Many startups are “bootstrapped” which means the founders are using their own cash to fund operations. In that scenario, equity in the company can be used to pay for some services and cover some needs. Many founders automatically create a static split among the group, without considering that the contributions of the founders will undoubtedly be different. The “slicing pie” approach set out in the Slicing Pie book by Mike Moyer.
Moyer suggests a great approach that tracks the contributions of founders and other contributors that will be paid with equity. The basic premise is that folks should be compensated for what they have risked.
- The risk if they are spending time supporting the startup, is the fair market value for what they would have been paid.
- If individuals contribute funds, the money can originally be put in the “well”. Contributors don’t actually receive interests in the company unless and until their funds are actually used. Funds are harder to come by, so they receive a 3x multiplier in the model.
- The ultimate size of the pie is determined either when the company has sufficient cash flow to pay for its costs, so it no longer needs to provide equity. The size of the pie can also be determined when a company is valued or when Series A funding occurs.
- Founders that start out using a static (fixed) model can use the slicing pie model to retroactively allocate ownership interests. However, it’s going to be an alligator fight as the author describes it. You would only want to have this tough fight once. So, do the prep work and buy the book for all of the founders. Give them time to read it. Have some early conversations with everyone. It should be the most fair system. Those that fight it usually just don’t understand it, or they know they have contributed less and will be losing out.
Here are some helpful notes and a summary of the book if you don’t have time to read the whole thing. It really isn’t long though.
Angela Madathil is a Business, M&A, and Deal Attorney and provides legal assistance to shareholders, buyers and sellers of businesses, as well as business brokers in Nebraska, Missouri, and Kansas. This can involve reviewing loan commitments, loan documents, general contract review and negotiation, due diligence assistance, and post-sale integration. The Goosmann Law Firm team advises to buyers and sellers of businesses, as well as business brokers throughout the Midwest and has attorneys licensed in Iowa, Kansas, Minnesota, Missouri, Nebraska, South Dakota, and other states.