Equity Stakeholding - Is taking stock a lure into the equity trap?

Taking equity in hi-tech clients may seem an attractive way to make a fast buck, but it carries its own risks. Kelly Holman reports on the deals that are being brokered.

Taking equity in hi-tech clients may seem an attractive way to make a fast buck, but it carries its own risks. Kelly Holman reports on the deals that are being brokered.

As stock prices continue rocketing skyward in the high-technology sector, a number of small PR firms have started taking equity in their clients - in the hope that one of them will be the next Amazon.com or Yahoo.

And why not? It's the ultimate acknowledgement of the role that PR plays in the creation of entrepreneurial businesses.

News last week that Gregory Communications has taken an equity stake in RealTIME was a classic example of this increasingly popular style of deal.

The equity deal represents approximately half the value of Gregory Communications' account with RealTIME.

But, given the seemingly obvious benefits of such a deal, it is interesting to note that the bigger PR agencies don't seem keen on taking equity from clients. The reason for this is that many large PR firms, like Burson-Marsteller, Hill & Knowlton, Shandwick, Ketchum Public Relations Worldwide and Fleishman-Hillard are owned by publicly held companies. As a result, the agencies are fiscally accountable to shareholders that want to see tangible results from PR firms - which result from cash billings - at quarterly shareholder meetings.

Even for privately-held Edelman Public Relations Worldwide, taking equity in place of fees isn't practical, says Paul Bergevin, head of Edelman's global technology practice.

'We have maintained a consistency in the form of payment for a lot of simple administrative reasons,' he explains, adding 'it is also fair to all our clients across the board who are paying us in currency.'

Threat to independence
Alan Ampolsk, a senior vice president and partner for Fleishman-Hillard's technology practice, says taking a financial stake in a client might jeopardize the ability of firm staffers to provide independent, objective PR counsel.

'If I become a financial participant then I feel compromised.'

But not all the major agencies are against the principle of equity deals.

Even though Weber Public Relations Worldwide doesn't take equity from clients, chairman and CEO Larry Weber says taking equity in a client's business needn't be a bad idea for smaller PR firms. 'You are paid very well for that equity portion and it shows a commitment from both parties.'

But Weber believes that whatever the size, agencies need to approach equity deals with caution, as he explains how to structure such an arrangement.

'The best formula is a 50/50 split so you can cover overhead with the cash fee you are getting.'

Nevertheless, whilst a number of small companies are adopting this practice, it is interesting to note how smaller companies are seeking to protect themselves by their own structuring of deals.

Paul Jensen, an executive vice president and principal of Kratz & Co., a New York-based PR firm that represents consumer, technology and business-to-business companies, says the firm is willing to take equity on a case-by-case basis. In fact, Jensen says the firm was in discussions last week with an entrepreneur who offered the company equity in return for representing the company.

PR firms need to carefully evaluate a client's business model before considering taking equity in lieu of a fee, according to Jensen. 'If you really question the business model you shouldn't be taking them on as a client regardless of cash or equity.'

Strategy Associates, a PR firm with offices in Silicon Valley, New York and London, charged a retainer fee but took equity earlier this year in Ignite Knowledge Management, a Silicon Valley Internet company. It was the third time the firm has taken stock in a client, says Bill Harris, partner and co-founder of Strategy Associates.

Harris says the firm usually limits the size of its stake to 10% to 15% of the value of its retainer fee.

RMR & Associates, a PR firm that represents emerging growth companies in the DC area, has made four equity deals in the past two years.

'What we're saying to some of our young companies is we're willing to sell $150,000 worth of services in lieu of stock options,' explains RMR president Robyn Sachs.

A client's business model, management team, market and future plans are all important criteria PR firms need to assess before taking stock in a client, industry experts say.

Risky business
Still, equity deals are fraught with risk, especially for stockholders of privately held companies that often don't realize liquidity for three to seven years after receiving stock.

Strategy Associates' Harris admits the firm lost all its equity in ViewMix, a California software developer that folded two years ago due to business difficulties.

In another case, Sally Jackson, the head of Boston PR firm Jackson & Co took a substantial equity stake in the mid-80's in then privately held Boston Beer Co., the makers of Samuel Adams beer.

The company went public in 1995 and the stock took a roller coaster ride leaving Jackson holding stock in the company that, at the time, had little value. 'The stock came out ... went way up and (then) crashed.'

Mark Heil, an account manager at Philadephia-based, Portfolio Associates, a marketing communications firm that works with entrepreneurial companies, insists the firm never accepts equity in place of a retainer fee and adds that receiving stock isn't financially feasible for all PR firms. 'When you have to finance your client's expenses and you still have payroll to meet and you are working on thin margins, it is difficult to do those types of transactions unless you have a big war chest.'

Cash for acquisitions
Heil says he was approached earlier this year by an early stage microbrewery that wanted to use its cash to make acquisitions rather than pay fees.

'But when there is growth and they want to bring another investor into the firm,' he asks, 'How do you deal with the dilution issue?'

Media First Public Relations, an Atlanta-based PR firm that represents small, venture-backed technology companies, has made two deals with clients using equity-related instruments.

'We're trying to have our company participate in the tremendous success that these companies realize,' says Jim Caruso, managing director, Media First Public Relations.

But PR firms considering taking equity as payment would do well to heed Caruso's words: 'If venture capitalists think one in 10 is going to be big, you have to regard the risk the same way as the venture capital community does.'.

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