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Startup businesses frequently look to minimise cash expenses in the early days. This is so they can reinvest cash into the business to grow quickly. Many startups also work with contractors rather than hire employees because contractors do not have employee rights and are more flexible. While the default position is to pay contractors cash, some startups may wish to compensate contractors through other means, including shares. This article will address whether you should issue shares to contractors in the UK by considering its advantages and disadvantages.
Advantages of Issuing Shares to Contractors
1. Attracting Top Contractors
As with paying employees shares or share options, you may attract more competitive contractors with a share offer. This is especially true if your business is already in a relatively advanced growth stage.
2. Incentivising Performance
A contractor is more likely to care about your business’s long-term performance if their pay is tied up in shares. This is because the compensation incentives are more closely aligned than when you pay someone with cash. This point may be particularly apt if you engage a contractor on a long-term complex project and want to ensure the contractor stays motivated throughout the project.
3. Minimising Expenses and Maximising Capital Conservation
Paying a competitive contractor in cash may require significant outflows. Most startups try to conserve as much cash as possible to reinvest it into the business. Therefore, you minimise your expenses and preserve your capital by remunerating your contractor either partly or wholly if you issue shares or options.
Disadvantages of Issuing Shares to Contractors
1. Ownership Dilution
If you decide to issue shares or share options in your business, you are effectively diluting your ownership in the business. Therefore, ask if the contractor’s value to your business is worth the dilution.
Moreover, are you prepared to grant your contractors the right to be a shareholder? These include matters like dividends and voting rights. These are not decisions that should be taken lightly. Once you grant shares or share options to a contractor, you may find it difficult to undo.
The truth is that most business owners are not prepared to dilute their ownership unless the contractor adds substantial value. It may be helpful to ask if the contractor’s added value is equivalent to a sizable cash injection.
On the other hand, contractors that contribute piecemeal to your business’s value, such as by performing discrete tasks like digital content production, may not generate enough value in the aggregate to justify you paying them in shares or share options.
2. Valuation
If you are prepared to accept ownership dilution, another challenge is adequately valuing the shares or options you will pay the contractor. This is a complex task that requires you to account for:
- your business’s present value;
- its discounted growth over the next few years; and
- how ownership dilution may affect any future fundraising.
Answering these questions requires the advice of a corporate accountant and legal advisors that can structure the transaction in a tax-suitable way.
3. Negotiations
The nature of contract work means that many contractors are simply looking for flexible engagement. As a result, this often (though only sometimes) translates into less interest in engaging with the business, at least from a long-term perspective. As a result, many contractors may have little interest in being paid primarily in shares. This is because shares are not liquid, especially in early-stage private companies.
It is also worth noting that many contractors treat equity remuneration as a non-starter. This is because shares are inherently risky. A contractor looking for steady, dependable work, such as a payment approximating a salary, may not be able to accept shares.
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Key Takeaways
While there are some benefits to paying contractors in equity — be they shares or share options — it is not the best option for many businesses. This is because you effectively give up ownership of your business in exchange for the contractor’s labour. Accordingly, you should consider if you are engaging the contractor for work that will add long-lasting, indispensable value to your business. For example, contractors engaging in piecemeal work, such as marketing or content producers, may not add enough value to justify giving away shares. However, for contractors engaged in high-value, complex projects, paying them partly in equity may be a compelling way to entice top talent. In practice, however, even those contractors not opposed to equity compensation usually expect also to receive cash.
If you need help deciding whether to issue shares to contractors, our experienced business lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
When you pay a contractor in equity, you effectively dilute your ownership share in the business. However, your contractor also becomes a practical company owner, which gives them rights under company law. Furthermore, structuring the transaction is often complex and requires the advice of a capable legal and corporate finance team.
One upside to paying a contractor in shares is that equity is a compelling motivator that can encourage contractors to work productively and innovatively. Likewise, it can be a great way to attract top talent.
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