Learn Me: Negotiating Equity as Part of Compensation

Talking compensation package with a potential employer. I think there is strong possibility of them growing up this business and being bought out by a large player in the industry in several years time. I'm coming on right as they're kicking off full scale production in a key role.

I expect to get paid a salary that's a good wage.

I would like some equity so that, if they get bought out for big money in five years, I can get a nice payday from it.

Any suggestions on the best form to structure a position to accomplish these goals? I know it depends a lot on how the company is structured, and I need to ask and find out.

Assuming it's most likely an LLC, Profits Interest seems like the easy-button option, at least for them. I gather that makes me have to qualify as a "partner" and get paid with a 1099 instead of W2.

Any experience with how that works out? Does that affect things like ability to claim Unemployment Insurance or anything?

Any other thoughts or suggestions?

My only experience with this comes from a somewhat larger scale -- tech companies and IPOs.  In that area one of the most important things is to look at what can happen to your ownership percentage on later rounds of funding -- if new investors come in and get 50% of the company, your shares are diluted by that much.  That's not necessarily a bad thing, so long as the new investment is what's necessary to grow the company enough to offset the dilution.  Also, sometimes there are differences in how "preferred" vs normal stock get paid out on "liquidity events", some structures can have preferred shares getting a certain minimum payment before any normal shares get a penny and if the purchase price isn't high enough then the normal shares get nothing.

No idea if those concerns are relevant here though.

There are many things that would go into this including corporate structure and accounting. The easiest way would be for them to create a phantom stock arrangement for everyone in the stock holding class. It's basically worthless until a sell and if done correctly doesn't act like a liability. For the employee though it's only valuable if there is a sale. 
Are you bringing something unique to the table in terms of innovation that makes it worth this to them? You may be able to argue for it by proving that you are bringing increased value to the company through your unique skills or knowledge. 

grover said:

Are you bringing something unique to the table in terms of innovation that makes it worth this to them? You may be able to argue for it by proving that you are bringing increased value to the company through your unique skills or knowledge. 

I'll be their first full employee and head of production. I'll be their head distiller. I'll be developing the production procedures for full scale production.

Once we had four guys pushing to own the rubber hose shop and three guys stepped up with cash and bought it from the elderly owner.  They bumped the 4th guy cause he had no cash but paid him well since he did all the grunt work.   

Can you invest?

Put yourself in their shoes.  What do you offer that nobody else can?  How much would you pay for that difference?  Would  you give up a portion of the company for that and a top wage?  
  Suggest as part of your negation you accept a wage they set and if successful you then get a portion of ownership.   A small portion.  
 

I've been in exactly that position.  They will typically forego a sure thing rather than give up complete control without investment. 

Negotiating equity without investment or a proven track record is tough, what's in it for them? Negotiating the opportunity to earn equity is the play here. Can we set certain benchmarks that earn me some equity when I hit them? If so, what are those bench marks?

There are a few types of equity as well, on going, and/or due at time of sale. If you're an employee, then the equity I'd offer the ability to earn is x% at time of sale. If you participate in growing the company so it gets a higher/faster sale AND stick around for said sale, you get rewarded for it. 
 

With no monetary investment, and wanting the benefits of being a w-2 employee, that's your best chance. 

Steve_Jones said:

Negotiating equity without investment or a proven track record is tough, what's in it for them? Negotiating the opportunity to earn equity is the play here. Can we set certain benchmarks that earn me some equity when I hit them? If so, what are those bench marks?

I think this is the correct answer. Also gives us time to research and looks at the situation of correct form/structure of equity.

Doing it as an incentive system means they're incentivizing me to work harder, find efficiency and quality improvements, and be more loyal. If I can get [1%] each year over 5-10 years, that's a strong incentive to stay with and help the company grow.

That's probably a lot more palatable to them as well, too.

Can't get anything if you don't ask for it. This is why it's a negotiation and discussion. Tone of the conversation does seem to be very much this being the right match, and it's what the deal will be rather than if there will be a deal.

Is this a new startup or an existing company? New starts will probably be more willing to negotiate what you are asking so they can get top-quality employees for less cash outlay. I would think it would look like a milestone bonus plan with an option to take the bonus as company shares. Or possibly a straight percentage of the sale of the business written into your employment contract. 

I would not shoot for being a 1099 contractor without a significant pay increase. The self-employment taxes will eat you alive. Also as a self-employed person, you are almost never eligible for unemployment. 

In reply to Toyman! :

They're a small distillery making the jump to significant regional production.

They've got a 130 gallon setup and a tasting room, and have products out in a limited market. They're jumping up to a 6,000 gallon setup with a fancier production-level still and greatly expanding the market they serve.

Financially, they made solid money during covid producing hand sanitizer for some major contracts. That paid for the expansion, rather than needing to get a loan or other methods of raising capital. But they're not making any money for themselves through this project yet.

Their only employees thusfar are tasting room staff, and part-time sales reps.

I'm certainly not a unique individual with the skillset I have, but it's a pretty slim labor pool for free agents with strong knowledge in brewing/fermentation/distilling *and* broad business/operations/management experience. I'm not currently competing against any other candidates for this position.

Beer Baron said:

Talking compensation package with a potential employer. I think there is strong possibility of them growing up this business and being bought out by a large player in the industry in several years time. I'm coming on right as they're kicking off full scale production in a key role.

I expect to get paid a salary that's a good wage.

I would like some equity so that, if they get bought out for big money in five years, I can get a nice payday from it.

Any suggestions on the best form to structure a position to accomplish these goals? I know it depends a lot on how the company is structured, and I need to ask and find out.

Assuming it's most likely an LLC, Profits Interest seems like the easy-button option, at least for them. I gather that makes me have to qualify as a "partner" and get paid with a 1099 instead of W2.

Any experience with how that works out? Does that affect things like ability to claim Unemployment Insurance or anything?

Any other thoughts or suggestions?

So I'll share my experience as a Head Brewer that has bought into the business.  First off, you probably are too late to negotiate a concrete financial stake in the business at the onset, assuming that the business is already established.  They'll have no incentive to bring you in, considering you're new, haven't born any skin financially, and the business plan/idea wasn't yours.  I don't mean this to sound mean- more honest.  

The way I structured MY (read: not all situations are alike, but I am in a very similar position to what you mentioned) deal was-  after 3 years of employment, in lieu of financial raises, I was offered a monetary value of 'investment' money into the company, and additionally negotiated 1% of gross profits from beer sales to be put into the business as ownership equity.  A third party valuation was done, and negotiated that $x equals Y% of business stake, and I'm locked into that valuation price regardless of where the business valuation goes- up or down.  Any bonuses and additional investments can be input to a cap of 33.33% total ownership stake, which would be an equal 3 person partnership.   I've been dumping every raise and bonus in for about 3 years now, and own exactly 7% of the business currently, after 6 years employed here.   If I do my job well, the business valuation goes up and I earn more equity per dollar than if I do my job crappily.  

I will say that I asked for a way to buy to buy equity in when I first started the job, and got laughed at.  But this was a well-established restaurant that was re-opening as a brewpub, so the situation is a bit different.  

My experience is from tech as well. Most of the people who have tried to get equity have either A. Not made it to the vesting period, B. been diluted into oblivion or C. not understood that their stock was basically worthless from the start because it was of a different class. The exception is somebody who was hired by Zoom in late 2019. 

It's one of those questions where if you have to ask it's probably not a great idea. YMMV though.

I would think that a base pay with milestone bonuses would be reasonable to ask for. It also wouldn't hurt to ask about turning those bonuses into stock shares. If they aren't willing to go that route, then they probably aren't going to be willing to cut you in for a share of the sale of the company. Again, it never hurts to ask. If nothing else it shows your willingness to be aggressive in growing the business. 

They are going to have a hard time claiming you as a 1099 contractor. If they control your schedule and are providing supervision, they can't claim you are a contractor. If they are willing to let you work for shares, then you will get a K1 based on the earnings of your shares.  

Whatever route you go, get it in writing and have an attorney look it over. 

Good luck. Hope the deal works out the way you want it to.

Toyman! said:

They are going to have a hard time claiming you as a 1099 contractor. If they control your schedule and are providing supervision, they can't claim you are a contractor. If they are willing to let you work for shares, then you will get a K1 based on the earnings of your shares.  

The mechanism I was looking at is Profits Interest, which LLC's can grant. If granted that, I would have to classified as a "Partner" in the company, and so are no longer a W2 employee. Profits interest is only equity on future earnings potential of a company, not current value. (E.g. If company is valued at 1-million, grants a 10% profits interest, then sells for 3-million - you get 10% of the 2-million gain in value.)

We'll see what they say. I don't think what I asked was unreasonable or going to put them off.

I'm not going to dig my heels in or balk if they say "no".

I'll still shoot for some mechanism to gain equity in the future, but more likely on something like converting the value of a bonus into equity after X-years.

In reply to Beer Baron :

Profits Interest at the time of sale would be taxed as capital gains.

Depending on how the LLC is set up, your income would be a disbursement based on company earnings. You would then have to pay quarterly estimated taxes and would get a Schedule K1 (1065) form to tell you what share of the income you are taxed on. You will have to pay self-employment taxes in addition to income taxes if issued a K1. It works out to about an additional 15% the government is going to take. Make sure your income can cover that without putting you in a hole. 

 It may be worthwhile to discuss this with a tax accountant as well as a lawyer. 

In reply to Toyman! :

Are K1 forms issued on LLCs? I thought it was only Corps. 

In reply to golfduke :

That sounds like the sort of model that would work well for me. Does that kind of model leave you as a W2 employee, or change your status?

In reply to Slippery :

It depends on how the LLC is taxed. For that, you need to talk to a tax accountant. My LLC has pass through taxes. I pay the taxes on all company profits based on a K1. I am discussing with my accountant changing to a Subchapter S corp. Then I would be listed as an employee and taxed based on a W2 and the company would be taxed as a corporation. There are some advantages and disadvantages to doing that. 

I'm not a fan of phantom shares. It's too ambiguous for a private company - and I've seen some outfits take advantage of that and screw over phantom shareholders.

If it were public already, then phantom shares make sense to me. Everything's out in the open and everyone understands what they're getting.

One other note, with actual equity comes a certain degree of responsibility. Food for thought.

In reply to Toyman! :

That is how my company is set-up. I get a K1 through my S-Corp, I also own the building through an LLC but I never get a K1 on that one. Hence my confusion. 

In reply to Slippery :

You can do LLC taxation as a sole proprietorship in which case you pay taxes on net income/loss from the LLC in your personal filing. You should file a Schedule C with your return. This is how I will file for 2022 since I bought out my partner on December 31 of 2021. In some states, you can also tax an LLC as an S-Corp. Those profits or losses have to show up somewhere or the black suits will be knocking on your door.