I don’t work for a profit share or equity unless I’m expecting to be heavily involved in the business or it’s in addition to cash remuneration (I have co-founded a company and been offered shares a few times). Shares in a private company are extremely hard to sell, and you only get a payback if the company starts paying dividends, is sold to another company, or floated on the stock market (the latter is so unlikely that I wouldn’t factor it in as a possibility). None of those are guaranteed and if those events don’t occur you have worked for nothing. I know people who have shares in companies founded 15+ years ago which are still trading and they haven’t seen a penny for their efforts. I see it as like taking the money you would have been paid for the work and using it to buy lottery tickets – you might be lucky and win a fortune, but most of the time you’ve just enriched someone else.
If a fellow freelancer is thinking about this, there are a lot of things to watch out for.
Pre-emption rights: The right to participate in any future share issues, usually in proportion to your existing shareholding (e.g. if you own 10% of the company, you’ll have the right to buy/receive 10% of the newly issued shares). This means your percentage stake remains the same over time.
If you don’t have pre-emption rights, there’s nothing stopping the company issuing more shares, effectively diluting your stake to nothing. For example, if the company has 10 shares and you own 5, you have 50% of the company. The company then issues 999,990 shares to another person. You now own 5 out of 1,000,000 shares, or 0.0005%.
Tag-along rights: If another shareholder sells their shares you can force the buyer to buy your shares at the same time and price. Closely related to this are drag-along rights, where the buyer can force you to sell your shares as part of transaction with another shareholder.
Majority shareholders: If one shareholder owns more than 50% of the shares, they have a lot of power in deciding how the business is run. If they own more than 75%, they can more or less do what they want within the law (certain decisions require 75% to vote in favour). If you have less than 5% of the shares, then you have effectively no power unless you can convince other shareholders to act with you.
Changes in ownership: What happens if shares change ownership, e.g. because the shareholder dies? You might find yourself working with someone who doesn’t share your interests in running the business and just wants a quick sale.
Different share classes: You might end up with 10% of the ownership but 0% of the voting rights, or you might own 10% of the company but have no right to share in the profits. There are legitimate reasons to have different share classes but they can be abused to allow one shareholder to keep control.
Profit share: You need to define what you mean by ‘profits’. There are strict rules about what profits companies can pay out to shareholders. Generally you can only pay out from ‘retained earnings’, which are (at a very high level) the cumulative profits made by the company. If the company makes losses for several years, it will have to recoup those losses first before it can start to pay dividends.
Shareholder agreement: You will need a shareholder agreement, because most of the rules about companies cover relations between the company and its shareholders, rather than the relations between shareholders. You might for example want to require unanimous agreement on certain decisions, such as whether to sell the company, what happens if a shareholder dies etc.