I think this happens way too often. People trying to get a company started give away pieces of the company for services they can’t afford, such as lawyers, accountants, business planners and so on. There are exceptions, but this is usually a bad idea.

Here’s the problem:

  • If the company takes off, small pieces of ownership become part of a larger financial structure, badly needed for recruiting star employees. As investors come into the picture, they don’t like seeing pieces of equity spread out to the service providers. And the service providers change. New lawyers, new consultants and so on.
  • If the company doesn’t take off, the service providers see they’ll never make money, and they disappear. Relationships turn sour. That stock you gave up isn’t going to make anybody any money, but it is partial ownership of your company. Minority stockholders have legal rights.
  • You only have 100 percent of a company. It’s for major players, people who are either totally dedicated to the company with their minds and work lives, or people who have written big checks. It’s not to save a few hundred or a few thousand dollars of necessary fees.

There are exceptions. I was an exception to that rule with Borland International. I started working with Philippe Kahn as a consultant, helping him with his business plan, and ended up as a co-founder of the company, with a small piece of ownership and a seat on the founding board of directors. It was great for me and I like to think it worked out for Philippe and Borland also–you’d have to ask him–but I still think that it’s not generally a good idea to give pieces of equity to consultants. I stuck around, gave advice, sat on the board and did everything I could, until the day it went public, to help the company. That’s not often what happens.

And I had less than 1 percent of the original founders’ stock. And that got diluted when investors joined. And that is a lot. No service provider should have any, unless he or she is committed to the company for the long term, for real. And it should never be more than 1 percent.

Tim BerryTim Berry

Tim Berry is the founder and chairman of Palo Alto Software and Bplans.com. Follow him on Twitter @Timberry.