It boils down to a mix of a leap of faith and a hard-headed assessment of the business prospects offered by the startup."

You can look for Web developers through social networking or professional job-hunting sites, such as Facebook, Dice, Craigslist, the Intuit forums, Elance, and PartnerUp.