21 Feb February 21, 2020 – Slicing Pie Mike Moyer and Targetable Vlad Edelman
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Mike Moyer – Equity Division Expert and Author of The Slicing Pie Handbook: Perfectly Fair Equity Splits for Bootstrapped Startups – Read interview highlights here
Sixty to eighty percent of all equity deals wind up in dispute that require
legal invention. If you set the ownership percentages in advance,
there is a very good chance you will hire a lawyer to unwind that.
Mike Moyer is the author of eight books that provide advice to people who want to solve specific problems like splitting equity in their startup company. He mostly writes and speaks about business and entrepreneurship, and Mike is the founder of Fair and Square Ventures, LLC where he invests in early-stage ventures and provides consulting focused on management and revenue generation. Mike has been an entrepreneur who has started a number of companies including
- Bananagraphics, a product development and merchandising company,
- Moondog, an outdoor clothing manufacturing company,
- MosquitOasis which creates camping gear for kids,
- Vicarious Communication, Inc, a marketing technology company for the medical industry, and
- Cappex.com, a site that helps students find the right college.
In addition to his experience as an entrepreneur, he has held a number of senior-level marketing positions with companies that sell everything from vacuum cleaners, financial data services, motor home chassis and luxury wine. Mike teaches entrepreneurship at the University of Chicago and Northwestern University. Mike is the author of Slicing Pie, Pitch Ninja, How to Make Colleges Want You, College Peas, and Trade Show Samurai.
Vlad Edelman – CEO at Targetable
Bootstrap, for lack of a better term, means you stay broke
for a very long time!
Vlad Edelman is the founder and CEO of Targetable, a company that uses machine learning to automate social campaigns for restaurants. He has 20 employees and is projecting 3M in revenue for 2020. The company was spun off of HeroFi, another marketing automation company where Vlad is the founder and CEO. He has been on the digital side of the restaurant industry for over ten years and has companies like Ansible, Soapbox Mobile, and ESPN’s mobile business under his belt. In 2014, he founded a game-changing product development agency called HEROFI that focused exclusively on creating better consumer engagement tools for restaurants. Targetable uses AI to collect your establishment’s data and instantly generate smarter ads that are more effective and cost less.
Highlights from Mike’s Interview
How to Divide Equity
The most common way people do splitting is right in the middle; 50-50. That’s called a fixed equity split. A fixed equity split is when you divide up equity, reporting work has actually been done in same percentages. So, it’s usually done equally. If there’s three of us, it will be a third, a third, and a third. If there’s four of us, we get 25% each. But a 50-50 split is very common. In all cases, whenever you do fixed equity split, there’s no possible way you can get a fair split; it’s mathematically impossible. It assumes you’re both doing exactly the same amount of work to produce the value over the long-term, which is never the case.
Let’s pretend that you and I are going to play blackjack as a team, not as opponents, but as a team. We’re going to split the winnings 50-50 as we discussed. We go to Las Vegas; we share $1 on the same hand of blackjack. The future is unknowable. We can’t tell what’s going to happen in the future. We don’t know if we’re going to win, or how much we’re going to win, or how long it’s going to take to win. We’re optimistic which is why we are playing, but we don’t know the future at all. We can’t tell the future. The dealer deals two aces, your blackjack is split and we double down. I’m out of money and you’re not, so you put two more dollars down. Now, you’ve bet $3 and I’ve only bet a $1. The future is still unknowable. You can’t tell the future, but what we know for certain is that you bet $3 and I bet $1. If we win that hand, a 50-50 split doesn’t sound fair, it should be 75-25. Your share of the winning should reflect your share of the bet.
In a startup company, it’s very similar though. We’re betting the fair market value for our contribution. We work for a startup company, we give time or money or ideas or facilities or supplies; whatever we contribute, and if we’re not paid for that contribution, it’s basically a bet. Startup companies finance themselves by not paying for stuff. So, I’ll hire you to work for me and I won’t pay you, that’s how I basically finance myself; I’ll get free rent with somebody or I’ll get some free supplies from somebody. I should be paying a fair market salary or I should be paying fair market rates, but if I don’t pay someone, the amount that I’m not paying them is considered a bet. So, if you’re worth $100,000 a year, you work free for a year and I don’t pay you, you’re betting a $100,000. If you invest $50,000 cash, you’re betting 50,000 cash. If I pay you half your salary, then you’re only betting the unpaid portion. A person who shares the equity basically shares the bets. If you’re based on anything else, you’re just making up stories like you’re a magical.
If I say to you, I’m somehow special because I have this idea, I’m basically a magic elf that makes something out of nothing. Because what’s fundamental to startups or anything is, there’s only one version of fairness. If we’re brothers, and our dad gives us a cookie, there’s only one way to split that cookie. Even if we agreed to split 50-50 in advance, but just because we agreed to it doesn’t make it fair. Our dad just gave it to us, we both paid equal amounts of nothing, so it’s 50-50. If you gave me your half, your generosity doesn’t make it fairer. If I stole your half, my greed doesn’t make it fairer. What’s fair is that our share of the winning or our share of the benefits is based on the share of the risk taken.
Every contribution that someone can make has a fair market value. If you’re coming into an established company and you bought supplies, you bought sales people, you bought fundraisers, and you bought people’s time, you would be expected to pay their salaries at the end of weekend or month. You would be expected to reimburse their expenses, you would be expected to pay their bills. If you don’t pay their bills, that’s considered a bet. My commission on a sale could be paid in cash or it could be considered part of the bet. My hourly rate to do the work could be paid in cash or it could be considered a bet. If you don’t pay my hourly rate, it’s just considered a bet.
Consulting companies are a little bit hard to do this way, simply because most people run it like this: cash comes in and cash goes out, it’s done on a project-by-project basis. So, this model doesn’t work in a consulting company, but you got to treat it a little bit differently. It’s better to think of it like a tech startup for instance. If you put on a $1,000 cash, you pay for developers, you put full time in, and you’ve the idea, all those things are quantifiable in terms of fair market value. It can be either paid out in cash or it can be considered bets, but you can’t pay cash and consider it bets. They’re all things that most companies track anyways. Most companies track time spent, most companies track payroll.
In order for an idea to have any value, it’s got to be fixed in space somehow, like an intellectual property. That’s considered a copyright, a trademark, a patent, or a trade secret. Your idea has to be solidified in some way that’s presentable as an idea. From there, you can go on to licensing the idea. If you have a license for the idea, the fair market value is the value of the license. For instance, I used to work at a fishing tackle box manufacturing company. We get paid 2% on revenues. So, the fair market value for a fishing tackle box idea in the United States is 2% on royalties. If you can’t find somebody to license your idea, it’s either worthless or it’s priceless. In most cases it’s worthless until you actually build it out. So, if you have a patentable idea, or a copyright or trademark, you can license that to your startup company in exchange for royalty on revenues. When revenues come in, you can allocate the royalty as a bet or you can allocate it as cash and actually pay the person out.
The problem with giving someone equity in exchange for just an idea instead of royalty is, most companies pivot away from their original idea. So, if you paid a big chunk of equity for my idea and you moved away from it, you overpaid me for my idea that didn’t work. In the royalty example, the idea only pays out if it actually produces any value.
In practice, it’s quite simple. If I hired someone to work for me and I paid them a full fair market salary, they’d come working for me happily every day. But they wouldn’t get any equity whatsoever, because they aren’t taking any risk. So, if I don’t pay you, then you’re making bets. You’re going to continue to make bets until I can afford to pay you. When I can afford to pay you, that betting stops. That happens at breakeven or Series A. Usually, maybe a year or two into the company, if you’re doing it right, you’ll reach breakeven or Series A investment round. At that point, I could start paying my bill, I could pay my salaries, my expenses, my rents, and things like that. And the pie, I call it, naturally stops accumulating slices in the pie. Then you simply freeze the pie, and that’s through the equity split. But trying to predict in advance what your equity split is going to be, means that every few months, we have to go back to table and renegotiate and fight about what our equity is going to be, which is very common. 60% to 80% of all equity deals wind up in dispute that require legal intervention. That means, if you and I do a deal and we set the percentages in advance, we have extremely good chance of having to hire a lawyer to unwind that for us.
With Slicing Pie Model, you don’t have to wait for a long time, it’s just till breakeven or Series A. It’s very common if someone doesn’t get it right away. It seems like, “Gosh! I got to track my time, I got to track my expenses.” Well, of course you do. You track your salary and expenses in all company; every business is running with that, instead that it’s in accounting. You think that things aren’t changing over time, things always change over time. Every company changes over time and so does your flexibility. You think you don’t know your equity split till the end? Of course, you know. Things are always going to rechange and renegotiated. It seems complicated first, but once you see what’s going on, it’s very basic.
In the Slicing Pie Model, you don’t have to renegotiate because equity is always checking versus model. If you have somebody who’s coming in and saying, you’re doing a lot of work and not producing, that’s fine. They would probably get fired for that and they would lose their share. As partners, you should always be giving each other warning, you should always be having conversations about performance. Let’s say, I’m your partner and you’re not performing and I call you on it. You push back and say, I don’t care what you say, and fight back. Well, then I have the opportunity to leave myself. If you’re not performing, you’re just dragging me down so I can just quit.
The logic of Slicing Pie reflects the logical fairness that exists everywhere. There are some people who aren’t willing to use Slicing Pie because they don’t get it or they’re not willing to learn it, or they do get it but they want to take advantage of people. The logic always applies, it always works properly based on people’s bets. In the 10 years I’ve been doing this, not once have I seen a single scenario where it backfired. Everybody has lived through these scenarios, but the great thing about Slicing Pie is, no matter what the scenario is: my partner isn’t performing, or my partner quit and left me in the lurch, or I’m doing better than my partner, it works.
If you agree to a partnership agreement upfront, that’s fixed equity split agreement, then all those things become major renegotiation problems. If I agree to give my partner 60%, I’m stuck with that deal and I have to somehow see my way out of it. But with the Slicing Pie Model, the rules are always very clear in advance. As a partner, I can have a discussion with my other partners and say we have a performance problem, or the resources aren’t there and we got to provide the resources. Everything always works out.
Now if your partner is a jerk, you can’t lodge your way out of a jerk, and that’s just an unfortunate scenario. In most cases, people don’t want to be jerks, they want to give people what they deserve. I’ve been in situations personally where I’ve gotten more than I deserved. I have been part of deals where my shares accelerated after a year of being there, while guys who were there for five years were at the same level. So, the traditional model backfired in my favor. I’ve also had deals where I’ve been taken advantage of horribly, where I had a partner who paid several thousand dollars to buy my shares back and turned around and sold them for hundreds of thousands.
No matter what’s happening, there’s always a repair with Slicing Pie. The beauty of it is, once you see what the rules are and you see what the logic is, all you have to supply the logic on a daily basis and it always works out. Whereas, a fixed equity split always winds up in a fight. I call it the fix and fight model. The key is to protect your relationships and make sure that you guys stay friends. I’ve had prenuptial agreements written with Slicing Pie before. It just makes things work out because there’s a financial equipment to them.
The book is available all over the world on Amazon, in different languages. SlicingPie.com is my website address. The model is free to use. I have got spreadsheets and videos and you can use it. My goal in life is to make sure that every entrepreneur gets what he deserves for his company, so I spend most of my time trying to promote that type of model. Once you apply this thing, it always works; I haven’t seen a scenario where it doesn’t.