The Shark Tank Approach to Contract Work

Creative Compensation Ideas for Building a Portfolio of Small Bets

There’s a great community hosted by Daniel Vassallo ?called?Small Bets.

I had some modest financial success building my own SaaS apps early in my career, but for the past decade I’ve instead placed my bets on the ideas of others.

One of the core concepts in Small Bets is that you can’t predict which of your projects are going to succeed, nor for how long they’ll be successful. Ideas should be brought to life and tested quickly, treated like cattle instead of pets, and with the end goal of building a diverse portfolio.

Instead of investing just money, I create partnerships where I invest my time and skills in return for a share in the future success of the business. Our family has a fun tradition of watching Shark Tank when we’re in a hotel on vacation. I love seeing the creative deal structures that some of the sharks propose.

Here are some unconventional arrangements I’ve used. For each, I include?some detailed implementation notes in italics.

% of Profits

This arrangement requires a high level of trust in the business owner, but is also the most “pure” in terms of aligned incentives. I’m encouraged to help the company minimize their expenses in addition to increasing their revenue. I structured a deal this way with one of my best friends over 10 years ago, and it’s still going strong. His?estate planning business?has steadily grown, and I’ve continued to help him optimize the workflows to handle the growth. I’m just now entering into another of these arrangements with a small retail store, and I’m excited to see how it goes.

Optimizing taxes as a small business owner often includes using write-offs that might be considered personal benefits. It’s helpful to spell out in the contract how profit is calculated, such that it more closely resembles what is known as?seller discretionary earnings. I also include a clause to ensure that if the business is ever sold, I receive a % of the sale. However, note that this would not be as tax-efficient as having actual equity, which can be treated as capital gains.

Reduced Hourly Rate for % of Equity

I’ve used this model three times now. I had one strikeout, one home run, and one that’s still TBD. It works by offering a reduced hourly rate in exchange for a percentage of equity in the company. This helps hedge your bet, since even in the case of the strikeout and the TBD, I still received decent cash for the hours I worked.

Similar to an employee receiving option grants at a tech company, it’s helpful to specify how many hours need to be worked before the % of ownership is vested or realized. I prefer to start as a bona fide member/partner, and give the other owner(s) an option to buy me out for a negligible fee if I don’t put in the agreed number of hours within the agreed timeframe. This starts the clock earlier on long term capital gains in the case of a buyout.

% of Revenues

This is one the simplest arrangements I’ve made. I agreed to complete a clearly defined chunk of work, and maintain it as needed. Rather than get paid my standard rate, the business owner agreed to pay me 3x that amount, but spread out over time via 15% of the company’s revenues. Once they paid out that full amount, they didn’t owe me any more. This gave me a great return on my initial investment, and it was good for the company because I stayed invested in their ongoing success and maintaining my work.

Per-Item Fee

Twice now I have found companies that have tedious processes they want to outsource, that I knew I could eventually automate. Instead of creating those automation first, I immediately took over the processes in exchange for a per-order fee. Over time, I have written custom software to mostly automate these tasks. I pay my teenage daughters* to handle the few parts that still require human interaction.

Unlike the other three arrangements I listed above, in these cases the software I write belongs to me. It’s wise to clarify that in a contract. It’s also valuable to stipulate a minimum length of time that your client will use you as their vendor. It would be no fun to put in the work of automating these processes only to have the client decide to use someone else a week later. Also, in one case I specified a minimum amount I’d get paid each month no matter how many orders I fulfilled.

*As a side note to the fellow U.S. business owners out there, paying your kids is an awesome tax-saving strategy. The business gets the write-off, but as long as it’s under the standard deduction amount, your kids don’t have to pay any taxes. My business pays them generously but within reason, and then we have them pay for most of their own things that we as their parents would otherwise cover.

Honorable Mentions: affiliates and bartering

Two last ideas:

• I never quite finalized a deal where a financial planner was going to give me a referral fee for every client that came to him through a complex tax savings calculator I built. Most of my work is in helping companies with operations, but if the help you’re providing will boost their sales and marketing, this can be a great option, as it can be structured in a way that the business has very little to lose.
• Twenty years ago when not many people knew how to create and host websites and I was just starting in my career, I built a website for?Sushi Xin Chicago. At a time in my life when taking a $7 cab ride gave me financial anxiety, it was incredible to walk into that restaurant and order whatever I wanted. I’m thinking of working out a similar deal for a nearby private indoor pickleball court that needs a better reservation system.

So which is best?

This depends on a number of factors.

• An established company with more than one owner may find it both emotionally and logistically challenging to give up true equity, even if the net financial result is the same as a profit sharing agreement that includes a share of an acquisition.
• Are you confident the business can manage their expenses efficiently? If they’re pumping resources into growth, do you think that’s going to pay off? If you’re unsure, then a percentage of revenue might be best. You don’t want to be counting on some near term profit split from a company that’s prioritizing growth for the foreseeable future.
• Is the result of your work going to increase revenue, or improve profitability? It’s easy to end up with misaligned incentives here, if you sign up for a revenue share but your contributions only improve efficiency and don’t help increase revenues.
• Do you need income now? Is the business profitable? How confident are you about the future success of the business? If your answers are “yes,” “no,” and “who knows?” then either taking a reduced rate instead of pure equity, or getting a % of revenues might be your best options.
• How likely is it that there will be new work for you to contribute beyond the initial scope? Do you like the idea of continuing to work with that company indefinitely? The profit sharing and revenue sharing can be set up to be either indefinitely or until a fixed payout is reached.
• Are you going to be creating something that could be reused in other partnerships or otherwise sold? If so, a per-item fee or affiliate agreement might be best, since it’s easier to maintain clear ownership of whatever you create. Just this week, a new potential partner approached me about implementing the same system as I set up for one of my existing percentage of profits partnerships. I don’t own that system, so it’ll be up to those two business owners to come to an agreement.

Lessons learned

• In one of my “reduced rate for % equity” deals, we have clear agreements on the minimum number of hours that I would need to work in order to earn my ownership percentage, but I neglected to think through a?maximum.?That is, as it currently stands, 10 years from now I would still be working at the original reduced hourly rate. On the other hand, I could also just stop working completely and I still get my equity ownership. Neither of those feels quite right.
• There is only one of my arrangements that left it unclear exactly what form “equity” will take. Not surprisingly, that’s the same one that is currently “TBD,” and I have written it off at this point. The deal was made with an associate of one of my business partners, and not somebody I knew and worked with directly. I won’t make that mistake again.
• A few missing clauses and fuzzy definitions have only been smoothed over because of the goodwill between me and the business owners. That’s a pretty fragile thing to depend on, and many a friendship (even family relationships) have been wrecked by business partnership disagreements. So you should clarify and cover as many specific things as possible, but I still feel strongly that these agreements should only be made with people you absolutely trust and like working with?as people,not just as savvy business owners.

Building up a portfolio of small bet partnerships allows me to diversify my income, and hitch a ride with entrepreneurs that are committed to their businesses. If you feel like taking some entrepreneurial risks but don’t have an idea of your own that you’re anxious to launch, consider finding a small business owner you can help.

thanks to Doug Bradshaw Ph.D. for his feedback on an early draft of this post.