Slicing Pie

-All ideas pies are worth nothing when theyre created or in the beginning
How pie is valued:
-Cash flow, revenue, and earnings: based on the amount of income it is
able to generatealso on the underlying assets
Cash-out Selling everything in your business or your share of the business,
AKA Exit.
Cash-in

If an investor pays $1,000 for 50% of the pie, the pie is now
worth $2,000 as long as the money stays in your business.
Cash value of your equity much more interesting than your percent
ownership
As long as people are willing to pay more and more for your companys
equity, the value of your shares will also grow, no matter what percent
ownership it represents.
Paying with Pie
Dont split ownership to too many people
Find people who will take pie and no cash
These are called Grunts
Grunts
Ask for little in return
Travel in herds: rarely can they do all the work themselves, so they offer
some of the pie to other Grunts
Required Pie Ingredients:
1. Time
2. Ideas
3. Relationships
4. Intellectual Property
5. Funds
a. Cash
b. Loans
c. Credit
6. Supplies and Equipment

a. Business facilitating: Supplies and equipment that facilitate the

business (laptops, pens/pencils, paper etc.) but business can still
exist without it.
b. Business-enabling: without these supplies, the business could not
exist in the first place.
7. Facilities
8. Other Resources
Fairness
Even if a Grunts work turned out to have negative or non-positive value,
it is not fair to deprive them of their piece of the pie
Grunts with better track records should get more of the pie because of
what they are capable of
Important to feed the Grunt the right amount of the pie because:
Too little makes Grunt feel undervalue and Grunt may leave
Too much makes other Grunts feel undervalue and leave
A Grunt feeling undervalue could give up and stay
Causes resentment and low morale
Splitting the pie before its baked
Most common (90% of the time) mistake is splitting the pie before its
baked
Renegotiation can be a company killer
Splitting the pie after its baked
Even worse than splitting before its baked because the company will
have actual value and Grunts will all scramble for the largest piece of the
pie
Vesting and Options
These are the hedging methods for cutting pie before baking
Vesting awards a number of shares, distributed over time. After that, you
either work for free or negotiate for more.
Problem: you must predetermine the amount of pie the Grunt
receives (therefore the value of the pie too).
This doesnt work during the Gap phase
Options allow Grunt to reap financial rewards but avoid some of the tax
implications

The Grunt Fund

Rewards participants for the relative value of the ingredients they provide
Provides the motivation for them to continue to provide ingredients

 Allows fair addition/removal of participants

Flexible in the face of rapid change

To Implement a Grunt Fund

1. Appoint a Grunt Leader
2. Assign a theoretical relative value of the ingredients provided by
various Grunts
3. Calculate the possible equity whenever you need to based on the
percent of value contributed by each grunt.
Grunt Fund Explained
Step 1: Appoint a Leader
Usually the founder, but not always
Leader will manage the Grunt Fund and hire or get rid of Grunts
Holds all the equity until its time to allocate
Step 2: Assign theoretical value of a Grunts ingredients
The equity has no value until someone invests
Pie is a promise, it is not equity, and has no value
Pie = Promise to Issue Equity
Step 3: Calculate the possible equity when needed based on the percent
of value contributed by each Grunt
Contribution of Individual Grunt/Total Contributions from all grunts =
Individual Grunts percent of the Pie

Creating a Grunt Fund

Keeping track of relative value of inputs by grunts
Determining Value
Time: determine a realistic opportunity cost for their time. Find out what
they could get somewhere else at a similar job. Must be fair relative to
other Grunts.
Value is the salary you would have paid them if you had the cash
multiplied by 2 because of the risk of joining an early-stage start-up.
Then, divide by 2,000 for hourly rate
The founder doesnt necessarily receive the highest hourly rate
For travel, in-transit travel should be their hourly rate
Can be hourly or daily rate
Wages: if you are giving a Grunt a nominal income to make ends meet,
then deduct it from their base salary to calculate the hourly rate.
Freelance or Consultant Grunts

 Paid the startup consulting rate times 2

You should reserve the right to buy them out (buy-back) within one year
of the last day they render services
Can negotiate buy-back by offering them a sliding scale that builds
to twice their rate over 1-2 years
After 12 (or 24) months, they receive pie that should translate into
an equity grant that they can keep
Should have a 1-year protection clause
If the consultant is long-term, the hourly rate should be adjusted to be inline with that of a full-time employee compensation, around of their
consulting rate
Milestones
Create encouragement for getting work done and discouragement for
taking too much time
Estimate a number of hours to reach a milestone and the hours the
Grunts put forward only count if and when the milestone is reached, and
only up to the agreed-upon hours
Grunts on Boards
A piece of pie may be allocated for Grunts part of the Board of Advisors
even though payment isnt usually expected
Advising Plan to set a fixed rate on the advisory board members time
and a minimum number of hours before a piece of pie is cut for them
Maximum Hourly Rate
$200 or $200,00 a year
Grunts earning rates over $200 tend to be de-motivating for other
Grunts
Absentee Owners or Dead Equity
Buyout rights for people who are not employees but have equity or
options and are not investors
Cash Contributions
if a grunt provides small amounts of working capital, pays for services, or
covers material out-of-pocket expenses for which no reimbursement will
be received, the theoretical value of the cash or credit used is the amount
X4
cash not being used to pay people (is just sitting in the bank) doesnt
count because it can be returned to the owner
would count as an investment instead

only for what is really needed

a grunt receiving current cash compensation cant simply re-invest it for a
piece of the pie
4X rate only for investment in excess of their pay

Crowd-Funded Cash
Less valuable to you since its from many people. Only give 2x or 1x
multiplier for theoretical value
Loans and Credit
If a Grunt uses their own credit cards or pays the bill, it is like cash and
will be 4X
Company should always cover interest charges and late charges too
Big Loans
No pie is given if payments are covered by business operations
Loans from a grunt are the same as any other lender (principle plus
interest) unless the company defaults, in which case its treated as cash
(4X)
Supplies and Equipment
If they FACILITATE business, no pie is granted because the value is difficult
to assess
Large or frequent purchases of supplies count as purchases without
expected reimbursement (Cash, 4X)
If they ENABLE business, then they are valued. If its specifically for the
business, its treated as cash (4X). If owned for less than a year prior to
startup, it is valued at the price the Grunt paid for it. If older, its valued at
the price the company could have gotten it from a 3rd party.
Facilities
Repaid at the value of lease or rent of space (not cash)
Only proportionate to what is needed (not a whole building)
Grunts house only counts if it would have been rented otherwise
Ideas and Intellectual Property: 2 Ways
1. Calculate the theoretical value of the idea
OR
2. Provide ongoing royalty payment to inventor (cash or pie)
ideas without action have no value unless:

o idea existed before inception of the business

o must be original
o must be non-obvious
o must be baked not half-baked
ideas developed during the regular course of the business is part
of the job
value=time taken to bake the idea multiplied by the
originators hourly rate, plus the costs of research or legal
protection
Royalties
without the idea, business would not be possible
only reward ideas that help the company generate revenue
paid as a percent of revenue or cash receipts
not a percent of profit because profit can be manipulated
royalty can be paid in cash or a slice of the pie equal to 2X the unpaid
royalty
may include a buyback provision
royalty payments may have a cap or expire
Relationships
only valued if an amount of time is spent on it
valued as the hourly rate times the number of hours spent cultivating the
relationship
if it makes a sale, there should be a bonus or commission with the
theoretical value of 2X the unpaid commission they might otherwise earn
if it was paid for in cash
Example: if the normal commission was 5%, then the grunt
gets 2.5%
If the relationship provides a significant Series A investment, a finders fee
may be appropriate
5% of first million and 2.5% thereafter
Other Resources/Partnerships
If it would otherwise be rented to another client, the value equals rental
rate X2. If not, then negotiate a fair rate.
For human resources, negotiate a hourly rate that makes sense for the
company and partner
Vacations
No pie for vacations
Can create vacation policy when company is more mature

Using a Grunt Fund

Theoretical Base Value (TBV)
Is the total theoretical value of all the contributions
Keep track of ingredients by each Grunt
When to Calculate Equity
Monthly, and when you anticipate an investor will ask about it
Calibration
When you and other Grunts have worked hard, and you want to harvest
a little of the value before allowing others into the herd
Pie Partitioning
Partition off a percent of pie for yourself and early Grunts, and the rest will
be for the Grunts in the future
Ex: 10% for founders and 90% for future Grunts
These numbers are unchanging, but the percent each Grunt
gets in the 90 percent and the percent each founder gets in
the 10 percent will still be dynamic
Outgrowing the Grunt Fund
Theoretical Base Value has no bearing on the value of your company
You can tell you lawyer exactly how many shares each person on the team
should receive

Subtracting a Grunt
Resignation

 Without Cause: Grunt forfeits all the pie earned in the Grunt Fund through
the TIME they contributed, and theoretical value of the other contributions
should be recalculated without multipliers
Reserve the right to buy back the pie equal to the new
theoretical value
Pay back their cash contributions
Secure a non-compete agreement in exchange for letting
grunt keep the pie
Grunt doesnt get their stuff back in they brought anything
since it is company property; same for ideas and intellectual
property
With Good Cause: if a Grunt is pushed out
An adverse change in title or responsibilities
Adverse change in pay that doesnt affect others at the same
level
Relocation of company more than 50 miles
Death or disability
Then:
Keep theoretical value, minus any severance pay
o One year protection clause
Death: pie goes to the family
Termination
Without Cause: similar to Good Cause
With Cause misconduct, dishonesty, assault, etc. or
Habitual neglect of duty or incompetence
Conduct incompatible with the employees duties or
prejudicial to the employers business
Willful disobedience
Then:
Recalculate their pie without multipliers
Company gets a buyback right
Company should require Grunt to sign a non-compete
agreement in exchange for keeping their slice

When to Stop Using a Grunt Fund

When you have built up so much theoretical value that you have reached
a point of diminishing returns
You have started to build an actual business model with predictable
returns

Call attorney, arrange pie, put together either a shareholders

or operating agreement
The company receives a cash investment that is large enough to warrant
legal and financial formalities
Options or vesting program is common
One million dollars or more
Call in the lawyers and accountants to get it formalized
One million dollars buys enough of the company to get the
investor to invest, but not so much that it discourages Grunts
from working

Retrofitting a Grunt fund

Getting buy-in from the herd: Skinny Grunts and Fat Grunts
Skinny Grunt - A person who has less than his or her share
of the equity relative to other participants
Fat Grunt - A person who has more than his or her share of
the equity relative to other participants
The Retrofit
you have to calculate what the pie would have looked like if you had
been using a Grunt Fund from day one
Time Tracking
divide people into full-time (40-50 hours), half-time (20 hours), and
part-time (around 10 hours) per week
when issuing stock, just create enough shares to bring everyone to the
right percentages

Going out of Business

Because of:
Bankruptcy
debt is usually taken on by a senior member
or
Bad Market

 your company shuts down because the market didnt work for your
company
Shutting Down
if debt is still present after sale of assets, creditors will come after Grunts
This is why you need an LLC
Extra Cash: first pay back Grunts who put cash in, then to all grunts based
on their percent equity
If not enough to pay back Grunts who put cash in, pay in
proportion to their contributions

Legalize It
When you find people that want to buy your product:
Discuss with a lawyer the liability, ownership, and taxation for
the company
Ownership rights: contributions made to the company
cant be taken back
Taxation:
o Depends on the formal entity you set (LLC or
Corporation)
o With an LLC, you can divide profits any way you
want
o Choose a corporation for short-term investments
o Issue restricted stock to Grunts that is subject to
vesting and buyback provisions
o All grunts file 83(B) to ensure theyre not taxed
Set up a formal corporate structure

Fairness is Key!

You dont necessarily have to follow all the rules

for the grunt fund specified in the book, but make
sure that whatever numbers you use is FAIR.