How to Split Equity with Cofounders - the Only Way That is Fair

thanks for everybody for coming I appreciate it my name is Mike Moyer and a few years ago I founded a company called cap X which is a school company that helps students find the right college and it's still in existence as it has lots of lots of customers and as a result of that I wrote a book about getting into college and I have a lot of clients who come to me for help looking for help getting into colleges like Stanford and I always tell them to apply to Stanford not just because it sets the standard high but because everybody that I have ever met that wins the standard really likes to go into Stanford so it's always been one of my I've always wanted to come here and I'm pleasure to be here in this to the school that recommend all the time and I hope that I know that Stanford keeps University Chicago northwestern good and I hope that we help you stay good too so thanks for having me we're gonna talk about slicing pie which is a method for determining a perfectly fair equity split in a start-up company how many of you are in start-up companies today or anticipate being in start-up companies or have been in start-up companies have you ever had a partner and it didn't work out a few of you so some of you are going to your first startups apparently I've been in and out of startup companies my entire career and I've always really enjoyed it but I've had trouble with my partners along the time and not because I didn't pick the right partner because it is the wrong deal and what we do is we go into it all gung-ho let's start a company let's start a business that start a business together and God ask ourselves why do you start a company why do you start a company why you starting your company no answer anybody have an answer why they're gonna do this Cash Money changing the world what else see what you can do what you're capable of doing what else be your own boss does anybody think this sounds like fun I think we're gonna have hard work now and work really hard now it's gonna be fun along the way and 71 get a big payout versus exciting the work for a company right and I've done this many times I've gone work for companies but it's not nearly as much fun right but there's a big payout there too so it's a comic combination of the fun and the big payout the problem is this how much you can get paid out who's gonna start up right now they said how much does your payout gonna be you ever start up right now what's the payout come on who's got the payout has anybody tried to figure out what their payouts gonna be one hundred million dollars they've got a number it could happen right this place has produced that kind of money before right have you tried to figure out how much it's going to be worth how have you tried to do this compared to get to their alternatives what else so cops build a financial plan did it look something like this losing money kind of flatlining right here is the hostile takeover of Google and year-3 lot of assumptions you build on assumptions on top of assumptions on top of assumptions on top of assumptions trying to figure this thing out cuz you don't know what that is we don't know how much we get we don't know how much we're worth we don't know that it's impossible to figure out this number yet people try to do it all the time there are whole industries built around just this problem alone how much is it going to be worth for a year if you only trying to figure this problem out trying to foresee the future in a very accurate way we cannot do it so what I propose is this calculation which I called the perfectly fair equity split the portion of your business that you should get is equal to the value of your contribution divided by the total value that everyone contributed so the value of your contribution divided by everybody's contribution the value of that that makes sense UB does anybody agree with this number anybody disagree with this number you disagree with it that's a really really good question really good question that's what we talked about today and the answer is okay if you want me to you the punchline now you can't we're gonna try most companies stayed you fixed equity splits a fixed equity split is with 67% of companies do they split the equity the outset of the venture that the first deal people do our first real negotiation is what we're gonna get then we've done that yet then we say you guys sat down and had an extra split discussion yet pre discussion you have an idea of what it might be it's just you two couple people who has an equity split right now anybody have any company has an equity split already you are not making the mistake that 67% of the companies do make because most of them do it early on and they do a fixed equity split 90% of people do fixed equity splits 90% of companies do this so it's gonna be 50/50 is the most common 64 tickets kind of my idea so I'm gonna take a little bit more than you but you're still good singing at 40% 8020 well it was my idea I've been working on for a couple years I'll give you 20% cuz I'm so much smarter than you 25:25 four good friends we're all gonna do exactly the same amount of work no matter what we're just still good friends 25 25 - let it up that's what I'm gonna do off to the races so we figure we do 50/50 now I'm gonna work hard everything's gonna go great I'm gonna hit on all cylinders we're gonna sell this thing for a hundred million dollars right fifty fifty fifty million bucks each right everyone's happy right no problem but what if what if you want to quit the job I don't want to do this anymore I don't think we're gonna buy out Google in year three whatever what you do all the work so we go in 50/50 you and I 50/50 and not you do all the work what happens what if you're an engineer and I'm a marketing person and we got to hire another engineer does it come out of you or does it come out of me cause it's gonna helping you they're not helping me right so what happens if one of these things happens what do you have to do about your equity has it do what reevaluate renegotiate how many people love to renegotiate things they love to go say we did a good deal we thought it was gonna work out great we're gonna go back to the drawing table and we're gonna figure it out again and someone's gonna come out with less than they had before and someone's gonna come up more than that before right that's what I mean renegotiate is so what's gonna happen is this someone's gonna have your share it's going to be greater than when something changes something quits so it goes somewhere someone does anything anything changes and the one thing I like to say about startup companies is the only thing does not change about startup companies is the fact that they're always changing they always change so what's gonna happen the minute something changes the second something changes the second you sign the dotted line 50/50 split the second you walk out the door this is gonna be true one of you is gonna have more than your fair share who's okay with this who wants to have more than that raise your hand if you want to have more than your fair share people in the back does anybody who does not always raise a hand want to work with these people as partners because that's a real thing right it's a real instinct right I really want to I want to have the most right that's that's the thing I don't want to have it we love getting a deal right so there's always a handful of people that are okay with the top equation is anybody okay with this your share is less than the value of your contribution divide what's total value anybody okay with that any real generous people here I'm gonna air the side of generosity give you a little extra cuz you're my friend anybody okay with that right now it's a startup company right right now it's worth how much zero the fact that you said that shows me you're gonna be successful because you realize that it's worth zero at the beginning that's what it's worth but what we do is you do our calculations in our assumptions we no no no no no this thing is worth so much money I can't believe it I can't believe how much it's hundreds of million dollars it's so exciting how much guy I read this idea is so great it's really worth zero do you do something with it so when you go into a renegotiation or negotiation you're actually doing this I called an alligator pin they're less than Gators and greater than Gators these are alligator pit negotiations and how do we approach an alligator pit does anybody ever approached an alligator pit or seen an alligator pit would anybody like to dip into an alligator pit if you were dipping into an alligator pit what would be your thoughts going through your head no ideas how about self-preservation first and for my something provides if fear anxiety you're gonna fight like there's nothing you gonna fight the Gator like you've never done before if you go into negotiation where Gators exist less than Gators and letting look greater than Gators you're going into an alligator pit negotiation this is what most of us do we're both going to the are these negotiations with this kind of fear about how we're gonna divide up for equity and it's a big deal and it happens all the time and startups across the world and getting over this fear is almost impossible so much fear in this decision that some people don't even move forward and if it's not fair it's not fun and this is where your relationships start deteriorating you thought you were good friends but all of a sudden it wasn't fun anymore things start kind of sucking so you started these are falling apart so what we need is this we need a perfectly fair system not a kind of fair system at a sort of fair system we need a perfectly fair system we want to reward participants for contributions that they make not contributions that they say they're gonna make if you go into a startup company and someone says all right I'll give you a 25% of the company to join my company that is the same thing as saying to someone you're gonna join my company gonna pay you a hundred thousand dollars a year you're gonna be here about five years before you find a better job so I give you five hundred thousand dollars on day one that makes sense has anybody ever taken a job at they've given your entire compensation on day one if that happened how and you flaked out the next day what would happen did you give me my money back I spent a little bit of it it's gonna be hard to get it back but by giving someone an equity share before they do when you work the same thing as giving them as giving them their salary upfront so you want to reward people for the actual contributions they make now what they say they're gonna do what they actually do we want to provide ongoing motivation to continue contributing so you have to have a way to reward someone for staying in the system freaking but continuing to be part of our startup we want to accommodate additions or subtractions to the team which happens all the time flexible the pace of rapid change because we're changing and changing and changing and we want to get rid of the Gators we don't want any alligators in our negotiation you've got to get rid of the last thing Gators and the greater-than Gators any questions so far the solution is using what it's called a dynamic equity split has anybody heard of dynamic equity splits a couple people a dynamic equity split is just as it sounds it's an equity program that changes over time it's dynamic equities awarded over time no dynamic equity split is not necessarily a new concept and in fact there's some folks at Harvard who identify this as one of the biggest ways to solve this problem what's more difficult is how to actually implement a dynamic equity split I'm going to show you how to implement a dynamic equity split today anyway that's going to be very logical very straightforward very easy and you're going to avoid going to the negotiation table every time you want to figure this out so we're going to work hard now and we're gonna get exactly what we deserve later on your share is going to be in proportion to what you contributed so if you contribute 50% you're going to get 50% if you contribute 10% you're going to get 10% if you contribute 23.2% you're going to get 23.2% no more and no less you're gonna get exactly what you deserve this is a one-size-fits-all universal way to divide up equity in an early stage bootstrap company and it will be perfect because fair equals fun your startup will be fun you're not got to worry about this piece of it you can move forward on day one I do a number of things in my professional life besides teaching I also do a little bit of angel investing and I wrote this model to the terms that I wanted to invest in companies and I wanted to create something that says instead of us going through a big financing deal was he a grater these rules we're gonna move forward and all we have to do is agree to the rules and move forward and everything's gonna be okay no sure how it works it's called a grunt fund these are grunts we can't predict actual value we can't predict real value we can't actually understand what the potential value is all we can do is guess but we can't assign a theoretical value so the step one is to sign a theoretical value to the various inputs provided by each participant and I'm gonna show you today how to calculate theoretical value it is a pretend made-up number because we can't figure out actuals we're gonna create a proxy for that value replace that value with a proxy that's gonna tell us exactly how much we should get so step number one the theoretical value of each piece of for each participant share number two your share equals the theoretical value of your contribution divided by the total theoretical value this is the calculation that makes this work and we allow it to self adjust over time it's called that's why it's dynamic so the challenge is how do we assign theoretical value startup financials are based on assumptions assumptions assumptions assumptions guesses and assumptions and crazy ideas and they're great one day they're wrong the next day and everyone has a different opinion on theoretical values are based on easily observable readily observable things in the market place things that we actually know and dollar amounts we actually know here that works so there's all kinds of stuff you contribute to a startup company right there's time there's money there's ideas there's relationships there's credit loans there's equipment the supplies all kinds of stuff we contribute the biggest one is what time most of its just time and especially in tech companies a lot of time what about is their lab space engineering students do you need a lab office supplies things like that all kinds of contributions mentors coming and going all the time so each one is a theoretical value even cash and ideas this is one of the biggest arguments we get is how much is my idea worth here's how you develop a theoretical base value of time it's your negotiated base salary - cash compensation times 2 divided by 2,000 that gives you a grunt alley resource raid girl now here's how it works has anybody ever had a real job here couple couple folks in that real job where you paid for it in that real job do they give you equity in the company as well in that you chose someone to get it equity it's a couple of equity people so the folks that didn't get equity are you angry you're angry you doing it equity so guys so we've got two out of three out there in the world there's a number that people like you and there's a number for everyone in this room the number is the number that you're willing to work for without getting any equity whatsoever it's your fair market rate it's the rate at which you are willing to work for without getting any equity at all hey you pay my full market size salary I'm happy I go home I buy my house buy my car's my stuff and I don't need equity there are lots of companies in this area that do that all the time that's the main way people get hired as we pay you what your market rate is and that's what you get and in that market rate will account for your experience your great ideas your charisma your loyalty all that stuff your education all these things that make you valuable will be reflected neatly in your market value and your market rate now the best way to maintain 100% ownership of your company just to pay people if I'm paying you your full market rate paying your full market rate there's no expectation of equity in fact I have people who work for me full time I paid them their market rate and then some they know what I'm business they know what I do for a living I'm not kidding anybody they know exactly what I'm up to but they're not upset because I'm paying in their full market rate and that's fair if I pay your full market rate I get to keep everything but if I don't pay your full market rate I have to compensate you in equities the tool we use so I understand every pay you in cash I'm gonna x - this is a multiplier that I made up based on my experience to reflect the risk that you're taking are you risking anything when you take a job at a startup company what are you risking the previous job you're risking singing very specific when you take a job with the startup company and that risk is that you're not going to get paid in fact you're probably not gonna ever get paid the chances of you not getting paid are almost 100 percent so that's a big risk so I put a big premium on I put two times two 100% premium and I divide by two thousand which is roughly the number of hours in a year that gives you a grunt I'm a resource right that is the unit of measure that we're gonna use to calculate our equity split and it reflects what the theoretical relative time value of our time is my time relative of your time any questions on that so far here's an example if my mark reads one hundred thousand dollars you need to pay me $100,000 cash or we gotta compensate me to him on their way I get paid $25,000 which puts 75,000 dollars at risk meaning I'm probably not going to collect that I multiply by two which is 150 thousand divided by two thousand I get a grunt hourly resource rate of 75 dollars an hour the relative value of my time is $75 an hour do I adjust it no they just keep racking it up cuz it's the same calculation for everything that makes sense in a startup you might work for thousand years hours but you'll just keep racking out for 75 bucks an hour it's relative everybody else will still work out the same it's a good question I think it's a good question I don't know a good question same way consultants are a little bit different I can talk about that later because there's no expectation of long term employment which means you have to even have a buyout right that's a little more complicated but you still good this is great for part-time people because your guess what you give them an hourly rate instead of an annual rate well they're risking not going out to the beach that day so people are too all taking risk they may not get as much risk which means they're going to lower our share of equity sufficiently answer your question small amounts of money cash four times a valley dollar amount of cash cash is worth a lot more than your time why would be worth more than your time what nothing happens it's easier to make 10 bucks or save 10 bucks much it's much easier to save it or make it to earn it or save it most of us have a lot of hard time saving money than we do making money make money spend it make it spin and make it spin it so it's much harder to come by cash we put a premium on cash cash is king we got to have cash we got to put a big incentive so it's dollar amount times four as the money is spent on the business if I give you a million dollars is it at risk did I trust you right and it's in in your bank accounts they can't have a money back and you say sure you're the money back so it's not a risk until it's spent until it's gone when it's gone we multiply it by 4 in the model so as the money is spent multiplied by four where we were wanting actual contributions putting a million dollars into a company is a not an actual contribution people think it is but it's not until it's actually spent that actually becomes a risk it's safe in the bank until it's actually spent so dollar Mon times four so everything has a theoretical value if it's a relationship got a guy with the big rolodex coming up at you hey this guy knows everybody in town you can sell everything instead of giving them in advance of that equity you say all right whatever you would otherwise earn in commission we'll multiply by two that's your theoretical value of your ID give your relationship your idea you're fantastic brilliant idea an idea is great if it generates revenues if nobody buys your idea no one gives you any money can't get any money because your idea then it's not really worth that much so you put a royalty on it which is an easily observable natural way to reward someone's intellectual property and multiply it by two supplies either nothing if it's petty supplies laptop or stapler but if you Couric expenses on behalf the company is treated as cash everything that goes into the company everything can be measured you know by creating a theoretical relative value so you know how much is this thing worth it's put at risk versus another thing your cash versus my time versus your idea versatile Asian ships if it's a piece of equipment capital equipment if you purchase purchase it for the company it's treated as cash if it's something kind of owned before we're gonna treat it you at the sale price but some used piece of equipment you had four years sit in your garage we treated the resale by surprise you look at eBay and pick it is again it's the easily observable number in the market there's a cheat sheet I'll be happy to send you it has a calculation that book that I wrote it explains every calculation that there is so I'll show you an example here there are three grunts doing some work you got grunt number one junior developer right out of college knows a little PHP little Ruby on Rails doodle development the founder came with the idea some equipment and some time didn't have enough money had to tap his rich uncle rich uncle brought some cash some relationships building the credit cards it will make it work for you providing stuff royalty on revenues right royalty rates are for different industries are easily to observe so if you're a publisher book book authors get about five percent you know some technology of things get them you know five to ten percent so all those things have a royalty rate that's standard which is a normal way to reward intellectual property so here they all are working hard all you do is add up the individuals values you get you get what I call the Thira code base value of the TVV theoretical base value a pretend value that has nothing at all to do with the actual value of your company but provides a way to do this calculation it's a proxy for actual value you divide up each person's share the contributions are number one divided by the total card number two I've got number three and that gives you a pie looks like this so at the end of period one grunt ember one the junior developer who knew dental PHP programming owns about two percent of this company guard number three the rich uncle put a much cash in owns a lot and the idea person the founder doesn't know as much but that makes a lot of sense because relative to each other person and what people are putting a risk it makes a lot of sense right but remember that negotiated base salary that's the market value that encapsulates all your ideas for that amount of money I'm buying your ideas for the company so if you paid me one hundred thousand dollars a year all my great ideas belong to the company when these folks work for a different company they have great ideas the company owns them so in this case the company is compensating you properly for those ideas now sometimes someone comes into the company with an idea the founders didn't I don't want to start a company that takes pictures on my camera on my phone that's a great idea right that's maybe the founding father so to speak that's got a little bit different of enough idea because cash is hard to come by and more important to start up and keep in time is you have to try to add an incentive in order to get the cash flowing you got a little extra weight to it incubator take a six-person random percentage so it's whatever they got it's either too high or too low because there's it's not grounded in the most the time it sort of would give you a time and equity you take 5% they just pick a random number this is a more precise number but that being said there are a number of equity of incubators that are using this model to determine their equity split especially in for-profit entities in a non profit incubator they usually don't take equity because the state doesn't mean nothing to it more questions for students who has no job you look at similar jobs in the market so if the students gonna be a marketing executive you see you know what is a typical Stanford to graduate get in the market and that's what you would call it you don't split hairs too finely on this but just to get something that would be willing to accept a job if I paid you $75,000 a year sure that's what's called a negotiator right because you get the same problem as somebody might be a marketing executive or $100,000 and their job is to clean the toilets in your new company well that's more of a toilet cleaner job not a marketing executive job right it's you would benchmarking with what the market won't what the market will bear for their services so if they have had ten years experience and as a marketing executive and they can be a marketing executive for your company you can look kind historically and to itsu they've been willing to take but it's the same kind of process you'd go through negotiate any job rate for any job so let's add a new guy this is a sales guy you bring some great relationships and put some time in now we're gonna assume for a moment that nobody else does any more work just to make it simple guys coming in making rain all you do is add his contributions to the base value now that denominator grows and you reek recalculate every one chair just card number two car number three turn number four here's our pie so now Grande number three has a little bit less most people call this dilutions now we got grunt number two and four in there car number one rounded up so a similar amount but the company is now moving forward they're getting revenues in there they're getting a good sales person things are moving forward so that the company as a whole hopefully it's worth more money so even though they're just down for some people enough for others it's all fair it always keeps it perfectly in balance now the next thing you got to worry about is what happens you get rid of somebody what's the what do you do when you terminate someone there are four reasons someone can be terminated they can be fired for good reason what's being fired for good reason not doing their job not doing the job specific its you're not doing your job warning number one you're still not doing your job warning number two you're fired it's warning warning fired it's not you're fired it's warning warning fired it's not fair to fire someone without giving them a warning if they're not doing their job it's perfectly fair to fire someone if you've given them a warning and they haven't shaped up why else can you fire someone stealing selling the ideas to competitors what else what hold that thought hold that thought they could bring a gun to work threatening people sexual harassment all kinds of good stuff can you just fire someone for that you're not playing fair it's out of here but if it's performance related you gotta give them some warnings now you can fire someone for no good reason why would you get fired for no good reason you just don't need them anymore you just don't need them anymore it's not your fault you came in you did your job just don't need you anymore I started a company I think we decided that telemarketing was the way to go right tell marki this is gonna be so awesome set this thing like crazy because I made a couple phone calls one day and they bought so that this must be the way to do it so you're gonna hire a home hotel marki staff set it all up and guess what I was wrong no one wanted to buy this thing on the phone so I said to her yes you did your job you did it right is it exactly what we asked we're not gonna do Telemark anymore so you're fired you're fired for no good reason you didn't provide me a good reason to fire you you can resign for good reason what's resigning for good reason that's a good reason to you what that's a good reason for you a good reason for you closer the company has made decisions that put you in a position where it's no longer the job you signed up for so we're in the Bay Area right now we're gonna move this company to Boston once you to relocate your kids your family to Boston that's a good reason to resign or guess what you were the VP of engineering now we need someone to do this sweep the floor so you're gonna kind of sweep the floors now we're gonna lower your salary that's the material change in which tile responsibilities and compensation those kinds of things the company making decisions that are make the company no longer you sign up for that is a good reason to resign and companies make these decisions and it's okay for them to make these decisions but they've got to suffer the consequences of those decisions you have to notice the consequences the last one is resigning for no good reason which is got a better job don't want to work for no money anymore what I need to get health care yeah these are all good reasons for you but the company is now what the company's left in the lurch right we were working together that's great yeah then you quit on me I gotta hire someone new give me a break so it's a decision that you make that hurts the company so these are very different circumstances but they have very meaningful ways to handle the equity in this kidney in these types of determinations so if you remove a grunt you fire them for good reason or they resign for no good reason in both cases the employee is making decisions that adversely affect the company as a result it hurts they get no equity for the time they put in you adjust your other inputs to the dollar amount no multiplier so this is what that Forex comes in play oh I went from 4 X 2 1 X that hurts you can't steal someone's money can't say give me thousand bucks and fire give you money you got to pay him back it's not fair to keep their money but you don't have to give him a premium on their money you buy it back if possible meaning if I have the cash in the bank and I gave you a thousand bucks back we part ways friends you gotta fires no good reason you're whole again we're out of here and you can ask for a non-compete now in California my gut tells me is probably pretty hard to gain force a non-compete but it doesn't matter you asked for a non-compete anyway why it's not fair dad this person quit your company or get fired then go on compete with you as a person has any moral fiber whatsoever they should honor that non-compete now if they resign for good reason because their decision the company made or they get fired fired for no good reason they just laid you off it's different they're going to keep all the equity at the full theoretical value they keep it well buy it back if possible we're gonna give you four times your money back two times your time back that's a big chunk of change it's expensive to buy back before the company lays somebody off they should beware there's repercussions and we can't ask you to sign a non-compete it doesn't you can't steal the company's ideas but it does mean you can compete in the same industry so the company encouraged the pain there so if you came and join my company put the game in a thousand dollars in a thousand hours I paid you twice with your Mart you're negotiated base salary wasn't four times your money back that's okay that's a pretty good deal it's a lot more money you probably wouldn't man the company in there anyways so that's a fair transaction to get you out of the company or I'll just let you keep your equity I determine it now the the the the reasons are generally accepted legal reasons so it's you know it's relocation of the company more than 50 miles away adverse changing so those things are other generally accepted again all these things are based on easily observable things values laws and all those things you know just non-competes are easily observable and what happens there I had worked with a guy a partner who wrote some contracts he had accelerated investing in the event of resigning for good reason it was an accelerated vesting schedule so when people resigned he said okay your vest him fully vesting good that's those cool right but then he said oh by the way there was an operating agreement amendment we made two years after you signed the original one that allowed me to buy it back at face value which is zero unless you want to buy an audit so I'm taking your equity back and so you subsidy he systematically pushed each one of the founders out of the company and took the equity back for himself does that sound fair does that sound we kind of know and inspire book like this sort of you got to do what's right for people this isn't a legal thing it's a moral thing it's by doing ripe and people who help you get we were going so let's show this one looks like when you remove a grunt so here they all are working hard Jiu Grande number one junior developer slacking off he got a warning got another warning and he was fired right so here's he just take his contribution out of the pool just take it away remember it's just a pretend number he's no longer a contributor so just take his numbers out this doesn't matter it's not actual values just a way to calculate the equity so you just take this out and recalculate everybody else there's two three and four now the PI looks like this now it's got a little bit more right because that numbered that to percents gone but they're not necessarily better off because now they gotta hire a new developer so again it's dynamically adjusted it's still fair but now they're little bit of worse off a year later because what are you beginning with the amount of money you could be getting the same proportion of equity for working from year one to year two I've been working just for this game so the assumption that you're making and I don't like assumption the assumption that you're making is that the company becomes less risky over time right my position on that is while that may be true it's unobservable and in this model you count where you can count so let's say for instance you're want to get a big customer we're going along great raise our money at the end of year one we're out of money we lose our customer there's a more risky or less risky things change so rapidly you never can tell where you stand I was with a company where everything looked great I was raising money we had tons that could we had hundreds of customers in there we had a cash flow we had money coming in everything and then we lost our biggest customer and the investor said whoa so the company looked like we were on a roll and then all of a sudden a couple things within a matter of days changed the whole picture so you just never know what the risk factor is it's it's an almost possible tail risk on you know publicly traded stocks let alone startup stock so what I do is I don't take that into account but it is common people to think that bad ass good or bad ass bad good good good bad ass yeah good that is did a lot of work I mean you're getting the full utility out of the work they put in and it was only time compensation under your model right so then they get a job after six months and you just took you know you've gotten benefit out of the work and you're saying basically they should be compensated because it wasn't a good reason for them to quit that's it that is what I'm saying but there's way around it we don't want we need as a start-up company we need retention programs we need a way to retain people to work for a company we can't just have them say oh I've got a better job in it and there's just leave us in the lurch if that was a story he built some great code he gave us a lot of momentum that he just bails ah that hurts the company right we may go out of business without that knowledge but if the person agrees to stay on as an advisor they can just drop down in the number of hours say listen your key contributor we want you stick around so instead of just taking your equity back you stick around and help us through the transition then you keep it so you got to provide an incentive for someone to stay so just like your question this guy go get it gets a full-time job he's still getting his hourly rate if he continued to continue to participate so there's some scenarios with the boots that would be appropriate but if the guys it's like screw you guys I'm leaving I'm remember they sign up for this in advance they know this is the pain they will endure the vesting is unnecessary in this model because all the protections are built in legally this is a vesting schedule and in a certain certain corporation in a c-corp for instance you would issue restricted stocks and then it would vest according to the schedule but the traditional time-based vesting doesn't apply here it's not needed this is a very straightforward system that most illegal things we used the legal constructs that we use to protect ourselves against the unknown aren't needed here because the protections are built in understand this so say somebody's putting in time for a full year and they're accumulating at that hourly rate but we're not paying on any base salary and then they they leave for good reason but do they keep the accumulated value of that time that they put in and that's if they leave if they leave for good reason it stays in the pie yes whatever cash they put in we put it the actual value but time goes away under this model it's painful to leave a company so we do as it should be startup they're very fragile places if you're failing Ottomans its trouble the multipliers help create that that the disincentive for the company to push you out and an incentive for people to stay in the company like four years and one a few thousand beer shares to you know get some could you do that if you could do that anyway you could do that start with coming you might have a hard time doing that and different corporate structures it's a different way and I have several attorneys that this is a big piece of their comp their business in the C Corp the vesting happens according to the schedule but there's also those buyback if it doesn't work out in an LLC I always recommend ur lying equity cuz the equity tool is different it's just a profit distribution or a proceeds distribution so whatever can be distributed if you need to get money back at the company the company can make a distribution to you and buy back some of your equity at that point or someone else could buy it so I had an attorney who wanted to do this but he was making seven hundred fifty thousand dollars a year now I started coming just need a seven hundred fifty thousand or your attorney so he hired he paid a junior level attorney Jews worked for him and he advised that person just took that guy's equity that makes sense what somebody else paid like it's for the best of the company that one person leaves just because the nature of people's opinions like how do you account for that in the system because it seems like the perfect like you have a disincentive to leave the company because you're losing equity at that point if you agree the founders change the strategy not that one person doesn't feel comfortable staying there anymore yeah that would be it's like some person gets replace just because of well as so there's a couple of different things going on there so let's say you and I the three of us start a company yeah what was your name again Christine we decide that Christine we don't want her anymore she's not pulling her weight so we could find a different place for in the company or we could say listen you're doing your job but you're you're you're fired for no good reason and she keeps her equity now that equity piece is gonna shrink as they were knows but earns against it better whatever she put the values children we reflected now if she's not doing her job we can fire her and take it back and let's say you and I are partners he said we're just not getting along well that we could agree that was a resignation for a good reason and I will keep my shares so there's a way to handle everything in those discussions just like you can always keep the person on as an adviser to help you work through the transition you could these rich other doesn't want to so it usually the or the president the company was this does there's this 51% thing that used probably your head right now I got only 51 percent so economic decisions I always tell entrence or there's an illusion of control because the second you hire to get any real cash into your company that controls gonna go away you maintain control of your company by being a good leader making good decisions but if the rich uncle decided you weren't doing your job rich uncle could push you out as he should be able to because he put all the money up at his money's at risk he's got the most at risk makes sense if you have enough cash just to fund your business you don't have to worry about any of that stuff but if you don't you have to be willing to spread the risk out and be able to take the take on that responsibility yourself as well a market value for them I mean what static model so when you as beginning you're talking about just straight-up 5050 splits or 25 25 25 did you add additional people into that mix are they assume that you pay them that fair market rate for each additional person or can you adjust in a static model we have to renegotiate it every time so you and I are in business we are bringing Sebastian we gotta say we give him 10% but I wanted to come out of you not me so you now you have 40 percent I have 50 percent he has 10 percent you say no no no when we take 5% out of region know and I why don't I take 7% you take 3% it's a negotiation every time in the dynamic model just automatically sits hey come on board we're in no problem in a fixed model we got to renegotiate all the time it's an alligator pit negotiation that's why it's tender tender Stickley are those so this is what this is what I'm gonna gain this what we have at the end we've got perfectly fair through contributions that are be made and being properly rewarded for accommodating changes of the team and the company and there's no alligators everyone's getting exactly what they deserve at any given moment two rooms because now we have two new innovation so now we have to really evaluate to some via four guys and they all have ideas which controller we do to one right side so your your struggle is around this idea that more ideas are being generated every day the idea sorted first is a founding idea so I have an idea to start a banana stand then my idea to start a banana stand is to the jury that its intellectual property I get a royalty on if you saw dipping the bananas and chocolate on you on the job that's not necessarily a royalty idea right this is a major they would make a pivot in that case the guy they had the original idea that sucked wouldn't get a royalty as you shouldn't that makes sense so this solves that problem and we pivot all the time in startups so my idea is to have chocolate dipped squirrels frozen squirrel stand y'all think that's a great idea and we're going along and we're not selling these chocolate of squirrels and someone says I got an idea Nana's instead and also that's that's a good idea and then banana start getting dipped the guy who came with the squirrel idea is not getting reward for that dumb idea as he shouldn't be yes and that sucks I hate tracking my hours do you hate tracking your hours who here loves tracking their hours a couple people maybe a unit earn this is a common complaint oh I don't want to track my hours it's so painful to track my hours and it is and there's a couple ways around them the first one is you can track days or you can track your hours and when you track your hours you realize what you're spending your time on and it's amazing to see the story unfold a few weeks ago at a guy if there's an incubator in Chicago called 1871 it's a big deal right and people work and so much fun to work there they're not get any little work done and he's using this system and he says to me we haven't these sales really frustrate out doing these sales so I said let's look at your timesheets and gets how much time they're spending on sales they were doing development they're talking to potential customers doing research they were doing email Martin there's all kind of stuff except for sales so we said all right stop not doing sales and just do sales and guess what happened they started getting sales because good sales after six months your time is more valuable your time component more viable don't wait for one month and after a year that that component continues to grow why like cash injected only does it you put any more cash right so you're right you might get some bad behavior relative to gaming it right sales generated for a professional salesperson you can agree that their compensation will be just on Ron just commissions then you wouldn't put necessarily under some scenarios pqv a give me a mix right and there's also this is incentive to game it right I'm gonna pad my hours right and that comes up sometimes but that's a management issue and if you're tracking your time you can tell someone spending too much time on a task they listen you're spending a lot of time on it to ask so you have management issue people messing around which is the same issue you have with a fixed split but you still recognize it because you not tracking hours but you can instruct your conversation with whatever is logical for the firm so if the CEO is a selling CEO then be logical to building more Commission if the CEO is more of a production CEO or operation CEO you wouldn't do that making it happen how do you value that because I feel like that that's a pretty big value in a start-up that is a value and that's usually the perks from the idea comes brings all good that that's where that royalty that's what that payout becomes that's called the idea person so I can form an idea for an advertising agency which is a not a unique idea right but I can still take a royalty on the idea because it's sort of my ID and that kind of rewards the person for that initial action putting the ball in motion that's kind of how that can be used so it would be like when you compared to a copper plate came with an idea for like a new pizza box and yeah I just sold it without doing anything right then there'd be some royalty premium on actually pretty every team to execute it right so idea doesn't always refer to legal intellectual property you know it's it's the act of putting this thing together in motion but if the ideas dipping squirrels and chocolate you mean I want to get a royalty for that thanks for getting the team together pal but your ideas sucked and we're lucky enough to pivot and you stay in business because we're talking about the junior the junior guy who just came out of college and he started with a lower salary but then after four years in Syracuse worth two more and maybe one of the guys up there was already with a super high salary for what they're doing just give me race they're they're they're negotiators his best seller egos up so they're growing out of the resource rate goes up in proportion so give me the same grade just change the right that's a good thing because you that that's another retention tool you have so there's this painful retention this fear of loss and there's also retention because you're doing a good job you want to reward you and they might generate sales for example you hire a lawyer or investor and they want something like that it's a nice for a end of this next piece here which is how do you how do you outgrow it so when you grow up when you go out the mark and raise real money so you're getting the converted convertible notes are great because they don't let the kind of script the issue right so when you raise the theoretical base value is just to pretend number I want to go out and get my Series A to B two million dollars or four million dollars even though our theoretical base value might be fifty five hundred thousand so that's what you negotiate and you know we're converted that rate so you just converted that right just like you would anything else now if it's a temporary you guys but consultants earlier to write what I do with consultants is I'd say whatever your hourly rate is will double it but I'm going to give you a schedule for I knew and when I get the cash so if I if you're a hundred bucks an hour I'll be I'll pay the hundred dollars now at the end of the first month if I don't I'll give you 110 percent of that 120 and it works up over a year at which point they would get equity in the pie but that it's that supposes that they're not they're not gonna be long-term player but they keep their equity because of they were consultant so there's a schedule for paying them off cuz you always want to have that option to pay him off but if you can't do that forever there's a certain point they may want a piece so I've done that with attorneys and actually up some several attorneys are participating funds this way that's how they do it but so when you raise money and you get real revenues you just start buying everything down just start paying cash for everything and the equity model stops to adjusting so just paying people is what it really happened so if you've got positive cash flow pay your salary pay for your truck pay for your supplies pay for your computer all the stuff gets paid for then I don't need to use equity anymore in their freezers and equity takes on a new life according to startup companies this risk that you're not gonna get paid equity an established company isn't the same kind of risk it's more of an incentive a bonus the thing it's not really but Disney represent that's not gonna get paid risk so becomes it's sort of a different tool it's the same underlying legal mechanism but it's it has different value to a startup companies employ you're dipping squirrel's wasn't good but your chocolate generally speaking the negotiated base rate should accommodate you the fact that you to come up the good ideas so the junior guy out of college we're going to assume that person with not a lot of experience is gonna have less good ideas and the person in the 2020 or glad exciting an exec is turning 200 thousand dollars a year so we're paying for the person for the ideas but if it's a game-changer then you can kick a royalty in so that the pivot we don't want to do is reward bad ideas so difference grows is a bad idea we don't want that person to get royal get anything upfront because if he said dipp'd squirrel's is the best idea in the world and i want 50 million dollars for it then you just pay it out for someone didn't have a good idea if it's a good idea should generate revenues so the moral of story here is we have a program that eliminates this guessing about how much everything's gonna be worth and provides concrete measures on how much the contribution wasn't the risk that was taken in order to get people where they could want to go that's why it's called getting them Gators out of the equation more questions the key to this thing the the beauty of this thing I think is your ability to start working with someone immediately as long as they agree to the rules we can start working together immediately you have to worry about anything else just negotiate our salary we're off to the races and that is a very powerful thing because when you take other people on you know you try to hire some of you have this angst and what am I gonna pay how much they worth when it's what's the equity to look at what's the split can look like this prevents all that like that seems like a big deal because it could be 5% it could be like 20% so each industry has some pretty standard royalty rates in fact if you look at Wikipedia look of royalty rates is like oh this is the record industry the publishing industry so I have people who have licensed this book from me and I take a 5% royalty that's the going rate for a piece of literature copyrighted work in this industry so you applied in the technology format 5% if it was some you know game-changing patented technology that changed how people consume food you know that might be a higher world traits you negotiate that right but it's usually between the general rule is 1% isn't enough 10% is probably too much somewhere in between there it would be very rare to someone take 25 percent royalty on revenues in the the idea person and like set that royalty in them whatever people will sign up for that's what they get if the idea person is the founder they would say my royalties 5% now if they said my emerald to 35% people come into company might say that's seems kind of bad so I'm not gonna join your company because of it you got to set it low enough that it's attractive other people but meaningful enough that it reflects the value brought to the firm and I get its lot with solo entrepreneurs they'll think what they put in before the cup team was formed is much bigger than it actually is so you often have to adjust down 5% of revenue right it's 5% of revenue in the model there's no fixed amount of anything equity equity always changes so that way you're confused yeah it's never a fix about you China goes in at 10 at 10 % times 2 because it's unpaid royalty what do you do about let's say an employee who does really bad work consistently and somebody else has to redo that work so basically double that time does that cut into their pie or do you not count the time that the employee prove easily put in I would fire that person I'll give it hopefully you've been monitoring closely enough you can get rid of that person I generally don't take pie back and keep an employee on because it creates ill-will and if that person is it going to be a performer he'll changes changes too and if not you will eventually add fire she would eventually get fired my second question is I can people do it every day I think people do once a month I got people who there's a guy in here that's really a calculator every time you enter your value of the pie goes brewery calculates so it's whenever you want to if you're gonna go ahead and raise full of money you wanted to say well make sure you get your timesheets and I have one of a woman who said everything's got to be in by Friday or doesn't count so our people put her in such flexible doesn't really matter when you do it just long as anyone's keeping it up to date what you don't want to do is have one person like not do it for a month then also they have a little bunch and use one people to kind of keep the spreadsheets and things you can use or software there's only goes in one direction really and so it's cause talk to down it's very hard for somebody to company somebody well the person who owns 30% of companies probably one of the leaders of the company boards the two percenters probably a employee so it's a typical management relationship right and one's gotta do their job and so if you know someone's not doing their job it's not because it's models brokens because you have a management issue you're not managing people properly I'm you could blame the 30% guy for not managing the two percent of very well which is a common problem and start with companies you know like they have they have management issues there's no doubt so this doesn't this is this what this does is bring some of those problems to surface and getting provides consequences for performance back there's no real difference everyone's in the same boat no in the world the founders to have this it's a thing made to buy the stock up and that founder shares and all these different there's no real difference here what description are you're going to be looking for are you gonna be paying this guy what a startup company well you want to pay so assuming that you're someday get cash what are you gonna pay that person once you get cash that's the number so if I'm right out of college and I make myself CEO and I give myself a two hundred thousand dollar salary doesn't make much logical sense so it's gonna mix it with their experiences and what the requirements of the job are and things like that so you want to pay a number that you'd be comfortable paying if you have the cash to pay it that make it that were you asked yeah you know what you can't like for instance I I personally when I participate in these things I kept my grunt out of the resource rated $200 an hour which is equivalent to a two hundred thousand dollar a year salary now I in my life have made more than that per year and I'm comfortable to the fact that I'm able to go out and make more money than that and a job but it gets ridiculous if you ask for too much so I just cap it at $200 an hour so any startup coming wants to work with me I save my rage to in a bucks an hour we're off to the races but they're country boundaries between a group of people were united on an idea like legal boundaries or how do you define them and I guess in addition when do you recommend as a part of a process of a growth of the company you recommend to start faculties blue this model works from day one if you if you haven't done it since day one you come in six months later you can ruin this a model for retrofitting it and kind of determining what should this year should be when your team starts working together you're starting work together so that's when it's a company doesn't matter there's no legal thing when you incorporate it and they just you should just keep track start companies start when they start and you just get together and start working on the common vision and you're in business now the company comes into trouble and these things are cash and tries to go another round or feces don't they have basically the playbook saying no and so they connect you dictate what the number is potentially but it's not fair the guys to put their money in earlier so what you do is you negotiate your series a pre-money valuation instead you know when you go your VCE or your seer your real money invested on your your angel investor your real money investor you know don't you don't say you know you don't say we're not playing by these rules anymore we're playing by regular business rules that way exposed to the houses happy if they haven't done it person with the head in my class in Northwestern I have a I designed a board game on this thing it's called it slicing my game and they've beginning in the class they do a fixed amount of my equity split they negotiate a fixed second then they play the game and it takes them through the ups and downs of startup company at the end it'll show them what would have happened is this - the dynamic split and the only people who are upset about the dynamic split are the ones who would have made off like bandits with a fixed split but they all agree that is much more fair I've never had anybody come back and say we did this and it really backfired I've had all kinds of people say we did the other way in a backfired so that's wrong coming from let's go and get this and you haven't actually put enough time so they're pretty good almost nothing well like the idea guys thank you that's why maybe it makes sense on day one the ownership is always 100 percent so I have a deal that I did under this model and we sat down we had a couple of coffees about this thing and I spent some time doing some development for the guy and we produced the product and he came up with the customer right away so we got Jimmy's generated cash right away with the business so we started now we can just pay ourselves for our time so our split for the two weeks of non paid time we got in or equal to about 50 51 52 48 numbers do 50/50 because we're getting cash right away so our still was 50/50 so it doesn't matter what what times this gives you incentive to get to cash right away so if you and I start a company and you put 10 hours and I put 1 hour in the next day we get a cash advance for a million bucks well it's a 10 to 1 split which is fair because you put 10 times as much as I did right now I would have liked to work a little harder the next day and gotten some more but that's winning our cash and it seems to start paying me now that's unlikely sneer that did happen for us question back there I have a copy of my book that were you happy to raffle off if anybody wants it I also have a box of cupcakes I'll be happy to raffle off the winner gets the book the second place person gets the cupcakes if you give me your email address and all there you happy to keep in touch with you and I'll stick around afterwards and happy to answer more questions now [Applause]

Channel: Slicing Pie

Views: 51,793

Rating: 4.8954606 out of 5

Keywords: Stanford University (College/University), stanford university GSB, Founders Equity, Startup Equity, Equity Splits, slicingpie, pieslicer, pie slicer, slicingthepiebook, mikemoyerslicingpie, mikemoyer, dynamicequitysplit, dynamicequity, slicingpiepdf, bestdynamicequity, bestdynamicequitysplit, founderequitycalculator, equitycalculator, equitysplitcalculator, startupcompany, startupequity, startupequitycalculator, bestfairequity, piestartup, equitycalculatorstartup, equitycalculatortool

Id: pLGDba8aSWE

Length: 66min 40sec (4000 seconds)

Published: Mon Mar 17 2014