On trading stock for services

IS IT BETTER TO USE STOCK OR CASH with an important vendor when your business is cash strapped and in it's development stage? This was the subject of a recent discussion with a local medical device developer whose first blockbuster product was ready for clinical testing and regulatory guidance in obtaining required FDA approval.

After seeing the product in development, one of the firms he was vetting to possibly run the nearly $1.0 million testing and application process offered to exchange some of their services for equity in his company. What should he do and how should he think about the process of deciding?

​Like most enterpreneurs in his position, the founder/CEO was already deeply involved in fundraising. He had to be. There were limits on his personal funds and the business could generate no product sales until it had an approved product to sell.

He had investors lined up and committed for a first fundraise to keep his business running through the end of the year and a key inflection point in his product development. He was finding success selling promissory notes that converted into equity in his next substantial round, defined by a minimum amount raised within a given period. The factors we discussed included:

• ​The advantages and disadvantages of having a vendor as an equity holder. Would it make the vendor harder to release if the work was subpar? Would they be more invested in the project if they had skin in the game?
• The relative cost and difficulty of raising the money to pay for the offset services if the company just paid for the services?
• How much of the services effort would the vendor exchange for equity? How would you value that equity? What form would it take? Options, warrants, stock or ownership units? Would the company have rights to buy the interest back under any conditions?
• When and how would they acquire the interest? Would it vest against performance or results?
• If you went forward, what kind of investment terms would be needed to protect the company? And, how would they mesh with the services agreement terms?
• Were they contemplating any terms or conditions that would make them more than a passive investor?
• Would you be getting the right vendor in the process? That is, you would not want to do the swap and get the wrong service provider in the process.

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​After discussing these and other relevant issues, we turned our attention to the convertible note terms being used successfully by the company and how bring potential investors to a decision point. We also talked about when and how you change the terms of those convertible notes as the company's progress de-risks the investment. We discussed some ideas on both topics that might help better rationalize the fundraising process.

​In the end we left the discussion open but noted that a structure like the convertible note might be used with the vendor if other criteria were met. Those criteria included removing the debt feature, as some companies do when they use SAFE documents in lieu of convertible notes, and linking both the vesting/grants and the conversion provisions to the timing of services delivery.

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