How do we slice the pie so it’s fair?

Dan called me yesterday to ask how much equity he should pay his marketing guy. I told him to check out the Slicing Pie book by Mike Moyer. Here’s why:

Years ago I started a company with two other guys. On day one we verbally agreed to split the equity evenly three ways, but we didn’t sign any documents or actually form a legal entity. Then we got to work building the company for the next few years.

Guess what? We all started by contributing equally, but over time it turned out that one guy was doing a large portion of the work and another guy wasn’t showing up much at all. I was somewhere in the middle. We started fighting over the equity split.

We eventually brought in an advisor to help us sort it out, which took months and still didn’t smooth things over. Then we moved the guy who was contributing less into an advisor role. That left two of us fighting over equity, and I was offered a substantially lower percent of the company than my original third.

I remember the last conversation we had about it. I negotiated more than the new lowball offer, but I got less than I had been expecting for the past few years. And then the elephant just sat there silently between us for the rest of our time together, coloring all of our future interactions. Ugh.

I always recommend that founders start with a vesting schedule, which means that you earn your equity over time. So I might receive 30% of the company in equal monthly installments (0.83%) over three years. You can add a “cliff” at the beginning, which means you have to work for a certain period of time—usually a year—before you earn any equity. This encourages people to stick around.

So a three-year vesting schedule with a one-year cliff means that I don’t earn equity for the first year, at the end of the first year I earn one third of my total equity, and then over the next two years I earn the remaining two thirds of my equity in monthly installments. The shares I’ve earned are “vested” and the remaining shares I have yet to earn are “unvested.” If I leave the company I get to keep my vested shares and the company gets to buy back my unvested shares at a low cost (please note that I’m talking about founder’s shares here, and the rules are different for stock options).

In this example my vesting for 30% of the equity would look like this:

  • First year: nothing
  • End of first year: I own 10% of the company (one third of my 30% share)
  • Over the next two years (24 months): 0.83% of my equity vests each month (one twenty-fourth of my remaining 20% share of the company)

A vesting schedule offers some protection but it’s a blunt instrument that only works for binary events, like if someone leaves or if you fire them because they’re not pulling their weight. A vesting schedule doesn’t answer Dan’s question of how much equity to pay his marketing guy. And it doesn’t solve the problem at my previous company, where people ended up working different amounts over the first few years. You want to keep working together but you want to gracefully and continually re-allocate the equity based on everyone’s actual contribution.

Mike Moyer offers a solution with Slicing Pie, a short book available on Amazon. He’s a serial entrepreneur who teaches at both Northwestern and the University of Chicago, and he’s come up with a system to dynamically re-allocate equity splits based on who contributes what. Slicing Pie keeps a running tab on the hours that people work, the money and other resources that people contribute, and offers a solution for what happens when people leave (or are forced out).

Moyer’s idea is that founders and early employees all agree to a fair set of rules up front, and then they get to work building the business. In our case it took several years to get to funding, and the Slicing Pie system would have fairly reallocated our equity at every step along that journey—without having to call in a mediator and without all the hurt feelings and awkward conversations.

Slicing Pie also gives Dan a simple answer to his question: come up with hourly rates for everyone including the marketing guy and then track all of the hours and other resources they contribute. The marketing guy’s percentage ownership will be easy to calculate vs. Dan’s and everyone else’s. Moyer offers an Excel spreadsheet on SlicingPie.com to help you keep everything straight.

At some point—often when you get funding like we did—you will be ready to form the corporation and allocate the equity. Slicing Pie is designed to get you from here to there.

What has your experience been with allocating equity to founders and employees? Leave a comment or question below and let’s discuss.

Written by Mike Lingle, if you like this then get my practical suggestions every week to help your startup grow.