Startups don’t typically have much money to pay outside marketing firms, but they do have one thing they can offer: a stake in those companies. Over the past 10 years, equity has become a commonly used currency, and it isn’t hard to see why. Almost 50 percent of startups fail, but with high risk comes the potential for high reward. Companies such as Uber, Snapchat and Airbnb are worth more today than traditional giants such as AOL. GitHub last year was valued at $2 billion, and messaging startup Slack achieved a $3.8 billion valuation in its latest funding round.
Equity payment isn’t just an American phenomenon: Sweat equity is such a valuable commodity in today’s global marketplace that the government of India is looking to increase the legal limit to help boost its startup culture. Back on U.S. soil, my own company has taken equity in 12 different startups over the past two years, and other marketing firms are just as enthusiastic.
But is it a good idea for all startups to give up equity in exchange for something like marketing assistance? Well, yes and no:
When offering equity payments is smart
For some startups, it makes sense to offer equity for services. If a startup lacks marketing experience or the necessary capital, offering equity in exchange for assistance is a great idea.
Consider Casper Sleep Inc.’s mattress ads, for example. The startup’s posters appeared in nearly every subway train in New York City in 2015 in a campaign that sprung from its partnership with a branding firm it had paid in stock rather than cash. Without that campaign, would Casper have managed its $55 million funding round?
Companies without effective marketing strategies might as well not have a product; waiting for opportunity to knock means losing ground to competitors. But that doesn’t mean they should hand over equity to the first marketing firm that offers its services.
Related: When to Share a Piece of the Pie
When offering equity payments is not so smart
Here are three signs that a prospective partnership might not be beneficial enough to warrant offering an equity stake:
1. An informed or instinctive lack of trust. Trust between a startup and its marketing firm is essential to developing a successful relationship. Any potential partner must be vetted like a potential employee; if the trust isn’t there, walk away. On one occasion, we met with a startup that was going through some intense political problems. We left, knowing we didn’t want to be part of that argument.
A few telltale signs of an untrustworthy agency include infrequent correspondence, incomplete communications and a tendency to point out possible problems but not offer solutions. Some of these issues may not be immediately apparent, so startups need to protect themselves from the beginning. Include an earn-out in the contract -- don’t hand over equity until the marketing firm has shown some results.
2. Wants placed ahead of needs. We once worked with a startup that wasn’t ready to engage with us. Its product wasn’t finished, and we were earning equity without any way to begin marketing. Instead of wasting the startup’s money and time, we chose to end the relationship.
Getting carried away is easy to do, but don’t think about marketing until the product is ready to go. Forty-two percent of startups that fail do so because there’s no market need for their product. The ducks all need to be lined up with a product in place before a partner is brought on, or everybody loses.
3. Cultural discord exists. Startups shouldn’t offer equity to marketing firms that don’t fit their culture. How can there be understanding if two business models don’t share common values?
When my own company partnered with Sweat Tailor, we did so because the startup’s objective of creating the perfect pant and the perfect clothing “experience” aligned with our own goal of filling a real need in the marketplace. The company had no money to pay us, so taking on the work as a partner in exchange for equity was a perfect solution.
Don’t throw around equity like Monopoly money. Month-to-month contracts offer a great alternative to marketing initiatives that demand deeper pockets, and they allow startups to evaluate potential partners.
Do your homework on potential partners: Study their company websites, talk to other clients and find out about their core values. Remember that playing nice doesn’t always mean sharing. If they don’t fit, don’t partner.