Frequently Asked Questions
What sorts of outside service providers might a startup need?
It can actually be an endless list. The first stage of starting something new is figuring out a general area to target, and someone, or some small group, making the courageous decision to pursue it. It’s an amazing development, but it generally doesn’t cost anything yet, and it leaves all the work of constructing a company out in front of the founder(s) with few, if any, resources assembled yet. Things that may need to be done vary widely from incorporation to product design to finding office space to identifying investor prospects to setting up servers, and more. Some of these needs tend to be excellent matches for founder talents, but some are not, and there’s only so much time and effort a small early team can put in. Benefitting from a little bit of world-class expertise in a key area can make a massive difference for a startup. The team can maintain focus on core competencies and main undertakings, with confidence that other crucial activities are well covered, and relief that resources are being preserved at a time when fundraising’s often barely begun. We are glad to consult with entrepreneurs about their companies’ situations to help understand what vital areas could get a substantial boost through work with the right expert through an EquityX arrangement.
What sorts of service providers are participating in EquityX?
The most crucial activities for startups concern bringing the best products and services to the customers who emerge as their early champions. Great service providers can augment these efforts, or provide support that allows focus on these primary efforts. Fields of service providers in the EquityX marketplace include code development, product design, law, bookkeeping and accounting for financial and tax purposes, real estate, recruiting, human resources, marketing, public relations, advertising, business development and more.
How is preferred stock different than other kinds of stock?
“Preference” refers to what happens when a company goes through an exit event such as an IPO or acquisition. If it’s a sufficiently large IPO then preferred stock usually simply converts to common. If it’s a more modest acquisition, then the preference means that preferred stockholders get back the funds they invested to purchase that stock before other shareholders are able to access any proceeds. We believe that holding preferred stock based on value of services provided is the best way for service providers to assure fair proceeds from their work. Because of the uncertainty of outcomes at early stages and the precedence of preferred stock, common stock proves especially difficult to value in order to determine how much a service provider may have fairly earned.
Does this work the same as an employee stock or option program?
Employee programs are almost always tied to common stock. There is good reason for that as employees are generally paid cash salaries, and risky common stock equity represents their upside above those salaries. Preferred stockholders are mostly investors who are putting cash into the company. Preferred stock can assure those investors that they get their cash back before anyone participates in equity upside. We believe that it is most logical for service providers who take all or part of their compensation in equity, often when they have alternative clients who would pay in cash. That equity should be preferred instead of common, so that the service providers have their best chance to realize at least the amount they’ve earned through their efforts, with less risk.
How can I propose myself or my company or someone else to participate?
We currently use LinkedIn for people to log into EquityX and engage with each other. We may expand those options over time. Logging into the EquityX web site this way, or sending a note via our web site’s “get in touch” page will put you on our radar and we may follow up with an invitation to join our marketplace. Additionally, startups and service providers already in the marketplace can invite other parties with which they work or aspire to work.
How does the marketplace work for startups and service providers to find each other?
Data we assemble include multiple characteristics such as field of work and location that may be utilized with search to find the most suitable service providers and startups in the EquityX marketplace. Startups can put particular tasks out for bid to the marketplace overall, or for response by particular selected service providers. Prior engagements and marketplace-determined ratings increases transparency for everyone.
Is this the same as a convertible loan?
Sometimes when in between substantial fundraising rounds, startups issue convertible debt in which investors make small loans that appreciate some interest and then the amount provided plus the accumulated interest converts to that value in preferred stock when there is a next round. The EquityX method is similar to such a convertible loan in that service providers get a specific dollar amount, with appreciation through a discount algorithm over time until there’s a round, and then there’s conversion to the next round at that round’s valuation. A main difference is that the equity arrangement is in direct exchange for the services a startup needs, instead of that startup having to find both sources of convertible loans and providers of service. The more direct and focused results from working through the EquityX marketplace aligns interests and accelerates success for all parties involved.
What happens if there’s disagreement about whether and how work has been completed?
Methodologies for mutual agreement about activities are incorporated throughout work startups and service providers do together with EquityX. Tasks should be clearly defined including indication of whether they’re tied to milestone, hourly or retainer compensation. Every time a service provider considers a task to be done, that should be submitted as such, and then it’s up to the startup to confirm completion or indicate what needs attention in order to achieve completion, which effects the micro-transaction. Smaller-scope tasks are advisable as they’re most clearly manageable and provide greatest transparency about how things are going. If there is a dispute that needs attention by parties besides the startup and service provider, there are mediation protocols within the agreements entered in the EquityX marketplace, including our taking direct responsibility to try resolving issues before involving any other parties.
What happens between each micro-transaction and the next qualifying fundraising?
Since service providers have specific rates at which they work, the portion from the pool allocated to them has a monetary basis. Once a micro-transaction is allocated, because it’s not yet cash or even stock, the stock award size will appreciate over time in consideration of its risk and illiquidity. Our current default formula is that conversion occurs with a 10% discount, which then starts going up by 2% each month starting after the sixth month, until reaching a maximum of 40% after the 21st month. To illustrate with an example, that means that if a service provider receives an allocation of $1,000 from the pool, then if a venture capital round were to happen within the first six months at $1.00 per share, the 10% discount means conversion at $0.90 per share resulting in 1,112 (rounding up) shares, and then after six months the corresponding numbers would be 12%, $0.88 and 1,137.
What are criteria for a financing to be sufficient to convert service provider positions to equity?
Default terms are that a round must be either at least $250,000 or at least one third the size of the round that closed immediately prior to relevant micro-transactions.
If a financing round takes a while, what happens to completed EquityX micro-transactions?
After 24 months, the service provider receives the equity security most recently purchased by investors, including effects of reaching 40% maximum discount.
What if a startup succeeds in becoming cash-flow positive and elects not to raise more funding?
24 months after an allocation, if there’s been no subsequent substantial fundraising, then the amount awarded, along with effects of maximum discount converts, to that valuation of the same equity as whatever was issued in the round immediately preceding the allocation.
How about if an exit event happens before there is an equity financing?
The micro-transation amounts, with full effects of discounts per amounts of time that have passed since allocations, are converted to the security most recently issued to investors, at the same valuation level, before execution of the exit event is incorporated.
Can service providers be paid with both cash and equity?
Yes and that often makes a lot of sense for multiple reasons. Of course paying for services with cash is a long-standing practice. EquityX has so far focused on our innovative approach to availing equity compensation to service providers. We do not currently have mechanisms for cash compensation, and if that’s done along with an EquityX arrangement, it should simply be done in parallel through conventional means. We engage frequently with marketplace participants, and we may incorporate methodologies for cash compensation to service providers side-by-side with equity, in the future. We are eager to learn marketplace participant thoughts and ideas about how that could be a valuable aspect of our system.
Are the EquityX terms adjustable?
At launch, terms such as the 10-40% discount range, 24 month term and one-third prior round criteria are based on consultation with lawyers, accountants and investors about the most sound and broadly applicable approach. EquityX is dedicated to agile development and we are consulting with marketplace participants to consider how they’re participating and what they want to see. Over time more options will emerge responsive to these conversations.
How are ratings used to assure quality of marketplace participants?
EquityX endeavors to measure satisfaction of work together by all startups and service providers that participate in our marketplace. This includes assessment of particular strengths and characteristics in order to assure that matches are made in consideration of specific needs and interests, in addition to representations of overall quality. Should ratings indicate problems in marketplace participation by any participant, that will be evaluated and it may impact marketplace access.
How much legal and accounting consideration is incorporated with EquityX?
Our highest priorities include getting out of the way so startups can execute and their service providers can provide vital support. To achieve that we’ve worked with the best lawyers and accountants we know to incorporate agreement terms and algorithms that fairly cover multiple scenarios that may be encountered. We know the EquityX approach is sound and robust. Everything we do is transparent and we encourage marketplace participants to share materials with lawyers and accountants they trust. We also make ourselves available available to discuss how EquityX works and its implications at any time.
How reliant are marketplace participants on ongoing involvement by EquityX?
The result of work with EquityX is documentation of agreements between participating startups and service providers. Those agreements hold between those two parties, including ensuing micro-transactions, regardless of the status of EquityX as an entity. To be sure, we are in this for the very long term, looking forward to succeeding alongside marketplace participants and working with startups through some of the same sorts of notable exit milestones we’ve experienced earlier in our own careers.
What’s the tax impact of working with EquityX?
EquityX is a worldwide service, and tax considerations vary country-by-country. We do recommend consultation with legal and tax authorities about EquityX terms and impact on particular participants. In many jurisdictions, we expect that tax implications of getting compensation by equity can be favorable for service providers if that equity appreciates substantially and is held for long terms. Resulting taxes after an exit may largely be applied at more favorable long-term capital gains rates. By and large, startups that participate in EquityX have not yet achieved profitability, so their tax situation is usually modest regardless of whether they’re issuing stock or cash for services. Both startups and service providers have capabilities to make charitable donations through EquityX which can be an excellent means to enjoy the benefits of stock appreciation, be philanthropic and realize long-term tax benefits. These generalizations are not fully set, especially on a country-by-country basis, which is why we do recommend consulting with appropriate experts when entering EquityX arrangements, and we additionally make ourselves available to discuss and also can help steer your attention towards those right experts in case they’re not known to you.
What’s the charity tie-in?
There is increasing commitment by emerging startups about the importance, for business and social reasons, of maximizing positive global impact, including dedicating portions of proceeds from success to worthy causes. Making such dedications at early stages, before equity appreciates in value, has tax and other financial advantages for both donors and recipients. EquityX allows startups and service providers to make such designations when they enter agreements and conduct transactions. Moreover, we make such a dedication with all of the equity allocations we receive. If you are making charitable allocations within your EquityX participation, we recommend discussing with a tax advisor and we are glad to share what we’ve learned if you want to contact us.
How does EquityX make money?
We are fundamental believers in equity as a currency, we have confidence in the promise of startups who pass our marketplace vetting, and we are supportive of how precious cash is. So our compensation is through startup equity too. We take a one-time allocation at the establishment of a pool, and then with every micro-transaction, EquityX gets an allocation 10% of that size, with the same discount provisions. This means that after the initial set-up of the pool, one-eleventh of all awards from that pool are allocated to EquityX and ten-elevenths are awarded to service providers.
How did EquityX start?
- The EquityX team includes veterans who’ve participated in founding more than a dozen startups, including several IPO and several acquisition outcomes. And we’ve also been investors within venture capital firms and as angel investors, and we’ve acted in advisory and other service providing roles to startups. We’re very eager for better solutions to the needs of startups in which we’re involved to work with great services and to conserve cash. We also fully appreciate the needs and interests of service providers and of current and future investors — all roles in which we continue to be active. So we’ve dedicated ourselves to rigorous work with lawyers, accountants, investors and other experts to devise a solution that is aligned with interests of all parties involved.
How does a startup qualify for participation in the marketplace?
EquityX reassures service providers that the startups in our marketplace have equity that’s worth owning, so we set quality standards. Considerations include market opportunity, team experience, technological accomplishment, competitiveness, financial backing and operational track record. It’s understandable that startups may not have substantial success in all of these areas yet, but we do expect great promise in each. Relationships are especially helpful startup qualifiers at the formative stages of the EquityX marketplace. Association with high-quality venture capital and angel investors as well as other parties we know and respect provide validation of a startup’s promise.
What are the EquityX system’s advantages for startups?
We break the logjams startups can face when trying to find and engage the very best service providers. Those service providers are often in great demand and charge rates that are too steep for startups to afford, especially those in early stages with limited cash on hand. Sometimes alternative arrangements have been made based on building up payable accounts that deplete future fundraisings as soon as they occur, or issuances of common stock that exhibit particular volatility for private companies and are therefore difficult to track from a value standpoint. EquityX provides a way that startups can work with the best service providers, and the amount owed is provided with more stable preferred stock the next time that funding is raised, so that cash isn’t drained when it’s most precious.
What does it mean to set up an equity pool with the board of directors?
The pool is a money-denominated amount approved for the startup to distribute to service providers. It gets approved by the board of directors or whatever is the appropriate governance entity relevant to the startup. Once established, the startup management team has discretion to dispense from the pool to service providers. The pool is entirely flexible so it can be established or expanded in any increment at any time, just requiring another iteration of the approval process each time. We believe that it is best practice for a startup to consider the total amount of likely services to be purchased, from multiple providers, over the course of several upcoming quarters or even a year, and request that size pool be approved. This empowers company management to find the best providers and receive the highest-caliber services, and not waste too many cycles seeking board approval for every small transaction.
What happens if a pool is not fully allocated to service providers?
The only equity issued from the EquityX pool is for allocations already made. If there is unallocated value in the pool when a next substantial financing happens, then that portion of the pool effectively goes away. Startups are capable of extending unused portions to a new pool that would tie to another future venture capital financing, and at that point may consider adding to pool amounts if there is to be more work with service providers through EquityX.
How does working with EquityX impact current investors’ situations?
Investors fully appreciate the pressures and distractions faced by even their best startups. Working with EquityX accelerates startups’ paths to success by availing higher quality service providers, reducing pressure to fundraise and prioritizing other vital activities for cash utilization. While ultimately there is some equity ownership going to service providers through EquityX, if those service providers were to be paid with cash, that cash would increase fundraising pressure which also results in dilutive issuance of ownership. By working with EquityX, startups have more flexibility to time their future fundraising to coincide with peak success which is more advantageous for existing investors, and also having the best service providers owning equity puts everyone on the same page of prioritizing startup success going forward.
Will working with EquityX impact how attractive a startup is for new investors?
Investors broadly and fundamentally realize that startups need the right services at the right time to proceed and those services have to be paid for. Getting services via EquityX can enhance startup attractiveness in a few ways. First of all, it preserves the company’s cash situation until a next financing, so the company is more likely to reach a next milestone that’s key for investors before that financing. Also, working with vetted EquityX service providers indicates the quality of services received, and we believe also marks how smart and leading-edge the startup is. Finally, because service providers may elect to sell their positions in the financing, this can avail more stock if there’s sufficient investor appetite.
When and how does a service provider get compensation from the equity pool?
Startups assign tasks to service providers at particular pricing levels, service providers indicate completion of tasks, and then an authorized party from the startup, often the CEO, approves that completion which allocates the corresponding portion of the pool to the service provider. Each one of these is a “micro-transaction”. There is flexibility for work to be based on hourly rates, a retainer arrangement or achievement of certain milestones. We recommend that activities be broken down to small, clearly measurable units for greatest transparency and easiest manageability.
What are the EquityX system’s advantages for service providers?
Being a key player in the success of a great startup can really boost a service provider through both the association, and massive upside of the startup’s equity if that’s a method of compensation. But service providers often have to turn down intriguing business because of of the illiquidity and uncertainty of common stock. Even in the best cases it generally takes years for an exit event like an IPO or acquisition to provide access to cash, and in many of these exit events, the preferences of stock held by VCs drags down or even wipes out the common stock positions that service providers have tended to receive. The EquityX solution allows service providers to charge their proper rates, tracked in monetary terms, with algorithmic methodologies that determine how to most fairly convert that amount to preferred stock when the next venture round occurs. This aligns service providers with VCs, providing the same investment upside as well as a faster and more stable path to getting cash for services than can be achieved with common stock in private companies.
How does a service provider qualify?
Working with startups we consider to be the very best, we feel obliged to help them fulfill their potential by availing the very best service providers. As EquityX launches, we are populating our marketplace with service providers to the startups that pass our vetting process. We are also building relationships with additional, excellent service provider professionals and agencies who bring qualifications of successful work with the startups of the caliber we seek for our marketplace, including those with clients backed by investors we know and respect.
When and how can a service provider convert EquityX micro-transaction to stock or cash?
Once a sufficiently large round happens, completed micro-transactions along with all discount effects, convert to the equity of the relevant round. See FAQ #16 for illustration of how the number of shares is calculated. If a service provider prefers to get cash sooner, and not wait for a subsequent exit event, there may be appetite among the participants in a venture capital round to buy from the service provider all or some of the shares to which they’re entitled, based on the same math.
How sure can a service provider be of making at least what’s owed?
Owning equity in a private company like a startup is definitively risky relative to cash for example. But EquityX incorporates several factors to best assure service providers that they get compensated. They may be able to liquidate when a round happens if there’s appetite for more stock by the participating investors, which is often the case. If a service provider chooses to proceed with the equity position, which does by the way maximize the upside, there is also downside protection because of the equity being in the form of preferred stock, which gets preferred treatment for its basis to be returned before equity investors generally participate in upside. This means that there is prioritization upon an exit for the service provider to receive at least the amount of pool allocation including its associated compounded appreciation.