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Shared Effort

Need goods and services but low on cash? Make vendors part owners and share the rewards.
February 1, 2008
URL: http://www.entrepreneur.com/article/188686

Last year, as Ted Farnsworth was getting his business, The Purple Beverage Company, off the ground, he devised a way to get quality services from vendors with a minimal cash outlay--and without taking on more debt. Turning to a type of corporate currency, he persuaded independent distributors and other vendors to accept shares in his company in exchange for services. As part owners of the company, these vendors are now uniquely motivated to help Fort Lauderdale, Florida-based The Purple Beverage Company succeed, says Farnsworth.

Now distributors work harder to give him advice on retail placement and let him know when a retailer is low on product. And the company's advertising agency, which receives shares in addition to a small monthly cash retainer, has a stake in finding the best way to deliver Purple's message. "They hit me with stuff all day long," says the 45-year-old founder. "I'd rather have partners than vendors because they've got their own interests aligned with ours."

This kind of risk-sharing arrangement has become popular among growing businesses as a way to get goods and services without having to tie up capital. "I strongly recommend it," says Bruce Lynskey, clinical professor of management in entrepreneurship at Vanderbilt Owen Graduate School of Management. "Cash is absolutely dear, so if you can get anyone to accept at least partial stock options instead of cash, that's good." Lynskey witnessed the upside of this financing tool in the '90s as an employee of Wellfleet Communications, which began paying its delivery vendor, FedEx, partly in options instead of cash at the vendor's request. Wellfleet's hugely successful IPO made the stock a Wall Street darling, says Lynskey, "and FedEx made much more money than if we'd paid them in cash."

Still, business owners need to be aware of the potential legal risks involved with this kind of financing and take the proper steps to avoid them, says David Staub, attorney and partner at Stahl Cowen Crowley Addis. For starters, make sure you've provided adequate financial disclosure to any potential investors; if it's determined that you omitted any key financial information when you issued the stock, you could be held personally liable for the investment. Second, says Staub, provide an exit strategy for minority shareowners and a buy/sell agreement that explains how the two of you will part company before or at a liquidity event, such as a merger or an IPO. "It's like a business prenup," Staub says. Even though most investors are more likely to write off a loss than make trouble, it generally isn't worth the possible risk.

Consider any issues that might arise due to a potential conflict of interest, adds Staub. For example, if your accountant becomes a shareowner, he or she will be prohibited from conducting future audits. Also know that your new investors will be entitled to see the company's financial statements and figures--including your salary. And above all, says James Chamberlain, management counselor and financial expert with SCORE, make sure you and your investor are a good fit. "This person is going to be a shareholder and part of your equity team," he says.

If you own a C corporation, an S corporation or an LLC and decide you want to go this route, you need to prepare your financials and make a business case to vendors--just as you would to a VC firm--to convince them to climb onboard. Farnsworth now pays a host of vendors with company stock, including distributors, consultants and, most recently, singer Chaka Kahn, who will promote the brand in a new ad campaign. Though each issuance of stock dilutes the owner's own equity stake in the company--and in its future potential upside--Farnsworth says there's still plenty of juice to go around. "My landlord said, 'Someday you're going to hit me up with shares,'" says Farnsworth. "He's probably the only guy I don't [use a risk-sharing arrangement with]."

C.J. Prince is a writer specializing in business and finance. Reach her at cj@cjprincemedia.com.