It is not common practice especially in this part of the world to use your business equity to pay for services. However, it is one of the most effective and strategic financing options cash strapped businesses can adopt. It has been said time and time again that money is the lifeblood of a business; therefore entrepreneurs must look for innovative ways to inject life into the business when it seems to be dying.
At the early stages of a startup, there is so much to be done and so little financial resources to cover them all. Giving out stock options to your vendors may just be the only way to afford the important services your business needs to survive. Also giving equity as payment builds loyalty among your vendors and can even initiate discount incentives.
But before you go out handing every service provider stock options, here are 3 critical points to consider:
Plan ahead. You should not be pressured into giving out stock options, neither should you do it on the spur of the moment. It is necessary to plan how much stock options you are willing to give out before you take this path. When planning, you should take into consideration your business’ valuation, the number of shares you are willing to give to your service providers, employees, and investors if you plan on raising funds. By taking into consideration these categories of people, it gives you an idea how much equity you are allowed to give out without losing ownership of the business.
Don’t give equity to vendors who are not credible. The only way to test their credibility is to engage their services first. Giving out stock options to service providers should not be a subjective decision rather it should be a well thought out and objective decision an entrepreneur makes as a last resort. Give out equity based on the required deliverables or performance measures expected from the vendors. The business equity is a valuable asset and you need to make sure you are not careless with it.
Document, Document, Document. Never settle for a verbal contract, rather make sure you get a written contract where both parties agree to the stated terms. This saves you pains and heartaches when you want to sell the business, take the company public or increase the capital base of the company. It also keeps your vendors in check of what they can do or not do with the equity they have, because the contract clearly states the terms of agreement like restrict share transfer to prevent vendors from selling their stock to others (like your competitors!), terminable at will meaning they can be cancelled at any time. You might require legal counsel to direct you through this process.
Entrepreneurs must continually look for inventive ways to finance their business if they are going to pull through the trying times. Having a 60% stake in profitable business is better than having a 100% stake in a dying business.
This article is part of a series of conversations around helping entrepreneurs in Nigeria become financially intelligent. This subject will be discussed more extensively at the June 2017 Startit Academy, themed, Finance Fundamentals for Startups & SMEs. For more information about the event and registration, please click here.