What questions to ask when somebody offers you an equity in his startup?
I own an IT service company providing development services to clients.
Recently one of our clients offered us an equity in his startup against the development services we provide.
He will give us shares worth of X amount per month for 3 months. The risk on our side is 3X/2.
He is planning to sell his company in next 6 months. He has done that before also. But for us this is the first time.
So I was curious what questions should I ask him before accepting or rejecting the equity offer?
PS: The beta version of the product is launched and it got covered by ReadWriteWeb.
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A little more detail would help: if 3X is the value of the shares, what was the amount you would have billed normally, what (if any) is the cash element you will bill? – Jeremy Parsons 13 years ago
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Jeremy, as per the below answer from James, I guess going with point 2 would be a better idea. What do you think? – Abhi 13 years ago
1 Answer
Four points: 1) Consider an alternative: your services in exchange for a percentage of gross revenues - taking a hard look at realistic sales expectations.
2) With the above alternative, consider sharing the risk. let us say your time and effort is worth $100 an hour. You ask for $20 to be paid cash, and defer the $80 -- to be paid from future sales revenue. Putting that into MBA-jargon: you subordinate a percentage of your fees to the back-end. The actual amount due will be a function of the timing and amount of revenues received, as specified in the following table. . .
3) Six months seems pretty fast from start-up to sale. Consider building the customer base over a longer period, and then selling the company for signficantly more. In this case (1) above is the first phase. The second phase is to negotiate an option on equity which vests in xxx months.
4) I suggest having a binding arbitration clause in your contract. Googling the American Arbitration Association is a good place to start.
And yes, I realize I am not really answering your question. However to come up with suggestions for a win/win equity negotiation requires a whole lot more information about the situation of both parties, their wants and needs, the market, the company`s regional, national and possible (in these days of Internet global reach) international potential, etc.
Regards,
James Hamilton
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Thanks James, even though it didn't give me the exact answer this is great information. I really loved the idea of sharing the risk. This way I won't compromise a lot of cashflow and will still become part of the company. I would try to offer something like this to him. – Abhi 13 years ago
