“Can we pay you in equity?” -Anonymous Startup Founder
It’s a common question I get from potential startups/founders when I attend events at Startup Houston, Houston Technology Center or Platform Houston. The answer, as usual, is it depends. For a new startup with lots of energy and minimal funds, trading equity for necessary financial and legal services seems like a no-brainer. Before executing this plan, however, budding entrepreneurs should consider the following:
Valuing the Company
Presumably, if you do not have enough money to easily afford a lawyer, then you probably also do not have enough cash to pay someone to value the company, assuming of course that the company is far enough along that you can value it at all. This valuation is crucial because the amount of equity you give needs to be proportional to the value of the services provided.
For the startup, you do not want an unscrupulous lawyer to take advantage of your lack of knowledge about the business environment, i.e., you don’t want to give him more of the pie than his services are worth. But, at the same time, he needs to receive enough value to make the risk of accepting equity worthwhile.
Finding the Exits
A second concern is having a well-thought out and doable exit strategy. I do not need equity in something that cannot be sold. Whatever the business is, it needs to be successful enough that an acquisition or IPO is a possibility. This is assuming of course the business does not fail, as 90% plus of startups are want to do.
Reconsidering Your Options
If you do have an idea that is the next BMC or Compaq but you do not have enough financing to pay the lawyer, perhaps you should either rethink your fund-raising strategy or reconsider your idea. A good/great idea should be able to raise some money. But, if this isn’t happening for you, something may be wrong with your strategy.
A very early stage startup can probably do most of its legal work itself. You should already be doing everything else, so teaching yourself about the law will benefit you and your company in the long run. At minimum, it will help defend you against those who would use the law to trick you. At best, you will have enough legal protection to get to the point where outside investment, and professional legal counsel, become an option.
That being said, if you feel comfortable valuing your business, have a handle on the exits and are competent to negotiate the legal mumbo-jumbo with an attorney, then trading equity is a great way to conserve cash and spread the wealth. The answer, as always, depends.
For ideas on how to self-form a LLC or corporation, check out this out.