To work for equity is a request that we frequently receive. As a rule, we turn it down but it is an appealing option for many junior or freelance developers. If things work out, you could be holding onto valuable shares of the next Instagram or Snapchat. But as with any opportunity, there are significant risks involved and you should be asking these 9 questions before you commit to working only for equity and the promise of future value.
1. Am I okay with developing this project purely for the experience it will give me, and nothing more (no equity, no money, no swap services, etc.)?
- Yes: Great, no need to read further. Enjoy the project and learn everything you can! Anything else you get in exchange is a bonus.
- No: If the prospect of getting nothing out of the project (apart from experience) frightens you - read on. There is an overwhelming possibility of this happening, especially if you commit to the job unawares.
Has the client done significant market research to validate their idea, i.e. ensure that there is a place for it in the market? Was this research done in the actual market with strangers from the target user group?
Note: Market research with friends/family does not count.
You can get to know this by asking the client about their idea and research before committing hours to their project - a reasonable request since you will be working for equity and affected if their project fails.
A project without proper market research is a clear red flag as it indicates a lack of strategic and business planning, which is crucial to the success of the product.
Are they (contractually) committed to put in equal hours towards business development/sales/marketing?
The contract should state that if they are not putting in sufficient hours and getting results they will forfeit their shares to the company for example. Same would go for any partner. Responsibilities need to be clear with set KPIs they have to meet.
Do they have sufficient budget set aside for operational and marketing costs?
Many times, clients are so focused on getting their product right in development that they do not plan enough on marketing. Marketing a new idea can be very expensive, but important in making sure a good application does not go to waste unnoticed.
A quote should be provided on all marketing materials and advertising costs that will be required to get the project launched, and the client should have a realistic plan on how to make these funds readily available by the launch date.
Are the shares being spread equally between different partners based on their input/hours/etc.?
A very disproportionate allocation of shares raises another red flag, such as the overinflation of one’s contributions to the company over others.
This comes back to contractual responsibilities, obligations and agreements. It should be fair and evenly spread. Ideas are not worth much if left alone, and any creative person will have many of them lying around. The value is in implementation and hard work to make these ideas a reality - and these should be rewarded accordingly.
You should ask for your work to be compensated based on the actual amount of time/work you put into the project, and not for a flat percentage like 1%. The more time and effort you put into the project, the higher your risk of not getting equivalent value in return - thus, the potential upside should be matched to this increased risk.
Does the client understand that you still need to eat and pay the bills, and that their project will not be a priority before you ensure each month that your bills are covered?
Any normal timeline estimate should be significantly increased to cater for this.
This involves realistic planning and budgeting on your side to know how long you can afford to work with zero return - without forgetting the time you need to find a job before you truly hit zero.
You may factor in taking on other projects which can pay you in cash to keep you afloat financially while working for equity. Unless, of course, you have no financial commitments or are ready to bet your savings on their idea.
Does the client have a clear path to subsequent rounds of funding?
When discussing the project with your client, you should also be asking about their funding so far, and if subsequent funding includes you getting paid. Most startups with seed funding will offer a base salary, and if some of it does not go to your pay, you should be asking why.
By learning about the client’s strategy and timeline to significant funding, you get an idea of when you can expect to start seeing your payroll in cash. This will help you to plan your own estimate from the previous step.
Are there anti-dilution protections in place to ensure your shares do not get diluted?
If, say, you are given 1 out of a 100 issued shares, you effectively own 1% of the company. When future investors come into the picture, and more shares are issued, the denominator (previously, 100) increases and the value of your share decreases. While this increases the overall value of the company, the real risk happens when the founders issue shares to themselves which doesn’t increase the overall value of your share.
Anti-dilution clauses for your equity ensure that after working for free, your stake in the company is protected, and you earn the value promised at the start. However, anti-dilution agreements are rarely offered to entry-level employees. A way to negotiate dilution is with pro-rata rights which allow you to maintain your percentage ownership by buying more shares in the future. Y Combinator, which has been called the “the world’s most powerful start-up incubator”, has an in-depth look at these legal and accounting issues for startups with their “How To Start A Startup” class here.
What are your cashout options at certain growth, funding, or revenue milestones?
Without the option to cash out, your hard-earned equity is ultimately worthless and a hypothetical value. Negotiating the option to sell at least some of your equity when the company reaches certain milestones gives you greater liquidity to earn cash, instead of waiting for an IPO or buyout that may not happen - leaving you with nothing.
Ultimately, working for equity is a bet, and a substantially risky one given the reality that many startups never make significant money and fold halfway. While you may feel like a “co-founder” given your work and stake in the startup, you are also taking on all the risks of working for free without a full “employee” status and its benefits.
My advice is to be cautious of any “work for equity” deal and be realistic about your long-term finances. Asking yourself the 9 questions above will help manage your expectations and choose the right startup to work with.