How To Secure Equity For Services
Written By Adam Yohanan
It’s so easy to say, “I’m getting equity for my services,” but it’s harder to have the equity granted in a legally valid way and to your favor.
Many advisors and service providers think that they’re receiving equity only to find that they technically never secured ownership of any equity, or that the equity they did receive is smaller than they thought, easily forfeitable, or a tax burden.
If you’re trading time or expertise for ownership, watch out for these pitfalls:
1. Your services agreement doesn’t grant the equity.
Most people assume that including a line about equity in their independent contractor or employment agreement is enough. It’s not. Equity grants almost always require a separate document. Usually, it’s a Restricted Stock Agreement or another equity purchase agreement.
If all you have is a vague sentence in your service contract, you probably don’t own any equity yet. It’s common to see a line in an independent contractor or employment agreement that says something like, “Contractor will receive 2% equity.” But that sentence alone doesn’t do the job. A provision in a service agreement is just a promise to grant equity, but it does not actually grant the equity.
Pro Tip: If you never signed an equity-specific document, there’s a good chance you don’t legally own anything yet.
2. The ownership is smaller than you thought.
Even when the equity is granted correctly, I often see people surprised by how little they actually own. For example, someone is told they’re getting “2% of the company.” That sounds great until they realize it’s 2% of the fully diluted cap table, not 2% of the company as it exists today. That distinction matters.
The “fully diluted cap table” assumes all possible shares that could exist are already issued, including ungranted stock options, SAFEs, and convertible notes that haven’t yet converted, and any other commitments. So your 2% might be more like 1.2% today, and it could shrink further with each funding round. What if there’s a 10% option pool that hasn’t been used yet? Yes, that’s baked in too, even though those shares don’t exist yet.
Pro tip: Check the fine print of the equity documents. Always ask for a fully diluted cap table that includes (a) outstanding shares, (b) convertible instruments, and (c) the option pool, and get a clear answer to these 2 questions: (1) What percentage of the company will I own on a fully diluted basis, and (2) what is my percentage of the currently outstanding shares? You’d be surprised how different those numbers can be.
3. The equity is too easy to lose.
Many people think that once they’ve signed a deal, the equity is theirs to keep. But in most cases, the equity grant is subject to vesting, which means you only truly earn the equity over time. It’s common to see a “4-year vest with a 1-year cliff,” meaning if you leave (or get fired) before one full year, you get nothing. Even after the cliff, you’re likely earning the equity in monthly slices over 4 years. As a result, leaving early could mean walking away from a large chunk.
In some agreements, it gets worse. The agreements have repurchase rights or automatic forfeiture provisions. That means even if you’ve fully vested, the company can buy out your equity for less than it’s worth or nothing. That can be devastating for someone who thought they had real skin in the game.
Pro tip: Read the equity grant carefully. Ask: Is the equity subject to vesting? What happens if I’m terminated without cause? What are the company’s repurchase rights? Push back on harsh forfeiture terms before signing because after you leave, it's too late to negotiate.
4. You get hit with a bigger tax bill than expected.
Sweat equity can feel like free upside until tax season rolls around. Depending on the structure of your grant, you could owe taxes before you’ve made a single dollar.
One common trap is when someone receives restricted stock that vests over time and fails to file an 83(b) election within 30 days of the grant. If you skip that filing, you’ll owe income tax on the value of the shares each time they vest. That sounds fine until the company grows and the shares are worth much more.
Example: You’re granted 10,000 shares that vest over 4 years. At the time of the grant, the shares were worth $0.01 each, so the total value of the shares was $100. If you file an 83(b), you only pay tax on that $100, and that’s fine because it’s a low amount. However, if you don’t file an 83(b) election, and in year two the company takes off and the stock is worth $5 per share, you’ll owe income tax on $12,500 that year for the 2,500 shares that vested at $5 per share instead of $0.01 per share.
Pro tip: Always ask whether you need to file an 83(b) election and talk to a tax advisor before signing your equity agreement. A two-minute form can save you thousands in taxes and a world of stress later.
Adam Yohanan is a transactional business lawyer with extensive experience representing companies, investors, and entrepreneurs in a wide range of high stakes business transactions.
Adam handles the small and large transactions in the life of a businesses, including mergers & acquisitions, entity formations, partnerships and joint ventures, investing and fundraising, commercial contracts, and dissolutions. His office can be reached at 212-859-5041.
Haley Kopp is a corporate lawyer focused on representing start-ups and small companies in formations, venture capital, angel investor financings, mergers and acquisitions, and general corporate matters.
Haley's diverse experience gives her a practical approach to solving complex business issues, whether guiding companies through financing rounds or corporate transactions. Her office can be reached at (619) 512-3652.
This guide is meant for educational and informational purposes only and should not be considered legal advice. It is essential to consult with an attorney or other advisors regarding all legal and other important matters.
