Why Asking For Equity May Not be a Good Idea

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I own a few domain names that receive acquisition interest from startups. I’ve always thought it would be neat to sell a domain name for cash plus an small interest in the company that is acquiring the name. If the company is hugely successful, the value of the domain name sale could soar.

After discussing quite a few deals that involved selling a domain name and receiving at least some of the consideration in equity, I have come to the conclusion that there are big issues for both parties.

From the sales perspective, selling a domain name for an equity stake requires the involvement of a good contract attorney that knows how to contractually protect the seller. I wouldn’t want to own an equity stake in an entity that turns out to be a worthless shell. I also don’t want my equity stake to be diluted nor do I want to be required to invest cash into the company, especially if the cash investment is substantial. Finally, I want to make sure I am protected if the startup fails or if the startup faces legal troubles. These are just a few items that need to be considered and negotiated in a deal that involves receiving equity.

Working with a lawyer can be expensive, especially when specialized advice is needed during the negotiation prior to having an agreement in place. A domain owner could spend many hundreds or likely thousands of dollars working with a lawyer to finalize various deal points to protect the domain owner’s interest, and the deal may not even go through! That’s a pretty big risk, especially if the cash component to the deal is relatively small. I do think working with a lawyer is essential when doing an equity deal.

From a buyer’s perspective, it can be difficult to deal with a domain investor who isn’t all that knowledgeable about startups and their needs. No startup founder is going to give up a ridiculous amount of equity to buy the domain name, so a domain owner who asks for a large percentage (but will play no role in the startup) is being difficult. Domain owners’ requests could also add to legal fees and take additional time to work out. If a startup is looking to move quickly, this could be problematic.

Selling a domain name in exchange for some equity in a startup sounds exciting. The domain owner is gambling that the startup will be successful, and if the owner is right, the domain name sale can be worth way more than if it was sold for just cash. There are many drawbacks to these deals, and the domain owner should look at it from the perspective of the startup, too, to see why it might not work out.

1 COMMENT

  1. Elliot,
    Totally agree with you, well said.
    And always make your own in-depth research before investing in a start-up.

    BTW, do you remember the guy who sold Ebola.com for 50k and a bunch of stocks valued “on paper” 150k, at 8.5$ each?: https://www.domaininvesting.com/ebola-com-domain-name-sold-200k/
    Now the stock is trading at 0.45$ … – 94.7% …
    As I said at that time, “as far as I see, these shares could be easily have no value … not more than a cloud of smoke” … lol πŸ˜€

    • P.S.
      Anyway, it always depends on the company we are talking about, those situations have to be valued on a case-by-case basis. πŸ™‚

    • True, but the parties didn’t agree to any form of price adjustments if interest in Ebola and consequently in this domain name would have been faded …
      It’s the very poor quality of the equity portion who made the difference … πŸ˜€

    • Andrea, Guess there was some creative accounting, what is your take on this:
      George Kirikos of Leap.com dug up a couple of big ones from late 2015 by going through a corporate SEC filing and a WIPO case this week. One of those was a monster deal involving the sale of CancerInsurance.com to Tranzact that could earn the seller as much as $7.9 million! the passage George uncovered said, “The purchase price included cash of $1.1 million and a liability of $2.0 million for contingent consideration that is payable if EBITDA exceeds amounts defined in the purchase agreement between November 6, 2016 and May 6, 2018
      http://www.dnjournal.com/archive/domainsales/2016/20160309.htm

      http://www.tranzact.net/

  2. You should lease the domain to them, with a “equity” buyout. Cash when they get funded. You get a angel type return.

    Simple, no stock needed, if they fail to make payments or the buyout, you keep all the money and the domain.

    Problem solved πŸ™‚

  3. Enjoyed the read Elliot, I would definitely go with the leasing option Anthony mentioned. I think it is the safest route especially with category killers or even domains over $5k for that matter.

  4. Lease for 10 years
    with option to buy shares with preferential price at year after 5.

    so you will have the possibility to evaluate the status of the company after many rounds and will get the option to buy shares at super discount prices, no need to gamble, also 10 years is a correct timing for a new startup, if it is not viable, it will die year around year 2.

  5. Cash is King
    Unless a company is self funded the owners usually have no value for other people’s money and will have no problems agreeing to financial engineering moves (reverse splits, dilution, pipes, bankruptcy, etc. etc.) in order to continue receiving a paycheck at the expense of others.

  6. If you want the risk/reward aspect structure a royalty deal off of sales of their product or service.
    Even then you’ll need to trust the people and their accounting

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