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PDtax
PDtax, CPA, MBA
Category: Business Law
Satisfied Customers: 4093
Experience:  Tax professional and business consultant for 35 years.
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What are the downsides of taking equity? I've offered

Customer Question

What are the downsides of taking equity?
I've offered company equity to a couple of developers and they said they don't usually take equity. I wasn't offering it in exchange for work, just as an additional incentive to finishing the project. In all three cases, the developer did not take equity, for whatever reason.
I never asked why, just accepted the answer along the lines of we don't take equity.
This makes me think there may be a reason why a contractor might now accept equity. Does equity come with liability of some sort or flavor?
If so, that might make sense but my gut tells me any contractor would be delighted to take equity to increase their upside potential.
Submitted: 6 months ago.
Category: Business Law
Expert:  Irwin Law replied 6 months ago.
Are you speaking about developers or contractors? I don't think a developer would ever have any qualms about taking an equity position as a Limited partner or low percentage member of an LLC. Most contractors that I know are not into investments of that type. They don't understand them and as such they are suspicious about what they might be getting themselves into. Back in the 70s and 80s, it was not uncommon for mortgage lenders to require" equity kickers "from commercial developers in addition to the interest on the loan. You never hear that anymore and probably never will again.
Customer: replied 6 months ago.

developers are contractors. The same thing on my end. A software developer on hire as a 1099 employee contractor.

Not understanding might be part of the case but for them to turn them down in general, in my opinion, something is wrong there. I may need to post this in the IT category.

Expert:  PDtax replied 6 months ago.
Hi from just answer. I'mCustomer I can respond since the first expert opted out.
Expert:  PDtax replied 6 months ago.
There are real downsides to taking equity, and that includes offering equity to people who know the risk and those who don't.Receiving equity is taxable. Lawyers and CPAs take startup equity commonly. But it's taxable to them. Contractors want cash instead of equity, since they likely live from job to job.Equity holders are exposed to business risks, like unpaid taxes, without compensation. Unpaid debts might be pursued by lenders, tax agencies, etc.Selling a small interest is almost impossible. Limited market, and getting value might be hard too.
Expert:  PDtax replied 6 months ago.
Small equity positions don't get to exert management control. Imagine a prestigious lawyer who owns 10% of a business that changed from a convenience store to an adult gift shop. He might have no voice, get no income, and be exposed to risks.And, don't forget, lenders get paid off first if the business fails. Maybe this leaves nothing for his minority interest.Thanks for asking at just answer. Positive feedback is appreciated. I'mCustomer

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