Mailbag: Skin in the game

(Readin’ time: 8m 57s, but worth every second 🙂 )

I got some very interesting replies from y’all to the Skin in the Game email.

I wanted to make sure I had permission from everyone to share these replies, thus the delay in turning them around for you.

Overall, it seems like the sentiment among my email list leans pretty pessimistic–or at least cautious and lawyerly–on the notion of putting part or all of your compensation at risk in the form of an equity or revenue share agreement with a client.

Personally, I think the caution is well-advised if you’re earlier in your career or your business is somewhat fragile with respect to cashflow. And the data that some of y’all share with me when you opt in to my list suggests that many of you are relatively early in your career, at least in terms of marketing sophistication:

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There are two ways to look at this. 1) Revenue sharing or equity stakes are always risky compared to cash compensation. 2) Earlier in your career, the opportunities you get are from riskier or poorly performing businesses, and therefore your revenue sharing or equity stake opportunities are similarly risky and unappealing compared to cash compensation.

That said, in the replies below you’ll see some thoughtful takes on this question, and some from folks who have put skin in the game via equity or a revenue sharing arrangement. Perhaps some of those will turn into interesting success stories in a few years?

Quick micro-tangent. I love this recent tweet from Blair Enns:

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OK, onto your replies!

From Gustavo:


Furniture design works like that. You design a chair, your client build the chair, you are paid based on how many chairs are sold. Some designers receive a fee plus the royalties, some just royalties.

If I think the business has some growth opportunity, I join in. But the best deal is when you get some money plus participation on the profit. That can be real passive income.

Something I might correct is that that is one of the business models. Not everybody on furniture design works like that. But it is pretty common one.

Also, some type design deals are almost like that. An example is The Guardian. They hired Commercial Type to design all of their fonts. But they are also available for retail. The thing is that The Guardian doesn’t own the font and Commercial Type has the rights to sell it.

Kind of the opposite of that can also happen. Klim Type Foundry designed a font for retail. I can go to Klim and ask them do design a custom font for my business based on one of their fonts. That deal is cheaper than asking for a font from scratch.


Fred:


That same as it would to take a full time job with the company. For an early stage, VC funded startup with no cash flow, they can throw some stock in if they like, but I value it at $0 and charge accordingly. For a company that’s two or three years from IPO or acquisition, that has solid cash flow, and where there is a normalcy it’s operating in, sure, I’ll take part of my compensation in stock because it’s probably discounted pretty heavily. For a publicly traded company where its stock has become blue chip, I probably wouldn’t take stock because there’s no discount, and it’s basically just exposing me to volatility for no good reason.

In a couple of cases I have given technical advice to early stage startups at a friend’s behest (my sister’s now ex-boyfriend’s startup for example). He offered me stock, and I declined, since when I was doing it out of the goodness of my heart, I could walk away and let him screw up the business side without any lost sleep. As soon as I owned a hunk of it, I would have to provide adult supervision. Holding that would have cost me money.


Kai:


Do I trust the client to execute on their responsibilities such that the expected value of the revenue share is positive?

If the client has to do B and C and I have to do A – if I do A flawlessly and the client doesn’t do B and C, the system breaks.

100% confidence in the client. Otherwise, if I could make that level of impact, why am I not in that line of business myself?


From the other Philip with a correct name spelling:


This would have to be a small business/startup client with big upside potential, and I’ve yet to meet one that has fully vetted their idea. I’ve done this long enough to have a very simple test – how many preorders do you have? However, they will often give a fake answer to that, like “we have 5 companies who are very interested!” So I made it super clear:

X potential customers out of Y asked have told them, “If you have these specific features I will pay you this specific amount per time frame.”

I would seriously consider equity if anyone did that, but nobody has. If they did and the other factors looked good (competition, barriers to entry, first mover advantage, implementation costs, scaling, etc) they could pretty easily get funding, or possibly convince technical cofounders to work entirely for sweat equity.

It also occurs to me that value-based pricing is a form of profit sharing. Not equity, but closer in spirit.


From Brian:


As a consultant, my track record doing 3 deals involving equity:

1 – fail (still in biz, but they had to refinance and dilute my shares)

1 – startup is doing very well and still going 4 years later

1 – exit (a small merger/acquisition not for a goldmine of money) but there was a payoff that was a nice bonus for me 6 years later

These days, I am very hesitant for the reasons you stated. If the consultant feels strongly there is potential, my advice is to strongly consider BUYING shares, not options and get a mix of cash + shares. Get your shares 100% up front or at the end of the engagement, pay the tax on them at low price, and then pray. That’s another thing : if you buy 10k in shares up front, you gotta pay tax on that right there (plus tax on the earnings). In the future, I would probably renegotiate my cash + shares deals so that the cash number is high enough to offset the initial income tax on the shares I bought.

And get a good attorney from the start.


Ewald:


Ugh.

I get asked to work “for equity” just about every single day. Especially when it’s startups who are at the idea phase and nothing more. In the past, I tried it, and lost 100% of my “equity” because the businesses either went bust, or never reached IPO phase and are still chugging along, though my “equity” amounts to less than 1% of the value of the time I put in.

These days, if I truly believe your idea will change the world, I work for up to 15% of my fee in equity. The rest, cold, hard cash, thank you very much. I also don’t work on projections of what your company might be worth 5 years from now to determine how much equity I should get, but do a more realistic estimate of what it’s worth right now. If nothing, well, then I don’t want equity, thank you very much.

It seems that, as a freelancer, I often (always?) get confused with an angel investor. Terms like “sweat capital” and “future value” are bounced around, yet, it’s almost never that the client has actual risk involved. They had the idea, right? So that’s their big contribution. All I need to do is put in the three months to build the MVP and be thrilled they are letting me in on the ground floor, for a whopping 1 or 2 percent of BILLIONS that the company will be worth in 5 years.

I wish I could show you the emails and chats that I’ve received from people when I say I’d much rather prefer to be paid for my work. I’ve been called a f@!cking moron, white racist pig and, once, an elitist little snot that doesn’t know my place. All because I didn’t just about faint at the chance to work for free, I mean, equity. It usually ends with folk telling me how sorry they are for me that I don’t have the vision to see where this is going and that I’m obviously not of the right calibre to help them realize their dream. That’s cool – I love being able to pay my bills at the end of the month, thank you very much.

As a rule of thumb, if it’s an existing business, with provable potential, I’m open to discussing partial equity. Revenue share is not something I feel comfortable with, to be honest, and I’d avoid it most likely. For brand new startups, no, equity can be a bonus, but not in lieu of payment, the risk is just too massive.


From Frank:


In my first five years as a freelancer in the early days of the Internets, I did a bunch of websites and design work for startups. Within three years, most of my client’s businesses had failed or folded. Even with established brick and mortar clients, the recession hit in 2008 and the majority of them went out of business within a couple of years. I used to joke with my wife that if you want your business to fail, hire me to build your website!

I think when you take a revenue share or some investment instrument in lieu of cash payment you are taking on more responsibility in the company and losing a small piece of your independence and consulting objectivity. It goes back to your question (or Liston?) asked a emails ago: If a new CEO were to come into your company what would they change and what is keeping you from making those changes? It’s that outsider, objective perspective girded by expertise that is valuable to a company. When you accept a revenue share, you start to become an insider of sorts and your objectivity and judgement becomes clouded, not to mention you run a high risk of the company failing when you have little to no control over other operational aspects.

I think I would consider a revenue share in lieu of cash in terms of licensing/royalty of a design/product where a company had a proven track record of success in that specific area. Partial equity for payment? No way. Unsecured debts get paid last in bankruptcy.


Tom shared this: www.tomkerwin.com/blog/2014/5/19/why-ill-never-accept-a-revenue-sharing-deal-for-conversion-rate-optimisation-work

Josh shared this:


I have now taken equity in two projects, but that was in last 12 months, and I had been consulting for 9 years before I took any equity as compensation. If someone asks me whether to take equity as a programmer, I tell them no.

On the second equity project I took, I pitched them on offering me equity (not them pitch me). And my pitch was, “you have reached a growth inflection point, a rare opportunity. This next 2 years you are going to grow no matter how bad the team performs. But an all star performance can change growing 2x to 20x. You should offer me an incentive equity plan on top of my retainer to play my All Star best, thinking and acting like an owner.”

That pitch doesn’t work generally, because most businesses aren’t sitting at a growth inflection point.


Tobie:


The main problem is the legal complexity and risk of dealing with anything that is pre-IPO, regardless of whether or not it’s going to have value in the future.

A bunch of equity compensations also have tax implications and might require that you make a large cash investment to purchase them, with no guarantee of recouping your investment.


Matt said:


This is an interesting topic, to me at least. I’ve got a wing of my business (just started, so I have no experience with it yet) that takes an equity stake in the companies we work with. A couple years ago, I completely dismissed the idea of taking an equity stake, but a few months ago, I started thinking, “Huh, maybe I should rethink that.” Because I need to pay rent and put food on the table, most of my work is still “cash for consulting.” But ask me again in a couple years, maybe I’ll say taking equity stakes for payment was the best thing I ever did.


Thanks for the thoughtful replies, y’all!

-P