Founders Guide: Deferred Payments for Lawyers, Accountants, etc.
As a startup founder, managing cash flow is crucial, and it’s not uncommon to be offered deferred payment options by service providers such as attorneys, accountants, or fractional CFOs. While these offers can seem attractive, it’s important to carefully consider the potential long-term implications before accepting them. In this guide, we’ll walk you through key considerations for taking on deferred payment arrangements, potential pitfalls, and strategies for ensuring that these agreements work in your favor.
Understanding Deferred Payment Arrangements
Deferred payment arrangements can be a lifeline for early-stage companies that need essential services but are short on cash. These agreements allow you to defer payment for services until a later date, often in exchange for a higher cost, equity, or a combination of both. While this can be an attractive way to manage cash flow, it’s important to approach these deals with caution.
Key Considerations Before Signing
Avoid Personal Guarantees
One of the most critical things to watch out for in any deferred payment agreement is the inclusion of a personal guarantee. A personal guarantee means that if your company fails, the service provider can go after your personal assets to recoup their costs. This can have serious financial consequences for you as a founder, so it’s advisable to be very cautious about signing anything with this clause.
Understand the Implicit Interest
Deferred payment agreements often function similarly to a line of credit, with service providers effectively loaning you their services. In these cases, they are likely to build in a rate of return on the services they’re providing. Expect interest rates to be at least 12%, which reflects the higher risk they’re taking on. Be sure to evaluate whether this is a cost you’re willing to incur.
Equity Considerations
Some service providers might ask for equity in exchange for deferred payment terms. While this might seem like a way to preserve cash, it can become very expensive in the long run. Once a service provider has equity, they might be on your cap table permanently, which can complicate future fundraising or even business decisions. Ensure that any equity agreements are carefully structured, with vesting tied to specific deliverables rather than just time spent.
Evaluate the Long-Term Relationship
Entering into a deferred payment arrangement can lock you into a longer-term relationship with the service provider. This can make it difficult to switch providers if the relationship isn’t working out. Before agreeing to such terms, make sure you have sufficient experience with the provider and are confident in their ability to deliver value over time.
Be Wary of Out-of-Market Requests
Some providers, particularly those not accustomed to working with startups, might request equity or other compensation that is out of line with market standards. For example, marketing groups might ask for multiple percentage points of equity simply for making introductions. Such requests are usually unreasonable unless they are introducing you to a top-tier investor or partner. Keep equity grants modest and ensure they are tied to meaningful contributions.
Managing Debt and Capital Stack Implications
If your company has already taken on debt—whether through loans from founders or other sources—it’s important to understand how additional deferred payment arrangements might impact your capital stack. In most cases, the service provider’s deferred payment could take precedence over other debts, depending on how the agreements are structured. This is something you should discuss with your attorney to ensure there are no surprises down the road.
Final Thoughts: Proceed with Caution
Deferred payment arrangements can be a useful tool for early-stage startups, but they come with risks. Avoid personal guarantees, be mindful of the implicit costs, and think carefully before giving away equity. Most importantly, ensure that any agreement you enter into is one that supports the long-term health and growth of your company.
As always, it’s advisable to consult with your attorney and financial advisors before signing any agreements to fully understand the implications for your business.
