There are a few dilemmas faced by all startups: one is figuring out how to pay for external expertise, particularly in areas like software development, tax and legal.

Because startups aren’t flush with cash, it can be tough to afford specialist consultants, which can charge upwards of $500 an hour. One simple solution, or so you’d think, would be to offer small amounts of equity in exchange for labor. Problem is, once you start trading equity in exchange for work, there are a number of issues that arise.

Put simply, if you decide to engage a consultant and pay them in equity, they will taxed when the equity (i.e. shares) are handed over, instead of when the value is realised (i.e., when the company or the shares are sold). Having to pay the tax up front is a major turn-off for consultants getting involved in startups in this way.

However, Lachlan Blackhall, co-founder of Canberra incubator Covate, thinks he has found a solution. Blackhall launched Covate with Adrian Mcgarva and Matthew Ryan in 2011. It’s a virtual incubator, with two companies currently on the books: BnE Media, a company which develops storybook apps; and Appatyte, building a system to better manage queues at large stadium events.

Covate made its first investment in March of this year, after many months trying to solve the whole ‘equity for work’ problem. He explained how it works:

Providing equity for work

All consultants have bench time, where they still need to be paid by their employer, but they are not earning any money: in between jobs, when things are quiet. Now what if their employer could be compensated for their base rate (say $175 per hour, instead of the usual $300), and given a form of equity in the project or startup for which they consult? It means a consulting firm covers its costs, with a potential for big-time reward, down the track.

Covate uses a unit trust to manage its investments. Each startup accepted by the incubator hands over equity, in exchange for mentoring, project support and funding. Perhaps the most interesting component of the strategy is how consultants are paid through the trust, essentially offering an equity equivalent without the tax issues.

For example, say I need to bring in a lawyer to do four hours of work for my startup. I’d pay the base rate of $75 per hour, or a total of $300. The trust would also hand over a share in the trust, to the consultant. The value of the work provided by the consultant is also treated like an investment in the trust, and as a result, the startup itself. Each hour of time spent working for a startup should theoretically increase the long-term value of the trust, which should be realised sometime in the future.

“In the traditional VC capital model, a fund is held in a unit trust,” says Blackhall. “There’s a management company set up, at the end of the fund’s lifetime it gets sold down — some of the profit goes to the investors, and some goes to the investment managers as what’s called a ‘carry.'”

Blackhall says Covate are essentially doing the same thing, but for suppliers. There is a carry offered, or a potential ‘upside’ depending on how the startups fare. And because labor is being provided over the lifetime of the trust, the actual share held by each consultant constantly fluctuates, as does the value of the trust.

For example, if I’d spent a day working for a  Covate startup in the first month, my share would have been worth more then than it is now, after other consultants have also spent time providing their expertise. Blackhall says because the more you invest (in time or money), the more value you’ll realise in the long-term, there is an incentive for recurring engagement with the startups.

“In essence, a consultant has a stake in the trust. The stake is constantly revalued, depending on a range of factors.”

The structure is intended to ensure that consultants and service providers are taxed  when the uncertainty of the income to be earned is removed. Because the whole trust setup is uncertain — whether it will make any money, how much each share is valued, whether a consultant will be paid — Blackhall believes the approach avoids those issues.

Have you established a similar setup with your startup or incubator? We’d love to hear from you — get in touch.