Is It A Good Idea To Accept Equity In A Company Instead Of Cash In Exchange For Legal Services?

Every once in a while, you may meet a client that wants to start a business. Like most startups, they don’t have a lot of cash for legal fees so they offer an equity stake in the business. You may have heard stories of people who became instant millionaires by accepting company stock instead of payment and later selling the stock at the IPO stage.

While only a few companies will achieve unicorn status, it may be a good way to set up an alternative fee structure. But in addition to the possibility of not getting paid for your work, these work-for-equity deals could come with drawbacks and traps that could cause trouble for the lawyer and the client. So this may seem like a gamble.

This is not like working on contingency. In personal injury cases, experienced lawyers can tell how much a case is worth and the chances of winning. They also know how to get paid from a third party (like the insurance company) just in case a client decides to abscond or straight out refuses to pay. So working for a percentage of the proceeds is not necessarily a gamble.

The first thing to consider is the person (or people) you will be working with. Do you know them? How did they find out about you? If you don’t how these people, how can you be certain that they know what they are doing or that they aren’t trying to scam you or someone else?

The next thing to consider is the type of business they are running. Are you familiar with that industry? Do you like the product or service the business provides? Do you know how people get paid? The more you know about an industry and its practices, the better the likelihood you can get paid for your work.

Conversely, there are situations where work-for-equity deals could work. Or where you could at least feel comfortable taking the risk. For example, if you know and respect the people involved or because you can get exposure to an industry you want to work in or because the work can open doors to more referrals.

One of the biggest reasons why many lawyers don’t work this way is because of malpractice insurance coverage. I’ve heard that some insurance companies will not pay out on claims where both the lawyer and the client own the same business. Even if they do pay out, the investigation time will be a lot longer. This is because there is the possibility of self-dealing and possible fraudulent claims.

Second is taxes. When you receive equity in exchange for your services, technically that is taxable income. This means that valuing your equity interest will be difficult. You’d want a low valuation to minimize taxes, but if a company has a lot of assets, that can be a difficult argument to make. Not only that, you will be taxed again when you later sell your equity, presumably when it is worth a lot more.

Lastly, you have to consider the ethics of the arrangement. ABA Model Rule 1.8 (or your state’s equivalent) states that a lawyer shall not enter into a business transaction with a client or knowingly acquire an ownership interest unless the terms are fair and reasonable to the client, the client is advised to seek independent counsel, and gives informed consent.

Clients tend to have differing ideas on what is considered fair and reasonable, especially when lots of money comes quickly. For example, suppose a lawyer offered 10 hours per month of legal services in exchange for 20% of the voting shares of the company. If a private equity group offers $10 million for all of the company stock, would the other shareholders feel comfortable giving $2 million to someone who only worked 10 hours per week while the others worked 80 hours per week?

If you feel uncomfortable with an equity for services arrangement, an alternative is to offer a discounted hourly rate or a set number of consultations without charge.

These are only a few things to consider when deciding to take on an equity for services arrangement. The ideal situation would be working with people you think you can trust who can help you gain connections and referrals in an industry you want to get involved in. So even if the venture fails, at least the intangible benefits you gain could be worth the time you spent. Otherwise, you risk not only working for nothing, but also working for people you might end up hating down the road.

Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at stevenchungatl@gmail.com. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.

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