Slicing Pie: Equity Slices In Movement
In many ways, the first steps of a startup will prove decisive. Unpreparedness for change, greed of some and naivety of others: the pitfalls that threaten founders in the early stages of a business are legion. By falling into these traps, partners risk jeopardizing their creation. However, as stated by Michael Moyer, these obstacles are often fatal but some are easily avoidable.
Multi-American entrepreneur and university professor, Michael Moyer is an accomplished author. In the book Slicing Pie, he provides the keys to distribute equity between founders as evenly as possible right from the start of the company, i.e. before it is even profitable. The dynamic formula that Michael Moyer shares ensures that the distribution key is not carved in stone, changes are anticipated and conflicts are bypassed.
The Fixed Distribution of Slices of the Pie, a Misguided Idea
Albert Camus said that “to name things wrongly is to add to the misfortune of the world.” Similarly, distributing equity poorly between founders at the start of a company adds to the company’s misfortune. Slicing the tiny pie of a startup is an art. Not calibrating the shares of a company properly upfront can lead to disaster and cost money, energy or reputation.
When a startup is born, its founders often believe that freezing the number of shares they each have in advance combines two strengths: simplicity and balance. The reality can be very cruel to those who make that choice. Indeed, the fixed share means that pieces of equity are distributed to people who join the project according to predetermined amounts in anticipation of the creation of value by the company.
Are startup founders too optimistic? Probably, because predicting the future accurately is a challenge for most of us. Add to that the impossible task of measuring the added value and you have a recipe for failure. The fixed sharing of equity is frequently the source of fierce negotiations, leading to tense relationships between partners or even lengthy and costly litigation that hurt everyone.
Just ask Mark Zuckerberg, founder of Facebook, what he thinks. He offered his friend Eduardo Saverin 30% of the social network when it launched in 2004 in exchange of an investment of $15,000 and his financial expertise. The initial division of the capital turned sour as the company grew and Saverin showed little interest in the life of the company.
Lorsque Zuckerberg choisit de récupérer les parts de Saverin à partir de 2005, il se retrouva in fine devant les tribunaux et, en 2012, accepta de transiger sur une somme qui avoisinait plusieurs milliards de dollars. Saverin, a gagné gros sans avoir investi ni trop d’argent ni trop d’effort dans Facebook grâce à un accord initial qui lui fut immensément avantageux au vu de l’évolution de la startup.
When Zuckerberg chose to recover Saverin’s shares in 2005, he found himself in courts and, in 2012, agreed to compromise on a sum that approached several billion dollars. Saverin, won big without investing too much money and effort in Facebook through an initial agreement that was immensely beneficial to him in view of the evolution of the startup.
An Evolutionary and Fair Way to Slice the Pie
Slicing Pie’s purpose is to fight iniquity and prevent this type of situation from happening. In the context of a startup, the more a partner contributes to its success, the more risks she takes. Indeed, before it reaches the breakeven point, the startup spends money without actually recording revenue. Any contribution of the founders will only be compensated financially if the company becomes profitable.
Michael Moyer has developed a dynamic and fair system for sharing equity that incorporates the risk, a fundamental element for a startup, around which its business model is built. Each shareholder receives equity based on what she brings to the ongoing development of the company: in the words of Moyer, the slice of pie that everyone gets is equal to the ratio of their contribution to the financial valuation of the startup and its total notional value.
A slice of pie represents a fictitious unit of measurement that reflects the risks taken by partners but not yet offset for the development of the startup. Each contribution is a certain degree of funds invested, topped up by time spent, ideas brought to the table, purchased equipment or the strategic relationships provided. All of this investment corresponds to the theoretical value of the startup.
Knowing How to Measure the Risk
However, how do you quantify the risk taken by each contributor? Michael Moyer proposes to measure the "individual contribution to risk" based on its fair market value. A service provided to the startup – for example, developing software, meeting a business angel or renting an office – may not be financially compensated by the startup but it still has a market value. Thus the price of each type of investment is estimated based on its theoretical value on the market – for example, the hourly wage of a developer, the cost of a service or the price of office supplies.
Then, multipliers are applied to adjust each type of individual contribution. In the model described by Moyer, the multiplier for money invested is higher than for time spent. Everyone is free to adapt the formula, however, based on discussions between partners, their desires and their principles. Moyer’s system is above all flexible and this is one of its main assets.
Let’s explore a hypothetical case. John is a developer with a sports application idea. Jade is a marketing specialist who loved the concept and agreed to sell it to her contacts who may be interested when the application is ready. They share capital at 60% and 40% respectively. The distribution is fixed ab initio.
John quits his job and work full time for a year to make the application ready for sale. Jade has moved on and does not want to sell the application, but still wants to retain a 40% share because she invested $5,000. This situation necessarily leads to conflicts between the two founders. Slicing Pie would not allow Jade to behave this way. However, Moyer’s formula would still treat her fairly.
Indeed, if John and Jade has implemented Slicing Pie’s adaptive and balanced distribution model, Jade would have listed her initial bet and indicated upfront that she would not give up her job, but would open her address book and help sell the application depending on the time available to her. Based on their contribution at the time, John and Jade would hold 60 and 40 shares respectively.
Jade’s share is thus primarily calculated based on her financial contribution, her commitment to providing a few marketing studies and sharing her address book only being recognized as secondary contributions. A year later, it is clear that her individual contribution, adjusted and reduced to the theoretical value of the startup would not have been the same: John, who devotes all of his time to startup now holds 90 pieces of the pie when Jade only holds 10.
It goes without saying that this system applies until the startup starts being profitable, that is to say before it releases enough money to reward each shareholder. Indeed, if partners were paid for their time or for the ideas they bring or they were being reimbursed for expenses incurred in favor of the company, the risk would no longer exist.
Equitable Distribution of Shares When a Co-Founder Leaves
The elegance of the Slicing Pie concept is also based on the fact that it applies to two critical stages of business development. It works for the distribution of the theoretical value of the company between partners not only before breakeven is achieved, but also in the event of the departure of one of the co-founders.
When one of the founders of the startup moves on, the cards are reshuffled among the remaining partners. Moyer’s formula is dynamic, this development is considered naturally. As for the partner who is leaving, the amount of compensation varies if it is a dismissal with or without cause or a justified resignation or not.
Suppose that Jade did open her address book and even quit her job. The application developed by Jean sold well and is profitable a year later. Jade is now marketing director of the startup of which John is the CEO. According the Slicing Pie model which John and Jade originally decided to adhere to, Jean still holds 60 shares and Jade 40.
However, John wants to change marketing director, considering that the company needs to change gears in order to grow and that Jade’s address book is no longer sufficient. He decides to dismiss Jade. Slicing Pie provides that in this case Jade, who committed no fault, is free to retain all of her slices of the pie with no compensation or to accept to sell them at their theoretical market value.
Without a doubt, if Zuckerberg had drafted a contract with Saverin implementing Moyer’s formula, his old friend would have received a much smaller amount in 2005 than that which Zuckerberg finally agreed to in 2012 ...
A Great Model to Launch a New Generation of Business
Slicing Pie is thus a great tool available to all the startup founders who want to avoid problems that will necessarily creep up but that they cannot predict when they launch their small business. The model developed by Michael Moyer is not pie in the sky. Rather, it is based on tangible and measurable elements for estimating the risk and calculating the value of a startup.
A true moral pact between partners witnessing the birth of their business, Slicing Pie prevents the most greedy from gaining an advantage over others. Aiming for fairness right from the start in order to reach success in the end, while avoiding futile costs and unnecessary blows ... An inherently ethical tool, the model developed by Michael Moyer seals a relationship of trust between partners, rewards each individual’s efforts and motivates all the co-founders to succeed together.
The wide propensity of startups that look to secure the distribution of equity between co-founders before producing any type of result shows that many do not hesitate to put the cart before the horse. Better stay pragmatic, warns Michael Moyer, take the time to be fair and prefer a formula that adapts to changes that are part and parcel of business.
Faced with quick market changes, reality requires that companies be responsive, agile and flexible in order to adapt constantly... everything that the fixed share distribution system among startup co-founders doesn’t allow for. In contrast, Slicing Pie is a dynamic concept of distribution of startups’ capital shares, an organic formula, a system suited to the rapid changes of startup environments and to the vagaries of group life. It is a tailor-made model for next-generation businesses.