By Chris Taylor
NEW YORK, May 3 (Reuters) - Whenever Manhattan attorney Ted Scofield gets offered equity in a start-up, he feels like he’s been thrown into the middle of a high-stakes Las Vegas poker game.
If he bets right, he could hit a flush and become richer than he ever dreamed. If he bets wrong, he could end up with nothing.
“It’s a real balancing act,” says Scofield, a securities lawyer who helps entrepreneurs and small businesses get started. “At that stage they can’t always afford to pay me for my advice, so I have to get out my crystal ball and decide if taking stock is going to pay off.”
The shares-versus-dollars decision presents a common dilemma for start-up staffers and consultants. Early-stage companies often don’t have the ready money to just write a check, so they have to lure talent with the promise of stock.
Indeed, over the course of the Great Recession, more private firms turned to equity as a compensation option. In 2007, about 35 percent of private companies were using long-term incentives like stock awards; by 2011 that had risen to 61 percent, according to a survey by the human resources association WorldAtWork and Vivient Consulting.
Stock compensation has become so prevalent that Bank of America Merrill Lynch recently rolled out an equity compensation award analysis tool for its high net worth clients.
PROSPECTS OF A $200-MILLION PAY-OFF
Make the right choice, and you could end up like artist David Choe. He famously painted a graffiti mural for Facebook headquarters back in 2005, took stock instead of a $60,000 cash offer and is now poised for a $200 million payday when the social network giant goes public.
Taking equity has also worked out well for Scofield - sometimes. He secured an early stake in Henderson, Nevada-based frozen-yogurt chain U-Swirl, which subsequently went public. But he’s also clutching options for ventures whose outlooks aren’t so rosy.
Once you’re offered equity by an employer or a client, “it becomes as much a discussion about business strategy as it does about pay,” says Will Ferguson, a senior partner with human resource consultants Mercer in Los Angeles. “You have to figure out how that value is going to be realized, and how and when you’ll get the chance to monetize that. Because a lot of companies don’t make it.”
So if you’re in the fortunate position of weighing a juicy stock offer, what issues should color your decision? A few tips:
- Think of your own needs. Your particular financial situation will help make the call for you. If you need cash for pressing concerns, like paying the monthly mortgage, then rolling the dice on a potential equity payoff isn’t wise. But if you have plenty of savings or other income to tide you over, then accepting a piece of the company could be worth the gamble.
- Evaluate your belief in the company. Not all ideas take off, of course. “If you take stock, you’re effectively saying, ‘I believe in your optimism,’” says Walter Zweifler, CEO of New York City-based Zweifler Financial Research, which helps start-ups establish their valuations (and helps staffers evaluate such equity offers). “If you believe that optimism could be misplaced, then take the cash.”
- Dive into the details. If you take the stock, your own financial future will become tied up in that of the company. So be ruthless in poring over business-plan minutiae - existing clients, revenue projections, competitors in the field. If the company is unwilling to disclose key figures, consider that a red flag. Enlist the help of financial planners or business appraisers with experience in the field to help you figure out if the shares being offered are actually worth anything. It’s not just the number of shares that matters, but the percentage of the company they represent.
Merrill advisers use their new analysis tool to create a customized report about how much a client’s shares might be worth, in both the best and worst-case scenarios. There are also similar Web-based products for the broader public at sites like StockOpter (). But these tools tend to focus on valuing stock options for companies that are already publicly traded companies; trying to evaluate an offer from a private start-up can be even more challenging.
- Consider the tax implications. Different methods of compensation come with different tax treatments. Just remember that Uncle Sam is always going to want his cut. “A stock grant is taxable as income, which can sometimes be an onerous expense,” says Zweifler. “If you don’t want to do that, you can secure options to buy the stock at a particular price. That isn’t taxable until the options are executed and you sell the shares, at which time taxes on the capital gains have to be paid.”
- Know your worth. It’s difficult to establish a ‘going rate’ in the start-up world, where some ventures take off and are sold for billions, and countless others crash and burn. But co-founders of technology start-ups could expect “a minimum of $60,000 to $80,000 in salary and equity,” says Cameron Keng, a New York City-based CPA. Early technical employees could expect even more than that, at $80,000 to $100,000, but likely with a smaller equity slice (and therefore less potential payoff).
- Split the baby. Your decision likely won’t come down to all-cash or all-equity. You can devise a blend of both that makes sense for both you and the company. “At this point, no one is going to work for equity alone unless it’s your own idea or company,” says Keng. “Everyone that’s going to be a valuable asset to their company is generally going to require a mix of both cash and equity.”