Can I pay consultants and strategic partners with equity?
Takeaways: Yes, you can. Startups often have cash constraints and need services so this can be a good option. However, depending on how well the company performs, that equity can end up being much more valuable than cash.
Startups often have limited resources, making it challenging to pay for the services of consultants and strategic partners. In order to attract and retain top talent, some startups may consider compensating these individuals with equity. Here are some considerations for startups when deciding whether to pay consultants and strategic partners with equity:
Can Startups Pay Consultants and Strategic Partners with Equity?
Yes, startups can pay consultants and strategic partners with equity. Equity compensation can take several forms, including warrants, stock options, and restricted stock awards (RSAs). However, it’s important to note that there are legal and tax considerations when using equity compensation, so startups should consult with legal and tax professionals before proceeding.
Should Startups Pay Consultants and Strategic Partners with Equity?
There are several factors to consider when deciding whether to pay consultants and strategic partners with equity:
Cash vs. Equity: Startups should consider whether they have the cash to pay for services upfront or if equity compensation is a more feasible option. Equity compensation may be a way to conserve cash in the short term, but it can also be a very expensive way to save some cash. For example, if you agree to give a consultant an option to purchase 1% of the company and you sell the company for $100 million, you’ve just paid that consultant $1 million for that work.
Alignment of Interests: Equity compensation can align the interests of consultants and strategic partners with those of the company. If the company is successful, the value of the equity compensation will increase, creating a win-win scenario for both parties.
Legal and Tax Considerations: Startups should be aware of the legal and tax considerations when using equity compensation. Equity compensation can be made subject to vesting and other restrictions, and it may have tax implications for both the company and the recipient. If you are issuing equity to an entity (as opposed to an individual), that entity likely will need to be an accredited investor in order for the company to comply with securities laws.
Equity Structure: Startups should consider the impact of equity compensation on their capitalization table. Dilution of ownership can impact the value of existing shares, so startups should carefully evaluate the impact of equity compensation on their overall capitalization table. We often help clients build basic models to understand the dilution implications of issuing equity either to investors or service providers.
Market Standards: Startups should research market standards for equity compensation in their industry and region. This can help them determine if equity compensation is a viable option and what type of equity compensation is appropriate.
Conclusion
Startups can pay consultants and strategic partners with equity, but they should carefully consider the legal, tax, and equity structure implications before proceeding. Equity compensation may be a way to align the interests of consultants and strategic partners with those of the company, but it may also dilute the ownership of the company over the long term. Startups should consult with legal and tax professionals and research market standards before using equity compensation.