If you are a solo or small firm who is looking to work with startup companies, you have probably been asked to take equity in lieu of compensation or to set up a deferred payment plan. When you are talking to companies who sound like they may be doing the next big thing, you may believe you are taking an educated gamble.
Yet, when you turn to the economics of being a solo or small firm, the numbers often do not pan out…
The idea of taking an equity stake in a client you represent is not new. In fact, in the first “dot com” boom, it was a popular practice for law firms. If a company comes to you with a high valuation and seems to be getting some traction, electing for what you think may be a big long term payout may be smarter than getting a couple thousand dollars to handle some of their initial legal work.
This is a big risk. The time and energy you spend working for this client, who is not paying you, could be spent in other paying places. Unless you are actually coming in as a co-founder to the company or other founding member, you are still a service provider. Since you are not getting paid by the hour, you will also likely end up spending more time on matters for the client than if they were paying you per billing period. It could start to seem like you are always on the clock versus working a set amount of hours per day or week for the client.
Even though the equity could pan out, and you could own a percentage of a company that may IPO, the reality is that so few companies actually get to that stage (or the stage where you are getting paid out anything based on your equity stake).
Deferred payment unfortunately often means permanently deferred payment. We get asked by many potential clients why we normally do not take on deferred payment matters but the larger firms do. It’s pretty simple economics.
The large firms that promise to do work for “free” initially can float that work since they are multi-million dollar shops. Incorporating a company is something an associate can be directed to do with ease. Since these firms have more people, cash, and resources at their disposal, allowing a percentage of deferred payments is not that big of a deal. Even if they never end up getting paid by some of these clients since the companies turn out to be duds, it will not drastically alter their bottom line.
Small firms do not have that luxury. If your firm has a handful of attorneys, time has to be money. Letting an associate spend five to ten hours working on something that you may never get paid for takes away from time that could be immediately billed for.
There is also an attitude amongst some startup founders that they are taking the legal services for free. We have heard many times from founders at events that they never intend to pay the firm for the services they have received. Since many of these companies end up closing up shop, that is thousands of dollars you may be out. You have to get in line with everyone else they may owe to collect that debt.
In the search to find flexible billing structures and alternatives to the way things have always been done, taking equity and deferred payment have been presented as sexy options. It is important to think twice and think small sometimes. Money in the door, even if only a couple thousand of bucks, pays for things. Equity may literally never be worth more than the paper it is printed out on.
Christina Gagnier leads the Intellectual Property, Internet & Technology practice at Gagnier Margossian LLP, with a specialization in social media, copyright and information privacy. She is also at the helm of REALPOLITECH, a digital public relations consultancy that provides a broad range of services, including crisis communications. She serves on the Board of Directors of Without My Consent, combating issues like revenge porn. If you ever need to find her, start with Twitter at @gagnier or email her at email@example.com.