English

Is Service-for-Equity an effective alternative to traditional funding?

Last updated on July 6th, 2021

 

As an early-stage Startup ourselves we know that (Startup) life can be challenging during the bootstrapping period. Startups who are looking for funding need to prove their business model before talking to investors, usually by getting user traction or some kind of market validation. So that means either investing a lot of their own time or finding supporters to accelerate the process. Assuming that finding and compensating potential cofounders, supporters, freelancers or other service providers is simple and realistic, is it also more effective than receiving traditional money investment, especially in the early phase?  

The concept I am referring to, is called resource investing or “service for equity”. Service-for-Equity is a way to fund projects directly with the resources that are needed in order to realize that project. Besides money, that can be anything from heavy machinery, over legal advice, to programming. When starting a business such resources are also called contribution in kind, but most common is actually sweat equity (labor). While sweat equity is mainly attributed to the cofounders who are splitting equity, other people’s work can also be compensated with equity or similar incentive methods. 

You may wonder why “Service for Equity” is important? Certain corporate VC’s (venture capital funds), such as 7Ventures who established media for equity, have successfully implemented these concepts. We believe that “Service for Equity” can become the alternative finance market for Startups. There are about 2´500 initial VC funding rounds in Europe, compared to 2.7 million incorporations per year. The majority of businesses will never get external equity funding. Not every business is super scalable or serves a billion-dollar market. Nevertheless, they offer something that the people want and create profitable business models. And, they also need external support to establish or grow their business. As I mentioned above, the companies that seek funding will also require support to realize their projects. Both can be advantageous to VC’s. On the one hand, it can weed out companies that are not VC worthy and only need certain resources to establish their business. On the other hand, companies can become investible by demonstrating proof of concept and that they are able to efficiently allocate resources. 

Especially now during the Corona crisis but also during normal seasonal downtimes, many service companies and freelancers have unutilized resources and are happy to invest them by working on exciting Startup projects. 

Let’s compare “Service for Equity” with venture capital by looking at some important factors for business funding. 

 

Service for Equity

Venture Capital

Access to funding

Egalitarian. Irrespective of business model, market size, and venture stage; as long as repayment is realistic and an agreement can be found.

Exclusive. Only a fraction of Startups are eligible for VC. 

Time to receive funding

Around 1-2 months for finding the right service provider, supporter, or business partner. 

Usually 4-8 months for preparation, networking, negotiating and signing.  

Flexibility of resource allocation

Low. Resources can only be used for very specific objectives. Requires comprehensive specification of what is really needed.

High. Cash can be used for anything, theoretically. The Startup should have a specific plan what to use it for.

The efficiency of resource deployment

High. Value creation happens while investing with resources. Results of investment are directly visible.

Medium. Taxation of money before investing and when spending. Efficiency depends on what the money is spent on.

Business efficiency/ 

Goal achievement

Depends. High for early-stage companies and new projects. The investment is much more direct and the business goals can be achieved faster.

Depends. High for later-stage companies if investors are lined up and money is deployed efficiently to scale the business. Otherwise, venture funding is distracting from the core business.

Control

Higher. Startups could cancel relationships anytime. Resource investors could be compensated with deferred payments and profit participation instead of real shares.

Depends. Typically, investors receive voting rights. Cofounders should keep the majority.

Risk for investor

High. The resource investor has more impact on the outcome and the success of the venture. 

High. Especially in early-stage ventures. Liquidation preferences can reduce risk.

Deal complexity

Depends. Besides shareholder agreements, other options are supplier credits with options, profit participation or phantom shares. 

High. Complex terms sheets need to be set up and notarized. 

Cost

Depends. Depends on the type of compensation. Very high flexibility. Resource investment should increase the company valuation 

High. Equity is considered the most expensive way of funding. 

 

I hope this table gives you a better understanding of the advantages and disadvantages of the two methods. They are not mutually exclusive and even complement each other, e.g. when creating a prototype with “Service for Equity” before raising capital. Overall, “Service for Equity” is a very broad and flexible concept that can be useful to almost any business but especially to early-stage ventures. If you have a project that needs some hands-on support to get it off the ground, you should give it a try. Just make sure to specify what exactly is needed for your project and request quotes from potential resource investors. At KAPSLY we want to give this process more structure and establish it as a real funding/investing option. We want to enable Startups to finance their projects directly with what is needed and make resource investing accessible to everyone. Our marketplace for Startups and Service Providers will be a first step towards achieving that goal. 

If you are a Startup or Service Provider and interested in this topic, please reach out to me.

 

Vincent Irrling 

 

 

Leave a Comment