🥧Slicing pie

https://www.icloud.com/notes/08NHWuGP73Tp87Hqx1zxUPZDg#Book_Summary_-_Slicing_Pie

Forward

• Avoid “quick handshake” equity deals that are made too early that don’t take into account the real contributions of each party. Aside from the internal problems between people it is proven to result in smaller capital raising results

• The most common organic approach to equity splitting is vesting where the individual needs to earn their equity stake over time. It’s much better than the “quick handshake”

• In the US 90% of vesting is time based and 10% is milestone based. Milestone based needs very clear milestones which is very difficult to do for most situations

Chapter 1 - meet slicing pie

• Slicing pie is a dynamic or organic equity splitting model that is designed for startups that are pre breakeven or pre external investment

• “The only thing that doesn’t change about startups is that they are always changing”

• 2 primary components of Slicing Pie are the Allocation Framework which tells us what each person should get and the Recovery Framework which tells us what to do when a person leaves

• (What an experienced programmer might do in a couple hours might take a grad weeks or months)

• The person contributing cash compared to time is putting more at risk so the adjusted fair market value (FMV) multiplier is different. There are other fair market values for ideas, relationships, equipment, supplies, etc.

• (Measuring early stage risk in a startup is impossible so pre valuation contributions can be given the same value and no need to take into account earlier contributions having being riskier and having more value)

• The model works without having to put an early stage valuation on the company.

• Resignation with no good reason. Person looses all of their intangible contributions such as time.

• Resignation with good reason. For example company moves to another state to be next to a key customer. Person gets to keep their intangible contributions

Chapter 2 - fix and fight

• Slicing pie is a structure for founders, investors, employees, advisors, partners where the company cannot pay cash

• For vesting approach the costs of legal increase as the structure becomes more complex. Slicing pie avoids these increasing costs

• (I guess it would also avoid costs like getting accountants to do early stage pre money valuations of the business)

Chapter 3 - the slicing pie principle

• Slicing pie framework is for before breakeven. After breakeven everyone is getting paid for their contributions. This can be often after receiving Series A investment

• After breakeven equity is only for bonus or employee retention strategy

• Slicing pie contract templates at www.slicingpie.com

Chapter 4 - Allocation Framework

• Calculations are based on the risk taken by the individual. So if their fair market value is $50/hr and they are paid $20/hr their risk is $30/hr times the non-cash multiplier

• I can see (at this point in my understanding) that lawyers are not going to recommend this model as it doesn’t fit with their interests. If using this model you could simply keep a record of all of the contributions in an official record and then when the company breakeven you finalize the equity split up to that point.

• The standard non-cash multiplier is two (2x). The standard for cash multiplier is four (4x)

• Cash is scarce and worth more. This aligns well also with investors as it indicates that their funds will be spend wisely

• They recommend keeping it simple and keeping the multipliers fixed as opposed to the idea of when the venture matures they reduce in line with the reduced risk, etc.

• They call the non paid value provided to the startup as slices. These slices equate to what the person would get paid if working for a company where they get a salary x the multiplier

• The individuals equity is equal to their slice divided by the slices of all of the participants

Chapter 5 - Cash Contributions

• This includes actual cash, unreimbursed expenses, equipment or supplies

• Fair market value of the cash is based only what is spent (at risk) and not funds that are just sitting in the bank account. I can see how this encourages the startup to be resourceful because the lest cash used the more equity available for the non-cash contributions like time

• They suggest putting the Angel investors cash into a bank account they call “the Well” and it converts to slices when spent (as above)

• They have “the Well” feature in the online software they have

• The well concept can manage the situation where new Angel investors come on along the way and put their cash in.

• The Well is best for when the cash is being provided by active participants in the company and not passive investors. For passive angle investors a traditional convertible note or convertible equity agreement is easier. He recommends the Simple Agreement for Future Equity (SAFE) from YCombinator

• A common cash related example is when the cash from one of the founders, that is in the Well, is used to pay or reimburse employees or contractors

• For supplies and equipment if the item provided to the company is already owned by them and passed to the company the non-cash multiplier (2x) is applied

Chapter 6 - Non-Cash Contributions

• Contributions without an outlay of cash. Often called sweat equity

• Calculate the hourly rate of the employee participants based on the fair market value annual salary (salary/2000). This will ensure that they are incentivized and when a participant is working 50-60 hours a week they get allocated the slices based on their efforts for that week

• Founder contributions vary from 80hr/week to 10hrs/week so good to track their contributions based on hours

• (At this point in the book I am unsure if the equity allocation is based on the slices is related to the whole company (100%) or just a certain amount of the company agreed to by the founders.)

• When people record their time it’s valuable to know what they did and what area of the business it was used for as it can help manage things. This allows founders to see how much efforts are going into product development, research, customer service, admin, sales, etc.

• Time tracking is the way to actively discourage time-wasting and ensure all participants are being productive with their time

• Time tracking can be annoying and most people don’t like to do it but it’s the best option. (We just have to be clear and upfront about it with all participants)

• A bonus program can be good for people that usually get a bonus however if the company isn’t making any money it may not make sense

• For contractors their hourly rate is higher and they may not be involved in the company later. In general it is best to avoid having non active participants so it is suggested to negotiate a buyout agreement with them. The company can either pay them for their work monthly or have a buyout schedule that goes from 100% for being paid immediately to 200% after 1 year (increasing from 100% to 200% over the 12 month). This allows the company the option to buy them out to avoid having non active future equity holders. After the 1 year the company can’t buyout the contractor unless they agree with selling.

• It’s suggests use contractors for limited engagements and put people on as employees when possible and for ongoing work. This will also avoid conflict with employees that have agreed to a rate related to their full time annual market value

• They outline how to deal with valuing ideas. Key points are; it needs to be an idea generated outside of the participants or founders work time, the value of ideas is typically received as a royalty which is a percentage of revenue directly related to the idea, it has to be good and unique enough to be an “ownable” intellectual property (either registered patent or copyright)

• In some cases the time and money spend developing the idea (before the company started) could be put into slices which in turn would become equity.

• People that can bring relationships are valuable but the value is only realized when they lead to revenue, investments or formal agreements. For revenue/sales the value can be rewarded by a commission which would be normal in that industry. Founders, senior managers and advisors don’t get a sales commission. Only the salesperson who is responsible for generating the revenue.

• For investors people get paid a finders fee of 5% for the first $1M and 2.5% after that. They need to be involved all the way and not just an introduction.

• For facilities they would get slices instead of rent. For example if someone if providing the office space or warehouse space.

Chapter 7 - Recovery Framework

• How to deal with people leaving for various reasons. Detailed explanation of how to handle these situations in terms of slices in the agreements with participants

• Slicing pie makes it easier to separate from participants because it doesn’t involve determining the value of their equity based on an early valuation of the company which often creates arguments

Chapter 8 - Freezing the Pie

• Once the company becomes cash flow positive, either by series A investment or generating its own income, then the pie will be frozen and equity splits finalized.

• After this point participants will will start to get paid their fair market value

• The first priority will be to use the revenue to pay cash items that were previously paid from the Well and the cash contributors were rewarded with a 4x multiplier

• The next priority will be to cover the non cash items that were rewarded with a 2x multiplier such as rent, commissions, royalties and salaries

• The pie can move from frozen when cash is available and then back to open when the company is out of cash and needs to start allocating slices

Chapter 9 - Financing the Pie

• Slicing pie is a financing tool for founders who don’t have the cash. If the founder does have cash to cover the costs then Slicing Pie is not needed

• So I guess we push it as far with our cash resources and then use Slicing pie when we run out. So it is not necessarily from the beginning of the venture… just when we need the pay for things but don’t have the cash

• Explain simple agreement for future equity (SAFE notes) which fit with Slicing Pie for non participants that help to finance the company

• If raising VC you need a Private Placement Memorandum PPM and this is complex and requires high legal fees. So better to convertible note or SAFE as they don’t require a valuation.

• Series A is the first officially priced round

Chapter 10 - Legal issues

• Includes clauses to cover the slicing pie concept in the contract

• Complex chapter basically saying that the slicing pie model doesn’t create added complexity and sound like you need an open minded lawyer to help with the agreements

Chapter 11 - retrofit / forecast

• Nothing specific

Chapter 12 - objections

• Nothing specific

Chapter 14 - resources

• The slicing pie board game. Sounds dead boring but probably a good way to get a deeper understanding of the model

Chapter 15 - the pie slicer

• The online pie slicer web based application is the easiest way to manage

• Because I am new to this whole thing I think it would make sense for me to use the application

• This chapter is a basic tutorial for the web application

• Seems tracking time is the aspect that some participants and even owners don’t like however seems it is needed

• One very interesting point from an earlier chapter was the fair market value is based on what the startup needs. For example a potential participant might be a VP of marketing earning $300k per year, managing a big team and high responsibility. However in the startup this level of responsibility is not required and as a result the market value of the role in the startup might be much less