United States: Stock For Services

You run a mid-size marketing agency You normally charge a $10,000 a month retainer for your services. An internet company approaches you with an intriguing offer: $6,000 in cash plus stock in exchange for your agency's services. Should you accept?

With stock being the currency of choice for many dot coms, this scenario may sound familiar. If your agency is considering taking stock, stock options or warrants in exchange for services, following are some issues you should consider.

When your agency takes stock instead of cash in exchange for its services, it is really an investor in that internet company Along with that investment comes the accompanying risk. The more informed your agency is as an investor, the better you will be able to evaluate the risk.

What questions should be considered?

• What do you know about the internet company and its business?
• Is it an established, successful enterprise?
• If it's a start-up, have you seen a copy of the company's business plan?
• What terms is the internet company proposing? For example, when would the stock, options or warrants vest?
• What about your agency's own business?
• What portion of your fee represents actual costs of doing business and what portion represents profit?
• Can your agency afford the loss if it never realizes a profit from the sale of the stock?

The agency faces another level of risk when accepting stock for services - how do you put a value on the stock, options or warrants that are being offered?

Ideally the agency would determine the fair market value of a share of the stock - i.e., what a willing seller and a willing buyer would pay for it - by obtaining the most recent quote for the stock on NASDAQ or another exchange.

Because many internet companies are not public companies, other ways to determine the value of the stock, options or warrants include:

• The company's business plan may contain valuations of the company and its business that the company has prepared to attract investors.
• In the case of stock options, the company's stock option plan will usually provide that if the stock is not traded, the exercise price of the options will be the fair market value of the stock as determined by the company's Board of Directors on the date of grant.
• If the company has done a private placement or a financing transaction with a venture capitalist, the company can provide the agency with copies of the private placement memorandum or other documentation which shows the price at which its securities were issued.

But today the issue has become more complicated because private power and money have an enormous impact on both the speaker and those who listen to that speech, and because we have new methods of speech transmission. Does this require a change of our perspective?

In the best case scenario, the agency will be able to determine the value of the stock based on a recent private placement or financing transaction which should provide the most accurate, third-party evaluation of the value of the company and its stock.

You know that there is a lot of risk involved, but you also know that when dot coms go public, there can be a big payday You're thinking that the risk may be worth it since the agency will sell the stock and make a killing when the internet company goes public.

Unfortunately, in most cases, the shares of stock the agency will receive in exchange for its services (or, in the case of options or warrants, upon exercise of the options or warrants) will be restricted securities. Restricted securities are not freely tradeable, because the securities have not been registered for public sale, even though the issuing company may be public.

Under the federal securities laws, restricted securities cannot be sold or transferred unless either (1) they are covered by a registration statement filed with the Securities and Exchange Commission or (2) they qualify for an exemption from registration. The filing of a registration statement is part of the initial public offering or IPO process. However, having the agency's securities included in an IPO or other registration would be very costly to the internet company and therefore is generally not something the internet company is prepared to offer. Qualifying for an exemption from registration will generally require, among other things, that the agency hold the shares of stock (not the options or warrants) for at least one year.

In addition, there may be contractual restrictions on when the agency can sell its stock. For example, if the officers and directors of the company or certain investors in the company have agreed to lockup or market standoff provisions (i.e., restrictions on stock resale following an IPO), then the company may require the agency to agree to the same lockup provisions. The typical standoff or lock-up period is 180 days.

In summary, the agency will generally be restricted from selling its stock for a minimum of one year after it receives the stock and for an additional six months following an IPO. As a result, the agency may not be in a position to sell in the post-IPO frenzy when the value of many internet stocks have typically shot up. By the time the agency has the right to sell its stock, the stock may be selling at a less inflated price and the possibility of the agency making a killing is less likely.

What's the saying? Nothing is certain except death and taxes. Just as the agency will be taxed on any fee it receives in cash in exchange for its services, so, too, will the agency have to pay income tax on the value of stock the agency receives in exchange for its services. Taking options or warrants in exchange for services may not give rise to taxable income at the time of receipt. However, there may be taxable income upon exercise or disposition of the option or warrant.

In the simplest scenario, if the agency takes stock in exchange for services and has taxable income upon receipt of the stock, the agency may not be able to sell the stock to raise the cash to pay the tax. Therefore, in all cases, it is important that the agency consult with its tax advisors to determine the impact of taking stock, options or warrants in exchange for services.

Taking stock, options, or warrants as payment for your services can sound appealing. Part of this mindset is fueled by the meteoric rise of many internet stocks. Who wouldn't want to see his or her investment increase 500% in a matter of weeks? Of course, the same investments can lose much of their value just as quickly Keep the issues we've covered in mind and you can decide whether the risk is worth the potential reward.