The Ins and Outs of Equity

As a consultant, you can earn equity as compensation in many of your clients, especially if they’re relatively early stage start-ups. However, understanding equity as a consultant can be a little confusing. In a recent Mylance community workshop we learned the ins and outs around equity and how to take advantage to build out a portfolio..

What are some basic things I should know about equity?

A lot of this will depend on your role within the company and there are a lot of arbitrary components involved. If a founder is offering you equity, they’re thinking long-term (e.g.: what will be the impact of the work you are doing in 2, 3, 5, 10 years down the road?). Be aware that if they’re VC backed, the VC might have a say in additional equity being offered. Focus on pinpointing what role you’re going to play, how bought in you are, and your impact on the company. When you really seek to understand the Founder’s side, you’ll have better success in coming around to an agreeable result.

Additionally, keep these concepts in mind:

Types of Equity

Incentive stock options: may have better tax treatment than non-qualified stock options (be sure to contact a tax professional for details applicable to your personal situation!)

Non-qualified stock options: does not qualify for favorable tax treatment for the consultant

Restricted Stock Units (RSU): a promise to give future equity at a liquidity event (these offer the least favorable tax treatment but are very low risk and require no purchase on your part)

Call Outs

• Options will have a strike price that comes into effect if / when you leave the organization. (More on that in the next point!)
• Companies will typically start with options and then switch to RSUs.

What’s a strike price?

This is the price at which you’re able to purchase your options. A high strike price can actually be a deterrent because, in a standard agreement, there’s a very small window of time (usually 90 days) for you to take advantage of the purchase and you could potentially have to come up with a large sum of money very quickly. Make sure if / when you leave, you have plenty of time to exercise your options by asking if the timeframe can be extended. Bradley was able to negotiate 3 months into 10 years, a much more manageable payment period!

How much equity should you target as a consultant?

For a company that’s in a very early stage, there are no real guidelines. For one that’s a Series A or B (e.g., more developed as a company) the company will likely have standards, and you can use those to come up with a number! Since it’s really hard to figure out what number of shares are worth a specific amount, Bradley shared with us a simple formula he uses. Let’s say you’re working 20 hours per week (1/3 time) in this role. Ask your new client how much equity they would be giving to someone who was full time in this role. Once that number is given, divide it by your hourly workload, which in this example would be 1/3, to get the appropriate amount of equity.

The start-up wants to quantify share value based on the preferred price (what investors are paying), and we know that’s not an accurate price. Further, which preferred price (they’ll want the upcoming raise, and you’ll want the previous raise). In Bradley’s experience, these are all things you have to negotiate. And again, every start-up needs you way more than you need them, so if you don’t get a deal you’re okay with, it’s better to walk away or just take a higher cash payment.

What’s the most concrete way to figure out a good cash/equity/revenue split?

You have to stay focused on your business goals. Are you looking to build a small VC profile? Then a higher equity split might be the way to go. Or are you optimizing your business for cash? Then negotiating your $15k per month fee down to $12.5k and the equivalent of $2.5k in equity could be your best bet. In terms of revenue share, that’s what most founders will prefer: you make them money and then they pay you. Continue that focus on your business goals if you’re presented with this scenario!

How do you know .25% equity is really .25% of a company?

While we definitely want to assume everyone is operating out of integrity, it’s also important to do our due diligence in these situations. Keep in mind that the more confident someone is in their company, the more likely you are to get the information you need to know! Short of asking to see financial statements, which few founders will hand over, you have some options:

• Ask about the last fair market value of the stock price, a number that’s usually determined by an independent party for valuation purposes.
• If the company has raised money, ask about the price of the preferred shares. You’ll also want to know their future plans for raising more capital because that will affect your shares. (More on that in the next point!)
• You can also ask for the total number of shares outstanding to understand the value of what you’re being offered.

What is dilution?

Simply put, it’s the decrease of the value of each individual share as a result of new shares being issued, usually for a fundraise. This can happen fast when companies raise multiple rounds of funding, especially in a short period of time or with only small increases in valuations! You may want to ask about the company’s future plans for raising capital. If they’re planning on Rounds A-B-C-D-E, your percentage will shrink substantially from its initial value.

Other great pointers

• To the extent possible, use the company’s lawyers. Using your own lawyer is expensive.
• Get your options / shares on Carta (or similar equity and portfolio management platform) so you can see your shares transparently.
• A company can’t actually issue shares until their board meets. You can ask when this is happening next, and make sure it’s before the raise / new 409a because it will affect your options strike price, and this could be a significant change.

And one major point to keep in mind:

There are potentially large tax implications involved with equity! For instance, if your strike price is lower than the fair market value of the stock, you may need to pay taxes on the difference. There’s a possibility you may also need to ​​file an 83b election with the IRS within 30 days for preferential tax treatment. In order to best understand your tax liabilities, please be sure to consult a tax professional.

If you’re looking for more one-on-one guidance in the area of equity, apply to our free, vetted community for access to experts who can answer your questions and give you guidance. The bi-weekly sessions like the one we’ve just recapped for you are one of many free resources available to the Mylance community and are a great way to learn from other consultants and up-level your skills. We hope to see you there!