A guide to compensating service providers — Part 1

In a transaction between two parties, sometimes cash for goods and services makes sense. And sometimes it doesn’t.

In 2015 as we were launching the Make in LA accelerator, we decided to create a venture fund to receive equity because we realized that cash was too precious a resource for pre-seed founders to spend on education and network. We knew we needed to create a venture fund to hold the shares and give out money. What we learned, however, was that being an equity investor aligned both investor and founder with a long-term time horizon.

Flash forward 7+ years later. Instead of investing money, I have been investing time — at any one time I can be found coaching 5–10 founders at early-stage startups and leading 2–3 teams within high-growth startups. With each engagement comes a fresh conversation around compensation. Everyone seems to do comp differently and I have not found a universal method with perfect alignment.

My contracting period sometimes drags on for weeks, and in a few situations, months. And that is one of the reason for writing this post. My hope is to start a conversation and narrow on a handful of models that will help me and other service providers, and clients, to contract more easily. Perhaps it is best to start by evaluating the more traditional cash compensation models.

Pay-as-you-go: Hourly Billing

Hourly billing is the gold standard for service providers. It is also a tool to make sure that you are adequately compensated for your time. It seems fair to pay for each our used and perfectly aligns time to money. However, as someone who has reviewed plenty of legal bills, there is a tendency to micromanage the lawyer, as well as a reluctance to call the service provider to avoid running the clock. Auditing legal bills and fighting each hour seems to be a loosing battle, one that misses the forest for the trees.

Also interesting is the concept of vertical time. Not every hour is created equal. For example, an hour at dinner time around my kids is worth a lot more than after a lunch break.

As you get better in your craft, hourly billing starts to penalize your efficiencies. And as every good locksmith knows, the faster you do a hard job, the more likely it is that the client feels they were ripped off.

I know many coaches who charge 150 USD per hour, though some charge 1000+ USD per hour.

Pay-as-you-go: Monthly Billing

Monthly billing solves the problem of micromanaging the details. There is better alignment between time and mission. There is also predictability. Most service providers will overcharge for this arrangement to cover for any outlier events. And as a client, it can feel unfair to pay during slow months.

With any pay-as-you-go model, they seem to be extractive. There is an incentive for the service provider to continue the engagement indefinitely and a desire to perpetuate an engage to earn fees and status.

Many of the coaches I have hired with this model charge 2000 to 5000 USD per month.

Pay-per-performance

I find myself salivating when a lawyer friend of mine said that he charged a fixed fee for a particular service and outcome. This works great for routine activities.

In most coaching engagements, the goals are squishy. Often, the original goal we start with is not the true goal of the engagement by the time we get past the fog and address the root cause.

The great thing about the pay-per-performance model is that it aligns with ROI thinking. The client never feels like they are on the clock. When outcomes are clear, time is not a factor.

For the service provider, there is a risk. We quote for the job and if the job takes longer than expected, we are on the hook for extra hours. As a coach, I enjoy this as it helps me to get better at estimating. However, I feel a desire as well to add a fudge factor to cover margins of error. Yet nothing can beat the fact that clients do not have to think about billing if they have an issue they want me to address. Each call with coach Shaun is about maximizing ROI, not a hit to the bottom line.

Equity compensation

Ultimately, understanding whether being paid in equity is a viable alternative depends on various factors. The biggest of which is: can you wait 10+ years to get paid? The company stage, the financial health of the company, the terms of the equity agreement, and the contractor’s personal financial situation and risk tolerance all play a role in determining whether being paid in equity is a good choice.

On the positive side, equity can provide a potentially lucrative payout if the company performs well. There is a direct link to the company’s success. This can create a sense of ownership and motivation to work hard and contribute to the company’s growth. There has been a bit written about equity grants and I recommend checking out Eric Friedman’s 2022 piece on the topic.

This model works with C-Corporations, a structure familiar to most tech founders, and does not work with non-profit clients. This model is also problematic in working with LLCs from a tax, liability, and influence POV. Yet even in C-Corporations, equity can be illiquid, meaning that it may be difficult to sell or convert into cash.

Equity compensation models work well if you are in the position where you are not dependent on a salary for the engagement. It also works well if you have a high risk appetite. Especially with early-stage companies, there is a high likelihood that the work will never be compensated. Just like being a venture investor, a way to manage risk is to build a portfolio of 10–20 engagements where a few wins will outweigh the many losses. And there will be losses. In some projects, I have invested so much physical, mental, and emotional energy for “free.” However, the experience, the lessons, and the relationships are all priceless. Investor thinking is helpful, and I often write up a deal memo before taking on an engagement so that I can think through how this work will pay off. In addition to the deal memo, the diligence process should at minimum involve reviewing the fully diluted cap table. Doing so will help you anticipate a total loss and may help you to avoid engaging in a company where you conviction level is not high.

For early stage founders, cash is a precious commodity. And it was in service to those founders that I launched the Make in LA accelerator with a cash-giving mindset instead of a cash-taking mindset. Most startups are not able to pay consultants what they are worth on the market, and many senior hires I know take a pay cut or shift their compensation more towards equity. It’s safe to assume that service providers will also take a cut to join a mission oriented company.

Equity models are fantastic because your success and your client’s success are very much aligned. But that also presents a risk. The client is the company, not the individual. I may at times align more with the board than the executive, such as in instances when the executive is not in the right role. When this happens, my role is to help those leaders find better fitting ways to make an impact in the world.

Equity is a leap of faith as you are just one tiny component in the company’s success. Luck is a big factor. And when tragedy hits, early stage companies have a harder time recovering when a key founder or leader leaves the company.

Another challenge in startups is what happens when you loose conviction. If I write off the company client, there is no longer a financial incentive for supporting the leader. Once again, this is where the experience, the lessons, and the relationships are all priceless. The world is a small place and reputations matter. I find that it serves me to be vested in the long term outcome (and development) of the leader even when the financial rewards are no longer present.

Because the company is paying equity for my services, I tend to work across the organization and not just with the founders. If we say that time is money, my incentive is to invest my time wisely and not drag out coaching engagements.

Many startup founders are familiar with 4 year vesting and a 1 year cliff for hires. I have found that coaching engagements tend to be shorter in duration and the traditional vesting model does not work for myself and other service providers like me.

Final thoughts (for now)

It is up to the contracting parties to understand and agree to what model works best for them. All compensation models have some level of tension, and I hope that this post reduces stigma around conflicts of interest for each model. I also hope that contractors and contractees are able to enter into future compensation conversations with more resources on the range of options available.

In Part 2, I will be diving deeper into equity compensation models. If you have experiences to share, please join the conversation below or on social media.

And if you are interested in learning more about my coaching or fractional COO work, which I often perform on an equity-only basis, check out my page here or this recent GoFractional interview.