Be wary of very early stage startups that casually offer you equity in return for your services

A friend of mine (let’s call her Alice) recently left a senior marketing job at a well-respected company in order to start her own marketing consulting business. Alice has a solid reputation and proven track record as a marketer; I have no doubt she’ll do well in her new venture.

Alice came to me with a question. One of her contacts was starting a new venture and wanted help creating a PR plan and a launch plan for their site. They couldn’t offer any cash for her services (she estimated she would have normally charged about $10K for a comprehensive plan plus about $2K/month ongoing) but were willing to give her an equity stake in the venture. Yet their site wasn’t built and they couldn’t produce a business plan, a list of backers to date, or even a scope document about exactly what they wanted her to accomplish.

“Should I do this?” Alice asked. My immediate and unequivocal answer was: “Run.”

The granting of equity should normally be considered as a trade for critical components that are essential to a startup’s success. ‘Critical components’ would generally be an exchange for significant financing or a part of the compensation package to attract and retain key employees. But trying to use equity as a way to avoid relatively low cash costs for temporary contract workers? That likely reveals a fundamental lack of experience that should set off warning bells.

Before an entrepreneur starts hiring paid contract services, he or she should have created a solid business plan, put in some of their own money, and probably raised some “friends and family” money to cover the initial basics on a cash basis. So if an early stage company says they have no cash to pay you, yet they are casually offering equity, it sounds like they haven’t done their homework and the equity won’t amount to much, anyway.

This general rule isn’t 100% watertight, though, and there have been some famous exceptions, like a consultant who refused to accept some Google shares in lieu of cash.  If you are convinced that the company has a good team and a solid plan for a product you believe in, and if you can afford to give up any prospect of money for 3 years or more, make sure you get the one and only number that really matters for equity grants: your percentage ownership.  The grant should also come with an option plan document (professionally prepared by lawyers) which you should run by someone who has experience interpreting the legalese.

Summing up: You know the old Groucho saying of “I wouldn’t want to belong to any club that would have me as a member?” Similar line of reasoning goes for early-stage startups tossing around equity offers to most anyone who comes their way: “If you’re offering me equity this casually, it’s probably not equity that I want.”