I started with my first healthcare consulting client back in 2016 when they were a young healthcare startup. Another physician was working for them at the time and she was pushing hard to get some equity in the business. I decided to forgo any equity because it wasn’t worth all of the terms and condition. I’ll explain the pro’s and con’s of such a decision.
Healthcare consulting for a healthcare startup is fascinating, especially when the team you’re working with is young and hungry. Consulting for a larger company has its upsides too but the work can feel more structured, predictable, boring.
Equity Types – Public vs. Private
An equity offer is a stake in the business in the form of private equity stock options. This is done either to entice you to work for them or to negotiate a lower pay. The idea is that you get to own, for example, 1% of the company based on certain terms. That’s the 1% equity offer.
Equity is the word used to describe your shareholder holdings. When you buy a public company like Netflix, you are purchasing equity in that business. The 1% equity in that healthcare startup is referred to as private equity.
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Private Equity Offer in a Healthcare Startup
Imagine that you consult for a healthcare startup which is working on the next wearable patient device. They end up raising millions of dollars and either go public as a company or get acquired by a larger company. If you purchased private equity in that company then you might be able to cash out – maybe.
Public equity is when a company is trading on a public stock exchange. The SEC regulations make the process very complicated for the business but transparent for the investor. You can go on any trading platform and buy however many stocks you want of company XYZ.
The private equity offer in a healthcare startup is not as transparent. There are also many more factors to consider before accepting private equity. Of course, you can also buy private equity by investing in a healthcare startup and I’ve addressed that before. Generally not a great idea unless you have an informational edge.
Private Equity Offer
A healthcare startup might have two different business entities. One might be the actual corporation which would be eventually bought out by another company. The other might be the Professional Corporation – P.C. You might end up with nothing if you’re getting a private equity offer in the P.C. Any private equity should ideally be acquired in the actual business.
The way it works out in the real world is that the CEO or board of directors will offer you 0.1-1% of private equity shares in the business in return for you offering them discounted consulting work.
In my case I work with the engineers to build the algorithm for their artificial intelligence system. I get a set monthly $3k retainer whether I do work for them or not. The retainer guarantees them 10 hours of work every week and guarantees me an income. Anything beyond that work, I can charge at a rate of $75-300 per hour – depending on my availability.
If I accepted a private equity offer then I might forgo the monthly retainer and instead charge them a flat hourly rate of $75. In return for giving up the retainer I would get 0.1% of private equity shares in the business.
Nuances of Private Equity
If I buy 1 share of AMZN I would pay $1,777 per share. I would own this share, and a percentage of that publicly traded company, without any stipulations or specific conditions. Easy, simple.
A private equity offer however can be a 35-page document with endless terms and conditions.
Angel.co published a great article on this topic recently. I have also written about private equity on this website. It’s a rather intricate topic, though not complicated. If you’re going to accept a private equity offer in a healthcare startup then I would recommend having an specialty attorney look over the terms.
Let’s dive into the various terms and conditions which can be placed on your private equity offer:
1 – Vesting
Just like your 401k or 457, you might have a vesting schedule attached to the private equity offer. Your 1% private equity might only become active after you’ve been with the company, in good standing, for 3 years.
Leave at 2 years and you’ll give up the entirety of your private equity offer.
2 – Options
Your equity offer might require you to put some money in before you can buy that 1% of shares. Or there might be an option for the company to buy back some of their shares. Or there might be an option for you to buy more private equity shares if you choose to do so. Lots of “options”.
3 – Tax Basis
It’s important to understand what kind of private equity shares you’re buying and how the company values each share. Every time the company raises more money from investors the value of the company goes up. This could drive up the book price of your shares and potentially create a tax event.
4 – Stock Options
Similar to the tax basis concept is the type of stock you receive from your healthcare startup. There are different types of stocks. When you sell one type of stock, you might be taxed at ordinary income tax rates. This isn’t often ideal but sometimes necessary.
There are other types of stock options which allow you to pay capital gains tax rates. These tax rates are more favorable and divided into long-term and short-term capital gains taxes. The latter is essentially the same as paying ordinary income taxes.
5 – Liquidity Event
Your company might go bankrupt, get dissolved, sold to another company, acquired, or it could go public. These are liquidity events and it affects your private equity stock. A good contract between you and the healthcare startup will address each such events.
6 – Liquidation Preference
Imagine the company is sold or goes public, a ton of capital flows in. First, the debt has to be paid off. Next, venture capitalists get their slice of the pie. Then there is a whole order of events as to who gets paid first.
Finally, after everyone is paid, your card is turned and if there is money left you’ll get your private equity payout. If not, you’re shit out of luck.
Value of Private Equity
You can buy private equity in damn near any healthcare startup. That’s what these companies do when they raise capital. They offer up a percentage of the company in return for money to help grow the business.
What’s the value of private equity to you?
Would you charge the healthcare startup a lower consulting fee in return for private equity stock options?
The best way I have answered this for myself is to inquire how much the cost of that 1% private equity would be to an investor. The startup might sell 1% for $150k. They want me to charge them 50% of my regular rate in return for that equity. If I had $150k, would I invest it in this company? If not then I would decline the equity offer.
Alternatively, if you’re planning on making healthcare consulting a full-time gig, work for as many healthcare startups as possible and amass a huge private equity portfolio. Some will go bust, some will break even. But hopefully you’ll profit from that one winner.