Do Commercial Vendors Deserve Equity?

If you asked startup founders whether they would rather give away 5% equity in the company or one of their toes, many would choose the toe. CEOs like Zynga’s Mark Pincus have always argued for startup founders to “own their destiny” and maintain control and ownership of their company. That’s why it was surprising to read VC Deal Lawyer Chris McDemus’ recent article entitled If You Provide a Strategic Technology or Outsourced Service, Consider Taking Some Equity in Your Fee Structure.

Early-stage startup companies are used to giving away equity to advisors, IP lawyers and key staff, but McDemus argues that those vendors who provide core technologies should also build an equity agreement right into their service contracts. McDemus gives the example of Mint‘s acquisition by Intuit and how if Yodlee had taken some of Mint’s equity for providing the backend of the service, the company would have made great money on the sale. While this might sound like a good idea for service providers who risk abandonment, the idea is likely to ruffle the feathers of many a startup founder.

The fantastic thing about startup companies in 2010 is that they’re iterating faster. Rather than stumbling in the dark for a few years before launching a product, many have launched in a mere six month engineering cycle. In fact, we’ve even featured companies being built in a week or a weekend. If vendors asked for cash AND equity as part of the commercial license, I wonder how this would change development.

While service providers risk abandonment after startups get acquired by bigger companies, they may also risk abandonment for pursuing the equity route. Alternatives to an equity-seeking vendor might include open source technologies, using competitors who do not demand equity, or in a worst case scenario, building the core technology from scratch.

If the bulk of your business’ technology is built in association with a commercial vendor and that vendor asked you for equity, would you give it to them? If yes, why? If no, how would you cope?

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