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Trading Ownership for Services is Risky Business

Over the holidays I received this question from my ask-me form on my website:

In todays economy with corporate streamlining and all that technology has to offer, how can one attract investment in the form of an ‘equity swap’? I am in need  of  web development and am willing to trade this for a generous portion of the company.  [Business description omitted]

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My answer:

Would you marry somebody you’d never met?

Never use shares of ownership to pay for  services. What you’re calling an equity swap is really a bad idea. Sharing a company is an intimate partnership for the rest of that business’ life. It’s like marrying somebody you’ve never met, the business equivalent of a mail-order bride. Minority shareholders end up with some serious rights regarding second-guessing your strategy, your decisions. Having an incompatible partner in business is a really bad situation.

There are exceptions to this rule: When you have somebody you know well, trust, would be happy to work with forever and ever, who also provides a service, that can be ideal. But you already have the relationship. This is somebody you’d be pleased to partner with.

And furthermore, finding a way to trade money now for money later, the underlying idea, is not so bad. But do it right.

A couple of years ago I wrote 5 non-traditional ways to get startup funding, which is still valid. Find entrepreneurial web development that will work for percent of future revenues, or royalties, or some innovative formula like “I’ll pay you three times more if I make it, so you share the risk.”

I have real experience with this, with my own company. In the early days of Palo Alto Software I found programmers for hire who agreed to work for a small minimum fee plus a percent of future revenues. It was win-win. They made good money eventually, way more than they would have if they hadn’t agreed to take a risk. And I found a way to get started without having any capital. It was really a good deal for all.

However, they never had a share in the ownership of the company. We owed them money. Not shares.

Also, in the interest of full disclosure, I benefitted enormously from a deal like this as a consultant and service provider, once. Some 30 years later, I’m still grateful to Philippe Kahn (founder of Borland International) for that one. But that was one of the exceptions.

(Image: wikimedia creative commons)


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