Why is dividing equity so hard for startups? Building a startup requires a tremendous amount of work. You have to pass through the stages of concept creation, development, and market testing before you can get to market. So, if you and one or two colleagues form a startup business, how do you determine a fair way of measuring your input rather than just dividing equity equally? Poor equity allocation at the start can create an inflexible millstone around your neck, particularly as you grow the business and seek further capital. So how do you maintain a committed working relationship that ensures fairness for all parties involved?
The answer: It is about how you slice and grow the pie.
An Example of Dividing Equity in a Startup
Mary, Eddy and Cheryl are startup entrepreneurs venturing into a SAAS business named MEC Tech. Mary is the marketing head and the founder of the business. She decided to bring her friends Eddy and Cheryl to her venture, making them co-founders of the startup business. Eddy is the software engineer while Cheryl became the CFO. Mary and Ellie are not able to contribute cash to the business, so are contributing their time and skills to grow the business. Cheryl, having the stronger financial position of the three partners, has financed everything to date, and only handles business presentations for future investors. She works in a much more part time capacity.
After launching their first software application, Cheryl was able to secure an investor to compliment her own investment in the business with the help of Mary to buy into their project, helping MEC Tech secure customers and turn a profit.
Let’s say the equity distribution was 40:30:30.
Cheryl is a co-founder and contributed the most in assets to the business. Mary and Eddy are contributing substantially more hours of work compared to Cheryl.
Realising the differences in work effort and equity received, Mary and Eddy started to wonder if the valuing of equity over time was fair, and this was impacting their commitment to the venture. So, how would they solve this dilemma?
What is A Slicing Pie?
Slicing Pie is a tool that was developed by author and American entrepreneur Mike Moyer using a simple formula basing the person’s percentage share in equity relative to the percentage share of investment incurred based upon what they bring to the startup. This approach was invented to cover the challenge where you have two or more founders for a startup, and they bring different things to the startup; for example, cash, connections, strategy, time, assets and material.
There is no one correct method in splitting equity among co-founders. Trying to set the equity position at commencement can be very difficult (and in some cases, practically impossible) so this approach allows for a more fluid way to reward ongoing contributions.
Since dividing the equity amongst founders is not all about the money invested in the company, the Slicing Pie concept is modelled to convert the founder’s contributions equal to their fair market value. The slice of a pie could be based upon the money invested, time, ideas, connections, strategies, plans, intellectual property, and so on. The slices of pie will then be converted to their fair market value, allowing assessment of the percentage shares of the changing value of the investment in the company. The purpose of the approach is to make it easier to identify the founder’s contributions and divide the equity fairly.
How Slicing Pie works
According to the creator of Slicing Pie, Mike Moyer from Philadelphia, USA, the founders that bring their contribution to the company are called Grunts. Their contributions are valued based on the Theoretical Base Value (TBV) — a starting value that provides allows for a method of calculation for the theoretical value of the business. In other words, a proxy for the actual value of the company.
Cash and Time have the biggest TBV. For part-time co-founders like Cheryl, using time as a theoretical value provides a fair consideration for those who give up income to work in the business and those that contribute income earned elsewhere.
Cash often has the biggest value in TBV. In a startup, raising cash may be very difficult as risk is highest at commencement.
In Mary’s case, since she conceived the idea, and it now belongs to the company, compensation needs to be considered. The equity Grunts receive should be equal to the fair market value of the contributions they make. The future value generated from existing contributions is not counted.
Slicing Pie provides a method to consider cash versus time versus concept – or other contributions.
What happens to the allocation of equity when a grunt is removed or replaced?
Building a startup is not easy. It requires a lot of time, money, and effort for it to reach market validation, minimum viable product and then breakeven. Some founders choose to no longer continue in the business. With others making a greater ongoing contribution, those that had made an early contribution can still be recognised, however their percentage will dilute over time based on new contributions made by the remaining team.
How does the Slicing Pie model help?
Investing any resources into a startup is a gamble and is a bet on the company’s future. Once these bets are placed, you’re already part of the game. It is like playing Blackjack — the more bets you place, the bigger the risk, but when you win the bigger rewards you should reap. It is a method that allows founders to contribute more or less to their startup in a way that is fairer to each party.
An entrepreneur can be described as a risk-taker; someone who is willing to try to make changes and create a better way. A successful business has a much higher probability of success when all of the founders are compensated fairly and treated justly. The Slicing Pie Method designed by Mike Moyer is one way of encouraging strong continued participation.
Want to know more about the Slicing Pie? Just click the link below and download a free sample of the book: https://www.slicingpie.com/