How to start the equity conversation - slicing pie retrofit
Initially developed for bootstrapped startups in the early stages, slicing pie is a dynamic equity split method enabling founders to split the company equity based on the cofounders’ contributions to the company.
The retrofit was typically used as a tool for founders who committed themselves to a fixed equity split and found out its limitations - and wanted to change to dynamic equity split. More from Mike Moyer on the topic here.
With many of the cofounding teams I have worked with, we found another very useful case of how to use the slicing pie retrofit.
Let’s think of the case of Paradise Cycling Solutions. Eva had an idea for a marketplace for cyclists and has been working on the idea for the last 6 months. She has the business plan, prototype of the platform and customer validation finished. She would like Adam, her previous colleague, to join as a sales superman and as an initial investor. She would also like to invite on the team Chloe - as a CFO with main focus to raise additional investment. Both Adam and Chloe like the project and would like to join Eva as cofounders. So the next million dollar question is - how should they split the equity of Paradise Cycling Solutions?
Some of the many options they have available are:
Equal split between the 3 of them - this could work, but more often than not, it does not. This is especially problematic when (as in this case) one member has already invested significant resources before others joining later.
Wish based negotiations among the cofounders - one of the most frequently used options but certainly not the best one as there is no common baseline
Let’s not speak about it now - probably the most dangerous of them all!!
Start with the slicing pie retrofit - let’s have a look...
As with any other use, what is needed for using the slicing pie framework is to record the different founders’ contributions to the project right up to the present date. Slicing pie has a simple and transparent way of categorising the different contributions (cash, non-cash), assigning multiples based on the riskiness of the founders’ investments (in the early days, cash is king and has therefore a higher multiple than non-cash contributions) and simply recalculating the value of the individual contributions into equity share.
As the CEO of Yova, a successful Zurich based value investment startup put it - it is a method that everyone can understand and that is already a great start! (more here)
Here is an example of what the retrofit result for Paradise could look like:
a) In the weeks of participation line you can see that the time Eva contributed to the project is accounted for. A very important alignment point is that her future cofounders agree that this time was a valuable contribution to the business.
b) The founders need to agree what is their fair market salary - which standalone is a VERY useful discussion for the future cofounders to have, as it does tend to very quickly uncover potential underlying issues between the founders.
c) Time contributions: in the case of Cycling Paradise Solutions - it is only Eva who is dedicated to the project full time. Chloe will be measured on results (fund raising) and Adam will be committed to the project 50% at the beginning and his contribution will be measured on time as of when he joins.
d) Cash contributions: Eva’s initial cash contribution, as well as Adam’s and Chloe’s investments are also recorded - with the recommended cash multiplier.
This exercise gives the team a starting equity allocation of 62% for Eva, 32% for Adam and 6% to Chloe.
The founders can further decide whether they want to do the forecast for the next few months (until profitability) and fix their equity split now based up on that (more on this here) OR whether they want to use the dynamic equity split further (and continue with simply recording their future contributions) until the defined pie split moment.
In any case, this exercise helped them to:
a) Clarify alignment on the value of the past contributions (time worked input)
b) Confirm alignment and agreement on their relative respective value to the business (fair market salary input)
c) And have a starting point for their equity split negotiations that everyone understands!