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Should I offer a reduced contract rate in exchange for equity?

Too Long, Didn't Read Version:

One of my clients is running out of money and will be struggling to pay me in the near future. Recent events have led me (a generally skeptical developer who refuses to work for equity/future pay) to strongly believe that with his industry contacts and my technical direction, we can release a product (already under development) that will be a massive success. I want to offer the client a reduced rate in exchange for ownership in the company. What could go wrong?

Wall of Text Version:

I have an interesting one for you guys. In general, I advise developers to NOT work for equity in lieu of income, especially if they are not familiar with the company/management/etc etc etc. In this case, I'm in kind of an inverse situation where I would like to offer my services in exchange for equity or ownership in an already established company. I will try to summarize as best as I can:

  • It is a small (about three years old, 2 employees, 5 outsourced developers) software development company with existing paying customers in a very specific industry with very little competition.
  • The owner has a history of building up multi-million dollarnon-technicalbusinesses, but is now running a technical business and struggling with it (hiring the cheapest developers he could find, taking on anything and everything customers throw at him, etc).
  • Due to those struggles, they brought me on as a process and software development consultant about a year ago, and I have made some significant changes to how they conduct their business. For example, prioritizing quality (of their product and the type of customers they take on) over quantity.
  • I am currently a contract consultant on retainer for 25 hours a week (although for the last 6 months have been putting in 40 to 50 hours a week).
  • 75% of the development work is flowing through my LLC and my own developers.
  • A few weeks ago I had the opportunity to visit an industry trade show and talk to hundreds of potential clients. During this show we had a booth where we demoed our product (currently under development) and were continually bombarded with questions like ("where have you been all my life?" and "how fast can you set us up?").
  • During this process I discovered some major pain points in the industry that nobody seems to be working on but everyone wants a solution for. We even had one of the biggest players (a $1B+ company that is already a customer of ours) in a private meeting ask us if we could help with their struggles. "We are not a software company and don't want to be."
  • Coincidentally, these pain points overlap with our product roadmap (but were not a priority). As a result, I have convinced the client that we really need to re-prioritize our development efforts and tap into this untouched stream.
The reasons for my question are:
  • Massive technical debt has started catching up and the client is starting to lose customers. This is not necessarily a bad thing because these are customers of a product that my client shouldn't have sold/supported to begin with.
  • However, with the loss of customers comes a loss of revenue, which means the client is going to struggle to pay me while we reboot, refocus, and build V1 of the solution that everyone is asking for.
  • I have many other clients and a successful LLC, and do not wish to become an employee of this company. (There are other legal reasons for this as well, including retaining copyright/IP for the work I do for myself.)
  • I stronglybelieve we have a massive, untapped opportunity and we already have the inside connections and customers necessary to make it happen.
  • I am the technical person with the knowledge and ability to make it happen. We both agree on this as a result of successes since I came on.
Given this situation:
  • Is it reasonable to approach the client and offer to reduce my rate and increase my hours in exchange for equity or ownership in the company?
  • If yes, what is a reasonable % or deal to ask for assuming that I am charging him 50% (or less) of my normal rates?
  • I believe I'd probably need to talk to a lawyer about this, but is this something I'd structure through my LLC or through myself personally? I feel like it'd be a conflict of interest to give an LLC ownership of a company that is also a client...but it's even more of a conflict for a part owner to contract out to that owner's company.
  • Assuming a deal is doable, is it reasonable to ask for access to the financials and have a say in how they're managed? (The client is already very open with me about revenue and operating expenses during our conversations.)
I appreciate any feedback or advice that you may have.

17 Replies

Dr. Jill S. Becker
2
0
High Tech Executive and Entrepreneur
Go with your gut and go for it. Sounds like you know there is something there. But the timing is almost..they need $. Can you help them raise some or get someone too ASAP? Good luck. Always go with your gut. You know the right call. You already made up your mind. :)
John Shiple
0
0
John Shiple Advisor
CTO
I would like to speak with you. I am in a similar but less impactful situation. Also, I talk to and advise CTOs and technical co-founders all the time and can likely provide you with some insight or relative "case studies" related to your situation. +=John
Francis Barletta
1
0
Francis Barletta Entrepreneur
CEO at UPTOP
tl;dr but if he has a history of multi-million dollar businesses, why won't he fund it or have the connections to provide the funding? Sent from my iPhone
Michael Brill
1
0
Michael Brill Entrepreneur
Technology startup exec focused on AI-driven products
I'm with Francis on the question of why he isn't able to raise money... and why you think there'd ultimately be liquidity.

Having said that, you are already working for 50% discount by virtue of putting in 50 hours for 25 hour pay. So getting something extra doesn't seem like a bad idea. If you go forward, there are a couple of issues:
1. The client is going to view his company being worth *way* more than you think it is. As things get more dire, this difference narrows... and if you're doing most of the product work then you may need to play a timing game to get what you think you deserve.
2. There are huge tax implications of being paid in straight equity, so be very careful how you structure a deal.



Marcus Matos
0
0
Marcus Matos Entrepreneur
Software Development & Information Technology Professional
Regarding the funding, I don't feel comfortable discussing the specifics publicly but I am aware that the founder did make some prior personal and business decisions that ultimately did not work out. That said, he did come back from it in a new industry which leads me to believe in his ability to recover from adversity.

As to his ability to raise funding, I don't know, but I can tell you that between managing developers, hustling for sales, and existing customer management, he's spread incredibly thin (this being a reason to bring me on).

Please don't take my response as cheerleading. We've had major disagreements and there have been days that I've wanted to fire the client. However, it's the trade show experience that has opened my eyes and based on our discussions the last couple of weeks, I feel we're on the same page and have the same vision.

It's really a situation I didn't expect to find myself in hence the post here.
Francis Barletta
1
0
Francis Barletta Entrepreneur
CEO at UPTOP
I will be blunt: Reading your last response makes me question some things you said. A. Your confident the product can be so amazing why are you even asking? B. Do you know the CEO as well as you think? Stretched thin is bad for everyone. C. You won't share details but are asking for support. That's almost like asking a psychiatrist to help you but you won't tell them your issues D. Can you even help the company succeed more than just developing a product? If you believe in the product and the team, follow your heart. Don't go by others because ultimately you need to sleep with your decisions. The community can only guide so far but every situation is different. Sent from my iPhone
Michael J. Gilbert
0
0
EVP Sales and Operations at DeedGuard.com
Marcus..very interested in talking to you about this.
Marcus Matos
0
0
Marcus Matos Entrepreneur
Software Development & Information Technology Professional
Francis,

You raise valid points that I'd like to address. My prior response was a bit quick because I was writing from my phone and you know how that goes. :)

A.) I am asking because this is not a situation where I can be objective and need to know what could go wrong. I'm fortunate enough to be in a situation where I can work for little to no pay for a period of time, and am willing to do so if it is ultimately a good business decision. The issue is I don't know if it's a good decision.

B.) I do not know the CEO on a deeply personal level, however after a year of working together I do have some insight into what makes him tick.

C.) What I meant by avoiding specifics is I don't think it's necessary to post something like "he got divorced and lost almost everything paying for his lawyers" (which is not what happened...as far as I know.)

D.) I absolutely do believe I am able to help beyond technical/product development, and in fact I have been over the last few months. Our results and feedback at the show validated everything I've done to date.

The truth is that this whole discussion could be a moot point as the client give me a flat "no" when I approach him with this. Recognizing that I am unable to be objective in this situation is why I am posting, and I'm kind of surprised to see the "follow your heart" responses.

The conversations I've had offline have been similar, and I'm just not sure it's so easy to walk up to a client and say "hey, I know you're running out of cash, so give me 35% of the company over three years and I'll come on-board as your full time CTO for almost no pay.".

Or maybe it is. Paralysis analysis, anyone? :)

In the end, even if I do make the leap, there are other implications (which I mentioned in my original post) that I am hoping for a little bit of insight on.

I appreciate everyone's feedback and thoughts.
Steve Owens
0
0
Steve Owens Entrepreneur • Advisor
Finish Line - A Better Way for Small Companies to Develop Products
If you really feel strongly that the company will succeed and they do not have the resource to pay you, then I would suggest a deal like this: - You bill him normal rates - He pays what he can and when he can - Charge interest on anything >30 days - 1% a month is normal - You get warrants equal to the peak value of the outstanding balance - The warrant price would be at any price the company sells for in the future - that is, best of the A, B or C round. - Get a security interest in the IP But always talk to a lawyer. Steve Owens - Finish Line PDS A Better Way for Small Companies to Develop Products e | Steve.Owens@FinishLinePDS.com p | 603 880 8484 w | www.FinishLinePDS.com 94 River Rd | Hudson, NH | 03051 Click for Product Development White Papers ---- On Sat, 24 Jan 2015 17:59:38 -0500 Marcus Matos <[removed to protect privacy]> wrote ---- FD:Discuss New Discussion on Should I offer a reduced contract rate in exchange for equity? Started by Marcus Matos IT & MIS Consultant, Matos Consulting LLC. Previously MIS Generalist, MasTec - Advanced Technologies. Too Long, Didn't Read Version:
Rob Roj
0
0
Rob Roj Advisor
Entrepreneurial Technical Sales
Don't do it. The CEO clearly does not value the technical side of the business. The warning signs are already there:
  1. He's coming from a non-tech industry
  2. He chose to use outsourced developers
  3. He chose the cheapest developers he could get
It's pretty clear you've decided that you're going to do it. Allow me to predict what is going to happen.

  1. He's going to value is company ridiculously high and even if the company does succeed, you would be better off working for another start-up.
  2. You are going to work more than you currently are for less pay and as soon as you are replaceable, you will be replaced.
  3. He's not going to learn the value of an excellent technical co-founder until it's too late.
Simply put, even if you can turn around the company, growth is going to be an issue because the CEO does not value GREAT people. In other industries such as manufacturing and distribution, you can get away with hiring "good enough" people and do ok. In tech, where it's chaotic, with rapid development cycles, and speed, time and quality are EXTREMELY important, this company will get crushed by the competition. My question to you is, "What is this company's moat?" How will this company defend itself from competitors and for how long? And no, IP is not a defense. IP is a battle that ends AFTER the market has decided. Just look at Samsung vs Apple, by the time Apple won a $1B suit (still under appeal), Samsung had already dominated the mobile market. Your moat, 3 years with 5 outsource developers, is generously 3-6 months.

Here's a better explanation from HBR (It's a bit dated but still true). https://hbr.org/2011/06/why-zuckerberg-is-almost-right.html

I'm curious to see how it goes. Please keep us informed.

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