Ask HN: Structuring a revenue stake agreement on web work

[velebak]

Recently, my side web development business has taken an interesting turn.

One current hourly client and one potential client have both approached me with revenue cut offers in exchange for long term arrangements and a reduced hourly rate. At first, I shunned such an arrangement, but now realize I may be losing an opportunity and an ability to guarantee some level of future revenue. It may even be possible to earn more than I do right now in my current full-time job.

Both clients have stated they want a long term partner for the development of their web offerings, and feel offering a revenue stake is their best path to get there.

What questions should I be asking? How are agreements like this typically structured?

I'm asking so when I speak with a lawyer I have some semblance of the key points with which I should be concerned. I'm sure other HN folks have been offered similar choices, and I'm having a hard time getting out of the "my time and experience is worth X per hour and any other arrangement is ripping me off" mindset.

I'd like to hear what you folks think, or if you have had experience in arrangements like this.

Thanks!

[bspring]

To pay a consultant with equity, the company should have an incentive plan. It'll be called something like 2012 [COMPANY NAME] STOCK PLAN and they'll provide you with a copy. The plan matters for securities laws reasons. If they don't have one, it's more their problem than yours, but it'd be nice to know they're doing things legit (because if they're not, it could indicate they're not paying attention to tax issues that impact you - see below). The company's plan will probably have a few different types of instruments they make awards with. I'd assume they'd provide you with restricted stock or restricted stock units (RSUs). The first makes sense if the company has no value, the latter makes sense if they do. I would not want options or any other instrument that only has value based on the increased value of the company, in this case.

It may seem surprising, but hopefully logical, that you become an "investor" for securities laws purposes when receiving equity awards. It won't hurt to think like an investor. You might ask the company whether they've done any external valuations, and do your own diligence to ascribe some value to the company. You'll also want to get a sense of what the company's plan is and how/when they anticipate exiting, so you actually get something for that equity. You can defer to VC's judgment on liquidation concerns if the companies are VC backed, since that trajectory is typically pointed towards an exit. Ultimately, the value of your share of equity over the time you'll spend working for the company, adjusted for the time-value of money and risk you'll never get to liquidate might help you get out of the current mindset, though maybe it'll often yield the same conclusion.

As I mentioned above, there are big tax issues in all of this. If the company (uses the wrong)/(misuses an) instrument, you can be personally liable for a lot of money, without ever having received any cash to pay the burden. If you get stock, you've received property for services which constitutes income in the US (IRC Section 83(a)). If that stock has no value, you're fine, but need to make an 83(b) election if it vests. If the stock does have value, you need to use an instrument that defers your recognition of income until you have the ability to liquidate (RSUs can do this) or be paid in a combination of equity + cash to offset the tax burden.

Hope this helps you decide whether you want to invest in these clients.

[velebak]

Thanks for taking time to reply. I had no idea this was so complex. Is this different if these are small, privately held companies? One's a retail hydroponic supply shop. I can't imagine they have a stock plan documented. I'm pretty sure they are not VC financed. Also, they mentioned a cut of revenue(unknown if it's from gross or net), not an equity stake.