This guest post came from an email conversation that led to a blog post.
I was recently approached with the following question by a designer looking for ideas on how to decide on working for equity in a startup:
If I were to work for equity at a startup, what is a typical percentage one asks for? 25%? 5%? 50%? 15%? How do I go about estimating that sort of thing? I know how to estimate a project’s cost based on my hourly rate but working for equity, as you know, can’t really be quantified in the same way as the project’s value is based on some future continent heretofore unknown. And I’m not an equal partner. I’d be the lead designer. What’s that worth percentage wise? What’s typical?
Here’s my answer:
This is a tricky question. In my experience there is no standard percentage. Different people value their companies in different ways, and some people value design more than others. I would say it’s best to have a good honest conversation with the founders and ask how the value the business (multiple of revenue, assets, etc). If they’ve had a professional valuation you can look at your rate vs how they price company stock to see what percentage to ask for.
If you’re in the gambling mood (which we all are from time-to-time) you can discount your time against the valuation with hopes of a nice upside. You’ll need to consider how you would liquidate your equity stake in the future, too. Sometimes early equity is bound to restrictions on sale to prevent the company from dissolving too early.
You should also consider whether your shares are voting or not. That can play a huge part in valuation and your role within the company as it grows.
Overall, just be careful not to invest too much time or money in something you don’t really believe in or have zero control over.
Hope that helps some of you.
You can find more thoughts and ideas from J. Cornelius on his blog and twitter.
One of the unfortunate things about being a founder and entrepreneur, is you learn more than you ever wanted to know about ownership structures, equity, and taxes.
Before trading effort for equity, consider the potential tax liability you could incur.
The IRS wants to get paid on any earnings of any kind, and they say they’ll tax you on the value of your contribution (not the value of the equity). So if you normally charge $75 per hour for consulting gigs, and you contribute 100 hours in exchange for some percentage of the business, you may owe an income tax on $7500 worth of earnings—even tho you haven’t (yet) received a penny. That would be an especially painful bummer if the startup doesn’t succeed, or it takes years to generate any income.
There are other simple ways to get paid for your work without getting dinged by the IRS. One is stock options, where the tax liability won’t mature until (and unless) you exercise.
Regardless, there are probably a host of options to consider, and though it sounds simple, trading your labor for equity might be the worst one. You and the founder may want to speak with someone who knows startups and taxes before finalizing your arrangement.
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