Investment paid in services. What’s the value?
Investors often own different complementary businesses. Some of these businesses may be focused on services that can actually be useful to your firm when you are approaching an investment. A fairly common example is marketing. If the investor owns a marketing company and you are selling part of your company to pay for the new advertising campaign, a payment in marketing services is exactly what you need, right?
Investment paid in services
It depends. Let’s give an example to make it more straightforward. Assume that you are asking $350,000 for 30% equity participation into the company. You need all the money just to launch the new marketing campaign. Suppose the investor you are negotiating with owns an advertising agency and offers you this deal: “I won’t give you money, since you don’t need it, but I’ll give you 350k worth of marketing services”.
The net worth of a service
He is basically offering you the equivalent money amount in services denominated at the price he usually charges for them. There is no discount or special offer: it is exactly what you would pay as a customer.
Now, the first concern is already written: as a customer. You are not a normal customer, you are a business partner. The deal should (at least) have a discount on the normal price, meaning that for 350k he should give you more than what the normal customer could buy for the same amount. But this is a minor thing. The important thing is that for him those services are not worth 350k. Why? First because he is making a margin on them. The actual cost he is paying for giving you the market service is way lower than what he is selling them for.
Let’s say he makes, what I consider a really low margin, only 100k, gross margin of almost 29%. His actual contribution to the business is 250k. In other words, you can ask him more money if this is the deal you want to get involved in. What he is paying 350k actually costs him 100k less and therefore you as entrepreneur should squeeze more liquidity out of his pockets. Don’t get fascinated by the offer: stay on the ground and counteract his point with economic argumentations. But this is not the single reason to expect more economic effort by an investor.
There are multiple owners
Second important consideration is the fact that probably he is not the owner of the whole advertising business. Suppose he isn’t and that the effective cost to the marketing agency in creating your campaign (250k) is coming from all the owners of the business. Let’s suppose the investor has control privileges, so he owns 51% of the advertising company, the participation on your company actually costs him 127.5k.
You need more than just marketing
Third important consideration: this deals affects your bargaining power with the investor. Usually your company requires more from a partner than money, and in this case you probably need more than marketing services.
So you go back into the negotiation room saying: “Ok, for the payment in services, I need them and your company is the best around. Now, I heard from other businesses that you sent some guys over to train the sales team, can you send them a couple of months to my company? They can really be helpful in increasing the client base.” How do you answer to: “I just put 350k of marketing services, what do you want more than that?” Yes, you can’t.
A complementary service that would be pretty granted without the marketing deal now is way more difficult to obtain.
You’re tied to the investor’s services
The fourth important consideration regards the nature of the deal itself. I mean, you are selling a stake in your company to somebody who is not injecting any physical funds but complementary synergies. Everybody knows the added value of that but are you sure you want to tie your success to such partner? Especially in cases where the amounts involved are rather high, wouldn’t it be better to outsource the initial stake of the services and then develop the expertise internally?
Again, who says that you will need to spend the whole equivalent sum into these services? For instance, what if you don’t accept the marketing deal and ask for plain green cash? You find yourself with a partner and 350k in the bank. Now you can choose. Should you go to the marketing agency of the investor? Maybe, if they are the best, or the cheapest, or the more suited.
You can go to the small new marketing company of your college friend. It is small but it had a big success, you know the guy and because of that and because of the amount involved, he is willing to give you a discrete discount on the services. Of course he will still make a margin for himself. A further point would merely concern the kind of marketing you need. Possibilities are countless and you should be well aware of what kind of specific expertise you need to penetrate the targeted market and which is the way to keep the cost as low as possible accounting for an extremely volatile future.
To conclude, as a rule of thumb, investment paid in services doesn’t seem a good deal. It doesn’t have the same value for the investor as it has for you and it closes a lot of options for your company. If offered such a deal consider it carefully and think about future scenarios and alternatives.
In the worst case, even if it can be practically difficult, try to apply a discount for this kind of payments. Try to ask for 27 or 25% of the company in return for that amount of services instead of 30 and if asked why, try to use the arguments outlined above. In any case, good luck!
Follow up questions:
- Are these marketing services creating more or less synergies?
- What is the healthy marketing expense/sales ratio for your company?
- Why are you planning another marketing campaign? What are the effects on the valuation?