Does payment in the form of equity rather than cash affect the incentives in a negative way? It's not enough to call out a distinction: how does it make a difference? If anything, the equity should mean that Google's incentives are more closely aligned with the startup's than the fire insurer's are with the insured.
Yes, because obviously if that equity turns out to be worth a very large amount of money and the company is never sued Google is not going to turn around and say 'oh, sorry for this vastly disproportionate payment, here is your repayment'.
In fact, the best outcome for Google would be if nobody ever got sued. (That's also the best outcome for the companies but there is no way of knowing if they would have gotten sued had they not paid their protection fee.)
How is that different to "You paid an awful lot of fire insurance premiums over the years but never had a fire"? The insurance company certainly isn't giving you a refund either.
It seems to me that if the equity turns out to be worth a lot, then the value of the protection is greater as well - the potential losses are likely to pretty closely track the company's value.
