Paying for Services with Equity
Transcript
Welcome back. In the last couple of weeks, I've had the same question asked multiple times. Seems like a great opportunity to do a video. So I've had a couple of entrepreneurs who have asked me about how they facilitate paying for services from a contractor with equity instead of cash. You see, as an early stage business, many times you have more equity than cash and it sounds really attractive. And at the surface it is. The problem is that you have more equity than cash.
have to align expectations. And too many times these deals are done for a fixed amount. For
example, if someone wanted to build my website and said, oh, I'll build your website for 2% of
your company, that may sound like a fair deal, but actually neither side is happy in the end
because I always want more for my website. I always want more and more and more and more.
And the contractor who built it, they felt like, whoa, I already did all my work. I only got paid
2%. You can't keep coming back to me for more and more. And it creates tension. So I have a secret
I want to share with you as an interesting way that you can go to build this services for equity
transaction that is completely fair, has consumerism, and even the IRS likes it. Let's
take a look. Let's go to the whiteboard. Let's assume that you have a company and a contractor.
The contractor is going to build the website, and we don't know how much the website's going to cost,
and we don't know how much equity to give for the website.
So what happens is the contractor does a bunch of work and then sends over an invoice.
And they send over an invoice for the initial work, and let's just say that it's $2,000.
They send over another invoice, and when they send over the invoice, that one might be for $1,000.
Doesn't matter.
At some point the project is finished and when the project is finished we have a total amount that the company owes the contractor.
Sometimes you think the project's finished and it's not actually finished.
Oh we got some more work to be done so another invoice comes over for $500.
We now have a new total. This can keep going on and on.
The agreement between the two is I am not going to pay you the cash.
I'm going to hold on to the pile of invoices.
Now, at the time that I raise my first round of financing, that's when we'll settle up.
And here's how we're going to settle up.
The company is going to write the contractor a check for the amount owed, in this case $3,500.
But at the same time, the contractor is going to write the company a check for exactly the same amount, $3,500.
No cash, actually, net cash changes hands.
And the reason for doing this two transactions is the first transaction was to pay for the invoices.
The second transaction was the investment in the company.
You see, this $3,500 turns into stock.
And guess what?
The contractor got exactly the amount of stock that is proportional to both the amount of work done
and the price that was paid by the other investors.
It's perfectly fair.
Two other really interesting things have happened here.
The first is that there is a record of the work done by the contractor for the company.
That actually shows up as revenue on the income statement.
And it's really important that that check exists.
The other thing that's really important is there is a record of what the basis or how much the contractor paid for that stock
so that they will only pay capital gains on what's above it.
the IRS thinks of this as totally clean. So at the end of the day if you want to
work with contractors in a way where you pay them equity for the work performed
I suggest that you set it up that they bill you for the actual work performed.
You then have to make a consumer decision. Do I want more work done? Oh that's going to cost
me too much money. No I don't. Yes I do and you will decide exactly how much work gets done
and have control over what the total is.
In that next financing,
you do an exchange of the same amount of money you owe them
and then they write it back to you.
The check to them was to pay for the revenue.
The check back was to buy the stock.
In the end, they get the stock.
The net is $0 changed hands.
They've worked for equity.
They've gotten exactly what they deserved.
I hope this is helpful.
Often times early-stage businesses have more equity than cash, which begs the question, can I pay contractors with equity? Check out today’s MATH 101 for Troy’s tips for building a services for equity type transaction that is fair for both parties, and even the IRS likes it!
Originally published on the MATH Venture Partners blog.