Everything is negotiable.
That’s one of the most valuable lessons I’ve internalized and challenged myself to apply in business.
It’s hard to be creative with legal agreements and financing terms. But these unique deals are oftentimes the most rewarding. The problem is… where do you learn to make creative deals?
The school of hard knocks… and this blog post.
I’ll share some examples from my life, others around me, and internet deep cuts.
My agency, Conversion Factory, is not cheap. It’s a great deal — you get 3 people for the price of 1 — but it’s by no means cheap. This can be a problem for early stage startups who don’t have the revenue or funding to work with us, so we provide an option for “equity based partnerships.” We’re willing to discount our fees for future upside. But this can be extremely tricky to figure out what’s fair on both sides. Here are some options I presented for a startup doing ~$350k ARR.
For a side project of another business, I wanted to loop in a friend to do some work on it but couldn’t justify the cash needed to pay them fairly for it. This side project would likely never generate revenue itself but intends to drive revenue for its parent entity. So instead of offering equity in the parent entity, which could be problematic because then my friend is only rewarded if there’s a substantial exit, I offered a fixed percentage of revenue share. The revenue share would be on gross revenue, so he’s guaranteed a reward, but there’s an option to buy out his portion of revenue share for a multiple of expected revenues so it doesn’t become a liability to a buyer later down the road.
For another software business, a cofounder decided he wanted to simplify his life and take a step back from entrepreneurship. I agreed to buy him out and we came up with a fair valuation. It was generating a rather small amount of revenue but the valuation still meant that his equity was a decent amount of cash for me to come up with. Instead of pulling from savings, getting a loan, or finding an investor, I talked with my accountant and came up with a plan to finance it without touching any of my own money directly. My agency, Conversion Factory, would loan the money to the software entity, which would then use the money to buy him out, and the software entity would pay back Conversion Factory over time. This is one perk of owning a cash generating machine like an agency.
I have a friend who made a hand-shake deal to buy a house, got it appraised, spent months and $100k+ renovating before actually buying it, then initiated escrow. This allowed him to get it reappraised and take a bunch of brand new equity out to pay for the renovations. The result? A free home makeover and a more valuable home that’s continued to appreciate.
This same friend used a HELOC to pull out a bunch of home equity earned through ZIRP conditions and inflation to buy a business. The business can very comfortably pay for the HELOC repayment with plenty of profit left over. Free money.
Nick Huber announced he bought controlling interest in Shepherd (now Somewhere) for $29.7M, with the business valued at $50M+ in total. Xavier Helgesen and Sieva Kozinsky of Enduring Ventures were lead investors in the fundraise to acquire the controlling stake. On this MoneyWise podcast episode, Marshall (founder) reveals that he hung on to a small amount of equity with Shepherd/Somewhere. This allows him to continue to participate in dividend distributions and future upside in the company’s valuation. A very untraditional "sale" that resulted in a win-win.
Ryan Kulp acquired a SaaS called Fomo using seller-side financing, which is one of the best (if not the best) ways to buy a business. How? A deposit, monthly installments based on revenue, and a claw-back clause that ensured the seller that if they couldn’t make the payments, the business would be immediately returned to them. Seller-side financing has one huge advantage: you can use the business’s revenue to pay the seller. Sometimes a deposit isn’t even required. Theoretically, you could buy a business just by putting it on autopilot and waiting until the installments are paid off.
One tricky part about acquiring a software business using debt is that most traditional lenders don’t know how to underwrite for them (and basically refuse to). Even if you do manage to find a debt financing source, they’re essentially siloed from the unit economics of the business. In plain English: the financing terms don’t work for the amount of profit the business generates. So if you go through with it, you have to race to increase profits so you can service the debt. That’s why I love Boopos. They’ll vet, underwrite, and finance up to 80% of the purchase price to acquire a business. The terms are tailored for that business. Oh and it’s non-dilutive and there’s no personal guarantee.
Jason Fried tweeted how they spun out a company called Know Your Company (now called Canopy) from Basecamp. The deal was simple: they’d give 50% to an operating partner and when the business generated $1M in cumulative revenue, it would switch to the partner owning 75% and Basecamp owning 25%. Simple.
Calm Fund’s Shared Earnings Agreement is a novel approach to fundraising. Calm invests a low six figure amount for a low double digit equity stake. Calm can be repaid through “shared earnings” up to a certain cap (e.g. 2-5x). The founder also has the option to pay down Calm’s equity stake to a minimum amount. This gives the founder a lot of optionality to optimize for profitability, growth, or ownership at the event of a sale. In any scenario, it’s a win-win.
SparkToro raised an unusual funding round of ~$1.3M with a unique caveat: they must return 100% of the original capital raised to investors before profits are distributed. From there, profits can be distributed pro rata to all stakeholders. There are a few other minor details, but you get the gist.
I invested in an angel round of a business that had an interesting and very specific method of repayment besides an exit event: “The [majority owner] shall promptly cause the [business] to distribute to the [investors] any cash held by the [business] which is neither reasonably necessary for the operation of the [business] nor in violation of applicable law; provided that such distributions are approved by the majority consent of the [investors]. Cash available for distribution shall be distributed to the [investors] in accordance with their respective [ownership percentage]. Distributions may be compelled by [investors] if cash held by [business] is greater than $30,000 and monthly operating expenses are below $10,000, or [business] cash is greater than $10,000 and monthly operating expenses are no more than 30% of available cash.” In plain English: if the business has plenty of cash and low operating costs, profits can be distributed to stakeholders.
Steve Balmer started out as Bill Gates’ assistant and employee #30. So how did he turn into Microsoft’s largest individual shareholder? According to this interview, when they were negotiating Steve’s compensation, they agreed on $50,000 salary + “10% of all extra profits.” When Microsoft was rapidly growing and converted from a two-person partnership to a corporation, he agreed to 8% equity instead, which would turn out to be worth billions. As of this writing, he became even wealthier than Bill Gates.
I’ve heard many other anecdotes over private conversations with CEOs and founding operating partners that involve some sort of mix of salary + upside in the business. One structure I’ve always been fond of is when that upside can change depending on hitting certain milestones. There are no rules — it's totally up to what you think is fair and what incentives you want to create. For example: ratcheting up profit share by 5% for every $1M in revenue generated. If a CEO comes in at $1M annual revenue earning a salary plus 10% profits, and their profit share can jump up to 25% at $4M ARR. Talk about motivation…
When the founder of Papa John’s sold the controlling stake in the company, he negotiated a deal that included lifetime free pizza for himself. Michael Dubin, founder of Dollar Shave Club, negotiated a deal with Unilever that included a lifetime supply of grooming products. As part of his agreement with investors and during various rounds of funding, founder Jeremy Stoppelman negotiated lifetime free use of Yelp’s premium features.
A friend has a product studio building MVPs for founders. He offers a 50% discount on fees in exchange for equity. Whereas he’d normally charge $2,500 per week, instead he’d charge $1,250 and 1% equity per week. After 8-12 weeks, you’d have a functioning app, having paid just $10-15k and 8-12% of equity.
Like any deal, it all comes down to risk vs reward. What’s “fair” is what both sides can agree is an acceptable amount of both risk and reward. If you’re looking at a deal and it doesn’t feel fair, think about why. Those reasons why are clues to how you can creatively renegotiate to make it a better deal for you.
Charlie Munger famously said: “Show me the incentive, and I will show you the outcome."
