Swap shop: exchanging equity for professional services

 

Back in the halcyon days of the dotcom boom, a nice little trend evolved that cut through the airy, overinflated fads of the day. Start-ups reluctant or unable to sell great slabs of their equity to drooling VCs instead gave shares to businesses who could actually help them grow, in return for that company's services. What usually happened was some creative spark with a big idea for a website gave shares to a development business. And the development team would work hard to build a top-notch site in the hope it would pump up the value of their shares. Things worked out pretty nicely for both parties: the business founder didn't have to spend a dime, the development company got a good chunk of equity in a potential next-big-thing.
This idea of swapping equity for professional services outlived the dotcom boom, expanded to all types of B2B businesses, and is still going strong in the US today. Websites such as stock4services.com are dedicated to matching up suitable parties. Big advertising agencies and media companies have set up programmes specifically to facilitate the exchanges. (http://www.clickz.com/310741 ) And you only have to browse top US small-business websites Entrepreneur.com and Inc.com to find examples of new businesses adopting the equity-for-professional-services model. (http://www.entrepreneur.com/magazine/entrepreneur/2010/june/206608.html)
Over on this side of the Atlantic, though, we seem to be a little slower on the uptake. Sure, it's happening, but it's not happening that often. When we asked our 6,000 Twitter followers if any of them had tried it, we got the sum total of zero affirmatives.
So we figured it was time to introduce you to the equity-for-trade model and how to make it work for you.
Why and when it works
Sarah Beeny, the entrepreneur founder of Mysinglefriend.com, gave web design and development agency Cogent equity in return for the build of her latest venture, Tepilo.com. "I could really see the amount of money you can spend on development if someone's heart isn't in it," she says. As anyone who's outsourced a website build knows, development spend tends to mushroom as your contractor encounters an ever-more-complex web of supposedly unforeseen complications.  "But it's not just the money, it's the motivation to work the nights and weekends too." The buy-in of being involved with Beeny's start-up meant the developers were happy to put in the extra man hours needed to make things happen as quickly as she wanted them to, without jeopardising the quality of the finished product.
An equity swap also means you get continuing support as your business grows rather than just the one-off services you'd get if you were paying in cash. So you get most out of this set-up from the types of B2B businesses you want long-lasting relationships with: marketing or advertising agencies who work best when they know your brand inside out; web development companies if you're running an online business (which inevitably needs a fairly constant stream of tweaks and improvements to stay competitive); IT companies; even well-connected angels who'll keep a steady stream of lucrative introductions coming your way. (Be warned that accountants are a no-no - the auditor of a company is disallowed from owning shares in it.)
And if things go to plan, that company is going to really graft to make your business a success - after all, the value of their shares depends on it.
For you, particularly if you're cash-poor, the set-up is something of a financial golden ticket. You save yourself whatever expenditure would normally go on X professional service, throughout the entire life of your business, and in theory get even more work done for you than if you'd paid in cash.
Choose your partner business wisely, and you'll also be able to work in a quicker, more flexible way than if you'd gone down the traditional private investment route. "The problem with investors is you spend so long discussing your business plan and it's all a bit tedious," Beeny says. She says she 'much prefers' the path she's taken because it lets her move at the rapid pace she wants to.
That's not to say a B2B company will always have the edge over an investor, though. Keep your options open - a private investor, VC firm or business angel might be the wiser choice if what you really need is one very experienced member on your board, or the lucrative network of an angel, or actually just a pleasing mound of £50 notes to distribute across a range of projects within your business rather than just one core function.
The risks
And, of course, if setting up an equity-for-services swap was really as peachy as we've made it sound so far, everyone would be doing it all the time. They aren't though - in part because of an unfamiliarity and lack of awareness about this kind of set-up, but also because there are plenty of potholes that could trip you up along the way if this is the path you choose to take.
So first things first: giving away equity isn't a decision that should be taken lightly. "My focus would be on retaining 100% of the shares wherever possible for the founder and the management," says Guy Rigby, head of entrepreneurship at accountancy firm Smith & Williamson. "That's my starting point." He's dealt with enough equity deals turned rotten to know that shared ownership of a business often gets messy, and becomes something the business founder regrets. He says it's incredibly complicated, and expensive, to reverse an equity deal once it's been documented out. "Once someone owns a share, they own a share." And every time you hand shares out, your ownership and control of the business are diluted.
But Rigby also concedes that retaining all equity is an ideal situation, and one most ambitious and cash-hungry start-ups simply can't afford. If you do decide to go ahead with an equity-for-trade set-up, 'definitely don't give away shares for just a one-off activity that ceases to be relevant in the future'. Instead, he advises thinking in the long-term: "If it's more of a partnership agreement where it has future then it might work."
There are also tax complications you need to be aware of. The company who provides services to you would normally be making a profit on those services, which they'd have to charge VAT on. So technically, what you should do is split the transaction into two, so that you pay cash for their services (and pay VAT), then they use that cash to buy your shares. This is what much bigger companies do when they adopt the same model.
These tax technicalities are, however, unbeknown to most start-ups who do a shares-for-equity swap. And for many of those that do know about them - well, let's just say the dog ate their rule book. Most don't bother with the pernickety end of procedures, because in all likelihood HMRC won't pick up on the set-up at this level. But don't tell anyone we told you that!
How to get it right: choosing the business you want to work with
Think of the company you give equity to almost like a joint venture partner, or a member of your board - that should give you some idea of how carefully you need to choose them. This is a long-term relationship that will have a direct impact on your success.
There are a whole host of qualities they need to embody: the right size and stage for you (if you want to scale quickly, they need to be planning to grow too, whereas if they want to expand fast and you don't you'll end up being neglected); genuine passion for what you're doing; a similar working style as you (are they happy pulling seriously late nights or do you both prefer to finish at 5pm on the dot? How quickly do they work?); near enough that you can reach each other easily; good enough at what they do to warrant part-ownership of your business. And you need instant chemistry too.
"You need to have people who have a similar ethos to you, who get the picture of what you're trying to create," Beeny says. "I looked for a very specific company: big enough to be able to swallow the costs and good enough to make an absolutely incredibly site. I needed them to be better than anyone else but small enough to make a decision right there and then without corporate meetings."
Once she'd tracked down one she liked, she trialled them by asking them to do a much smaller website - keeping the Tepilo.com project strictly schtum until they'd proven themselves. "Then I'd had a positive experience and quite liked the way they did things, so I said we were taking on a partner, do you want to come along?"
If funds are tight to finance a pilot project, draw up a shortlist of companies you'd like to work with then get each to pitch for an imaginary piece of work or a small section of your bigger project (although be wary of sharing your whole idea with developers, some of whom are prone to nicking it for themselves). The most enthusiastic and capable team will hopefully shine through. If no one catches your eye, go through the process again - this is not worth the risks involved with cutting corners just to save time. They're going to be with you for the whole lifespan of your business, and they need to be good.
How to get it right: drawing up the deal
You need to have a rough idea of how you want the equity-for-services swap to work before you approach the prospective business. Decide how much equity you're prepared to give away, and what you expect in return.
When it comes to equity, Beeny says: "Other entrepreneurs have given 2% or 3%, but I think it depends how hard you want them to work - you're going to need a very successful company to make that worthwhile for them. I think 25% or 26% shareholding is decent, and it gives you space to give shares to other people. Also, if you're working with someone you've given maybe only 2% to, and they're difficult and not quite delivering, you wish you'd just paid for it."
She advises against owning anything like equal portions of the business. "The danger is you end up in stalemate. You're kind of in a situation where you can end up just not agreeing and no one can make anyone else do anything."
Once you've found a partner and talked out the nitty gritty over a good few double lattes, it's time to get everything in writing.
Now we know that penning 40-page legal documents aren't every business starter's idea of a good time. But at least exchange emails confirming the basics you've agreed on, so you have a foot to stand on if things do go skewiff before you've made your collaboration more official.
That gives you some protection for the short-term, then aim to get an official document drawn up not long after. You'll need a shareholders agreement, and, Rigby says sagely, 'you'll definitely need a lawyer to get the agreement properly drafted'.
Discuss whether you want to write in a clause that allows you to buy back the equity should you want to or need to further down the line. It's perfectly possible that you'll fall out, or one or other of you will outgrow each other, and it will simplify things immensely if you've both given yourself safety cushions for that at this stage.
You should also map out roughly what work you expect them to get done by which dates. You hopefully won't have to clockwatch too much if you've picked your partnering business wisely, but this isn't just a favour they're doing for you - you've paid them with part-ownership of your business. Leave your expectations out the conversation, and you risk being disappointed further down the line - which will inevitably lead to a sour, unproductive relationship.
But as long as you both get all your cards on the table early on and live up to your sides of the deal, there's every chance yours will be a happy and fruitful partnership - and one that might just benefit your business more than any investor ever could have, however many millions they had to spare.

Back in the halcyon days of the dot-com boom, a nice little trend evolved that cut through the airy, overinflated fads of the day. Start-ups reluctant or unable to sell great slabs of their equity to drooling VCs instead gave shares to businesses who could actually help them grow, in return for that company's services. What usually happened was some creative spark with a big idea for a website gave shares to a development business. And the development team would work hard to build a top-notch site in the hope it would pump up the value of their shares. Things worked out pretty nicely for both parties: the business founder didn't have to spend a dime, the development company got a good chunk of equity in a potential next-big-thing.

This idea of swapping equity for professional services outlived the dot-com boom, expanded to all types of B2B businesses, and is still going strong in the US today. Websites such as stock4services.com are dedicated to matching up suitable parties. Big advertising agencies and media companies have set up programmes specifically to facilitate the exchanges. And you only have to browse top US small-business websites Entrepreneur.com and Inc.com to find examples of new businesses adopting the equity-for-professional-services model.

Over on this side of the Atlantic, though, we seem to be a little slower on the uptake. Sure, it's happening, but it's not happening that often. When we asked our 6,000 Twitter followers if any of them had tried it, we got the sum total of zero affirmatives.

So we figured it was time to introduce you to the equity-for-trade model and how to make it work for you.

Why and when it works

Sarah Beeny, the entrepreneur founder of Mysinglefriend.com, gave web design and development agency Codegent equity in return for the build of her latest venture, Tepilo.com. "I could really see the amount of money you can spend on development if someone's heart isn't in it," she says. As anyone who's outsourced a website build knows, development spend tends to mushroom as your contractor encounters an ever-more-complex web of supposedly unforeseen complications.

"But it's not just the money, it's the motivation to work the nights and weekends too." The buy-in of being involved with Beeny's start-up meant the developers were happy to put in the extra man hours needed to make things happen as quickly as she wanted them to, without jeopardising the quality of the finished product.

An equity swap also means you get continuing support as your business grows rather than just the one-off services you'd get if you were paying in cash. So you get most out of this set-up from the types of B2B businesses you want long-lasting relationships with: marketing or advertising agencies who work best when they know your brand inside out; web development companies if you're running an online business (which inevitably needs a fairly constant stream of tweaks and improvements to stay competitive); IT companies; even well-connected angels who'll keep a steady stream of lucrative introductions coming your way. (Be warned that accountants are a no-no - the auditor of a company is disallowed from owning shares in it.)

And if things go to plan, that company is going to really graft to make your business a success - after all, the value of their shares depends on it.

For you, particularly if you're cash-poor, the set-up is something of a financial golden ticket. You save yourself whatever expenditure would normally go on X professional service, throughout the entire life of your business, and in theory get even more work done for you than if you'd paid in cash.

Choose your partner business wisely, and you'll also be able to work in a quicker, more flexible way than if you'd gone down the traditional private investment route. "The problem with investors is you spend so long discussing your business plan and it's all a bit tedious," Beeny says. She says she 'much prefers' the path she's taken because it lets her move at the rapid pace she wants to.

That's not to say a B2B company will always have the edge over an investor, though. Keep your options open - a private investor, VC firm or business angel might be the wiser choice if what you really need is one very experienced member on your board, or the lucrative network of an angel, or actually just a pleasing mound of £50 notes to distribute across a range of projects within your business rather than just one core function.

The risks

And, of course, if setting up an equity-for-services swap was really as peachy as we've made it sound so far, everyone would be doing it all the time. They aren't though - in part because of an unfamiliarity and lack of awareness about this kind of set-up, but also because there are plenty of potholes that could trip you up along the way if this is the path you choose to take.

So first things first: giving away equity isn't a decision that should be taken lightly. "My focus would be on retaining 100% of the shares wherever possible for the founder and the management," says Guy Rigby, head of entrepreneurship at financial advisory and accountancy firm Smith & Williamson. "That's my starting point." He's dealt with enough equity deals turned rotten to know that shared ownership of a business often gets messy, and becomes something the business founder regrets. He says it's incredibly complicated, and expensive, to reverse an equity deal once it's been documented out. "Once someone owns a share, they own a share." And every time you hand shares out, your ownership and control of the business are diluted.

But Rigby also concedes that retaining all equity is an ideal situation, and one most ambitious and cash-hungry start-ups simply can't afford. If you do decide to go ahead with an equity-for-trade set-up, 'definitely don't give away shares for just a one-off activity that ceases to be relevant in the future'. Instead, he advises thinking in the long-term: "If it's more of a partnership agreement where it has future then it might work."

There are also tax complications you need to be aware of. The company who provides services to you would normally be making a profit on those services, which they'd have to charge VAT on. So technically, what you should do is split the transaction into two, so that you pay cash for their services (and pay VAT), then they use that cash to buy your shares. This is what much bigger companies do when they adopt the same model.

These tax technicalities are, however, unbeknown to most start-ups who do a shares-for-equity swap. And for many of those that do know about them - well, let's just say the dog ate their rule book. Most don't bother with the pernickety end of procedures because in all likelihood HMRC won't pick up on the set-up at this level. But don't tell anyone we told you that!

How to get it right: choosing the business you want to work with

Think of the company you give equity to almost like a joint venture partner, or a member of your board - that should give you some idea of how carefully you need to choose them. This is a long-term relationship that will have a direct impact on your success.

There are a whole host of qualities they need to embody: the right size and stage for you (if you want to scale quickly, they need to be planning to grow too, whereas if they want to expand fast and you don't you'll end up being neglected); genuine passion for what you're doing; a similar working style as you (are they happy pulling seriously late nights or do you both prefer to finish at 5pm on the dot? How quickly do they work?); near enough that you can reach each other easily; good enough at what they do to warrant part-ownership of your business. And you need instant chemistry too.

"You need to have people who have a similar ethos to you, who get the picture of what you're trying to create," Beeny says. "I looked for a very specific company: big enough to be able to swallow the costs and good enough to make an absolutely incredible site. I needed them to be better than anyone else but small enough to make a decision right there and then without corporate meetings."

Once she'd tracked down one she liked, she trialled them by asking them to do a much smaller website - keeping the Tepilo.com project strictly schtum until they'd proven themselves. "Then I'd had a positive experience and quite liked the way they did things, so I said we were taking on a partner, do you want to come along?"

If funds are tight to finance a pilot project, draw up a shortlist of companies you'd like to work with then get each to pitch for an imaginary piece of work or a small section of your bigger project (although be wary of sharing your whole idea with developers, some of whom are prone to nicking it for themselves). The most enthusiastic and capable team will hopefully shine through. If no one catches your eye, go through the process again - this is not worth the risks involved with cutting corners just to save time. They're going to be with you for the whole lifespan of your business, and they need to be good.

How to get it right: drawing up the deal

You need to have a rough idea of how you want the equity-for-services swap to work before you approach the prospective business. Decide how much equity you're prepared to give away, and what you expect in return.

When it comes to equity, Beeny says: "Other entrepreneurs have given 2% or 3%, but I think it depends how hard you want them to work - you're going to need a very successful company to make that worthwhile for them. I think 25% or 26% shareholding is decent, and it gives you space to give shares to other people. Also, if you're working with someone you've given maybe only 2% to, and they're difficult and not quite delivering, you wish you'd just paid for it."

She advises against owning anything like equal portions of the business. "The danger is you end up with a stalemate. You're kind of in a situation where you can end up just not agreeing and no one can make anyone else do anything."

Once you've found a partner and talked out the nitty gritty over a good few double lattes, it's time to get everything in writing.

Now we know that penning 40-page legal documents isn't every business starter's idea of a good time. But at least exchange emails confirming the basics you've agreed on, so you have a foot to stand on if things do go skewiff before you've made your collaboration more official.

That gives you some protection for the short-term, then aim to get an official document drawn up not long after. You'll need a shareholders agreement, and, Rigby says sagely, 'you'll definitely need a lawyer to get the agreement properly drafted'.

Discuss whether you want to write in a clause that allows you to buy back the equity should you want to or need to further down the line. It's perfectly possible that you'll fall out, or one or other of you will outgrow each other, and it will simplify things immensely if you've both given yourself safety cushions for that at this stage.

You should also map out roughly what work you expect them to get done by which dates. You hopefully won't have to clock watch too much if you've picked your partnering business wisely, but this isn't just a favour they're doing for you - you've paid them with part-ownership of your business. Leave your expectations out the conversation, and you risk being disappointed further down the line - which will inevitably lead to a sour, unproductive relationship.

But as long as you both get all your cards on the table early on and live up to your sides of the deal, there's every chance yours will be a happy and fruitful partnership - and one that might just benefit your business more than any investor ever could have, however, many millions they had to spare.

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